-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Fs9Sgk37qNTG4ULAwz6X4hPmn0p4mdZS2s7jxeq1c/bjtHcWd91PDpOrpc6buCO+ qsNeahOnNl05NthLiej9zQ== 0001194396-06-000302.txt : 20061004 0001194396-06-000302.hdr.sgml : 20061004 20061004140420 ACCESSION NUMBER: 0001194396-06-000302 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20060831 FILED AS OF DATE: 20061004 DATE AS OF CHANGE: 20061004 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COGNOS INC CENTRAL INDEX KEY: 0000746782 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 980119485 STATE OF INCORPORATION: CA FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 033-72402 FILM NUMBER: 061127739 BUSINESS ADDRESS: STREET 1: 3755 RIVERSIDE DR STREET 2: PO BOX 9707 CITY: OTTAWA ONTARIO CAN K STATE: A6 ZIP: 00000 BUSINESS PHONE: 6137381440 MAIL ADDRESS: STREET 1: 3755 RIVERSIDE DR STREET 2: POST OFFICE BOX 9707 CITY: ONTARIO 10-Q 1 f10q26530cog.htm FORM 10-Q Cognos Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

_________________

FORM 10-Q

[X]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended August 31, 2006

OR

[   ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
For The Transition Period From _________ To ________

Commission File Number 0-16006

COGNOS INCORPORATED
(Exact Name Of Registrant As Specified In Its Charter)

CANADA 98-0119485
(State Or Other Jurisdiction Of (IRS Employer Identification No.)
Incorporation Or Organization)

3755 Riverside Drive,
P.O. Box 9707, Station T,
Ottawa, Ontario, Canada
(Address Of Principal Executive Offices) 		K1G 4K9
(Zip Code)

(613) 738-1440
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES   X       NO         

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer   X      Accelerated filer           Non-accelerated filer         

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES             NO     X     

The number of shares outstanding of the registrant’s only class of Common Stock as of September 28, 2006, was 89,882,907.

COGNOS INCORPORATED

INDEX

 
PAGE
 
PART I – FINANCIAL INFORMATION
 
Item 1.   Unaudited Consolidated Financial Statements  
 
    Consolidated Statements of Income for the three and six months ended August 31, 2006 and August 31, 2005   3  
 
    Consolidated Balance Sheets as of August 31, 2006 and February 28, 2006   4  
 
    Consolidated Statements of Cash Flows for the three and six months ended August 31, 2006 and August 31, 2005   5  
 
    Condensed Notes to the Consolidated Financial Statements   6  
 
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   22  
 
Item 3.   Quantitative and Qualitative Disclosure about Market Risk   60  
 
Item 4.   Controls and Procedures   61  
 
 
PART II – OTHER INFORMATION
 
Item 1A.   Risk Factors   62  
 
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds   68  
 
Item 6.   Exhibits   69  
 
Signature     70  

2

PART I – FINANCIAL INFORMATION

Item 1.   Unaudited Consolidated Financial Statements

COGNOS INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(US$000s except share amounts, U.S. GAAP)
(Unaudited)

  Three months ended
August 31,		   Six months ended
August 31,		  
  2006   2005   2006   2005  
Revenue          
   Product license  $  78,005   $  78,649   $151,740   $149,795  
   Product support  103,262   92,062   203,443   180,567  
   Services  48,623   41,331   91,747   81,755  
Total revenue  229,890   212,042   446,930   412,117  
Cost of revenue 
   Cost of product license  1,445   1,409   3,202   2,631  
   Cost of product support  11,384   8,914   22,611   17,910  
   Cost of services  39,805   32,705   77,321   65,002  
Total cost of revenue  52,634   43,028   103,134   85,543  
Gross margin  177,256   169,014   343,796   326,574  
Operating expenses 
   Selling, general, and administrative  117,981   109,327   235,573   215,042  
   Research and development  33,869   29,520   67,148   59,285  
   Amortization of acquisition-related intangible 
     assets  1,702   1,637   3,403   3,274  
Total operating expenses  153,552   140,484   306,124   277,601  
Operating income  23,704   28,530   37,672   48,973  
Interest and other income, net  6,216   3,051   11,227   5,831  
Income before taxes  29,920   31,581   48,899   54,804  
Income tax provision  6,160   6,681   10,601   9,532  
Net income  $  23,760   $  24,900   $  38,298   $  45,272  
Net income per share 
   Basic  $0.26   $0.27   $0.43   $0.50  
   Diluted  $0.26   $0.27   $0.42   $0.48  
Weighted average number of shares (000s) 
   Basic  89,718   90,740   89,805   90,909  
   Diluted  90,221   92,806   90,523   93,350  

(See Accompanying notes)

3

COGNOS INCORPORATED
CONSOLIDATED BALANCE SHEETS
(US$000s, U.S. GAAP)
(Unaudited)


  August 31,
2006		   February 28,
2006		  
Assets          
Current assets 
  Cash and cash equivalents  $    417,499   $    398,634  
  Short-term investments  200,585   152,368  
  Accounts receivable  144,598   216,850  
  Income taxes receivable  7,162   1,363  
  Prepaid expenses and other current assets  25,604   31,978  
  Deferred tax assets  11,828   12,936  
   807,276   814,129  
Fixed assets, net  77,963   75,821  
Intangible assets, net  18,928   22,125  
Other assets  6,356   6,096  
Deferred tax assets  6,780   6,928  
Goodwill  225,709   225,709  
   $ 1,143,012   $ 1,150,808  
Liabilities 
Current liabilities 
  Accounts payable  $      24,603   $      33,975  
  Accrued charges  33,112   30,799  
  Salaries, commissions, and related items  66,827   73,229  
  Income taxes payable  7,173   6,009  
  Deferred income taxes  5,908   4,118  
  Deferred revenue  212,473   246,562  
   350,096   394,692  
Deferred income taxes  32,676   30,344  
   382,772   425,036  
Stockholders’ Equity 
Capital stock 
  Common shares and additional paid-in capital 
     (August 31, 2006 - 89,729,851; February 28, 2006 - 89,826,706)  460,536   439,680  
  Treasury shares 
     (August 31, 2006 - 124,854; February 28, 2006 - 55,970)  (3,705 ) (1,563 )
Retained earnings  298,463   283,168  
Accumulated other comprehensive income  4,946   4,487  
   760,240   725,772  
   $ 1,143,012   $ 1,150,808  

(See accompanying notes)

4

COGNOS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(US$000s, U.S. GAAP)
(Unaudited)


  Three months ended
August 31,		   Six months ended
August 31,		  
  2006   2005   2006   2005  
Cash flows from operating activities                  
   Net income  $   23,760   $   24,900   $   38,298   $   45,272  
   Non-cash items 
     Depreciation and amortization  7,360   7,240   14,600   14,405  
     Amortization of deferred stock-based compensation  4,586   4,558   9,743   8,640  
     Deferred income taxes  (413 ) 1,735   4,768   (2,092 )
     Loss on disposal of fixed assets  377   186   516   273  
   35,670   38,619   67,925   66,498  
Change in non-cash working capital 
  Decrease (increase) in accounts receivable  (4,865 ) (1,871 ) 76,275   44,964  
  Increase in income tax receivable  (1,485 ) (4,307 ) (5,792 ) (6,309 )
  Decrease (increase) in prepaid expenses and
      other current assets		  522   (586 ) 7,413   837  
  Decrease in accounts payable  (2,969 ) (981 ) (9,996 ) (9,024 )
  Increase (decrease) in accrued charges  (352 ) 2,629   1,258   (5,374 )
  Increase (decrease) in salaries, commissions, and related items  6,230   5,615   (8,595 ) (30,518 )
  Increase (decrease) in income taxes payable  4,206   2,959   851   (12,982 )
  Decrease in deferred revenue  (20,836 ) (12,821 ) (40,568 ) (23,646 )
Net cash provided by operating activities  16,121   29,256   88,771   24,446  
Cash flows from investing activities 
   Maturity of short-term investments  264,354   118,610   376,969   246,535  
   Purchase of short-term investments  (191,486 ) (96,140 ) (424,122 ) (198,123 )
   Additions to fixed assets  (4,544 ) (6,161 ) (10,915 ) (10,917 )
   Additions to intangible assets  (370 ) (196 ) (696 ) (441 )
   Increase in other assets  (488 ) (365 ) (219 ) (120 )
   Acquisition costs, net of cash and cash equivalents  --   --   --   131  
Net cash provided by (used in) investing activities  67,466   15,748   (58,983 ) 37,065  
Cash flows from financing activities 
   Issue of common shares  576   5,802   13,511   17,586  
   Purchase of treasury shares  (2,545 ) (177 ) (2,545 ) (177 )
   Repurchase of shares  --   (23,694 ) (24,998 ) (48,948 )
Net cash used in financing activities  (1,969 ) (18,069 ) (14,032 ) (31,539 )
Effect of exchange rate changes on cash  (1,297 ) 751   3,109   (3,208 )
Net increase in cash and cash equivalents  80,321   27,686   18,865   26,764  
Cash and cash equivalents, beginning of period  337,178   377,426   398,634   378,348  
Cash and cash equivalents, end of period  417,499   405,112   417,499   405,112  
Short-term investments, end of period  200,585   96,140   200,585   96,140  
Cash, cash equivalents, and short-term investments,
    end of period		  $ 618,084   $ 501,252   $ 618,084   $ 501,252  

(See accompanying notes)

5

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

1.

Basis of Presentation


  The accompanying unaudited consolidated financial statements have been prepared by the Corporation in United States (“U.S.”) dollars and in accordance with generally accepted accounting principles (“GAAP”) in the U.S. with respect to interim financial statements, applied on a basis consistent in all material respects with those applied in the Corporation’s Annual Report on Form 10-K for the year ended February 28, 2006 except for the adoption of Financial Accounting Standards Board (“FASB”) Statement No. 123 (revised), Share-based Payment (“FAS 123R”) which has been retrospectively applied. These consolidated financial statements do not include all of the information and footnotes required for compliance with GAAP in the U.S. for annual financial statements. These unaudited condensed notes to the consolidated financial statements should be read in conjunction with the audited financial statements and notes included in the Corporation’s Annual Report on Form 10-K for the fiscal year ended February 28, 2006.

  The preparation of these unaudited consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes. In particular, management makes judgments related to, among other things, revenue recognition, stock-based compensation, the allowance for doubtful accounts, income taxes, business acquisitions and the related goodwill, intangibles and restructuring accrual, and the impairment of goodwill and long-lived assets. In the opinion of management, these unaudited consolidated financial statements reflect all adjustments (which include only normal, recurring adjustments) necessary to present fairly the results for the periods presented. Actual results could differ from these estimates and the operating results for the interim periods presented are not necessarily indicative of the results expected for the full year.

2.

Revenue Recognition


  The Corporation recognizes revenue in accordance with Statement of Position (“SOP”) 97-2, Software Revenue Recognition as amended by SOP 98-9, Software Revenue Recognition with Respect to Certain Arrangements (collectively “SOP 97-2”) issued by the American Institute of Certified Public Accountants.

  The Corporation recognizes revenue only when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is probable. For contracts with multiple obligations, the Corporation allocates revenue to the undelivered elements of a contract based on vendor specific objective evidence (“VSOE”) of the fair value of those elements and allocates revenue to the delivered elements, principally license revenue, using the residual method as described in SOP 97-2.

  Substantially all of the Corporation’s product license revenue is earned from licenses of off-the-shelf software requiring no customization. If a license includes the right to return the product for refund or credit, revenue is deferred until the right of return lapses.

6

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

  Revenue from post-contract customer support (“PCS”) contracts is recognized ratably over the life of the contract, typically 12 months. Incremental costs directly attributable to the acquisition of PCS contracts, which would not have been incurred but for the acquisition of that contract, are deferred and expensed in the period the related revenue is recognized. These costs include commissions payable on sales of support contracts.

  Many of the Corporation’s sales include both software and services. The services are not essential to the functionality of any other element of the transaction and are stated separately such that the total price of the arrangement is expected to vary as a result of the inclusion or exclusion of the service. Accordingly services revenue from education, consulting, and other services is recognized at the time such services are rendered, and the software element is accounted for separately from the service element.

  As required by SOP 97-2, the Corporation establishes VSOE of fair value for each element of a contract with multiple elements (i.e., delivered and undelivered products, support obligations, education, consulting, and other services). The Corporation determines VSOE for service elements based on the normal pricing and discounting practices for those elements when they are sold separately. For PCS, VSOE of fair value is based on the PCS rates contractually agreed to with customers, if the rate is consistent with our customary pricing practices. Absent a stated PCS rate, a consistent rate which represents the price when PCS is sold separately based on PCS renewals is used.

  We have historically used two forms of contract terms regarding PCS: contracts which include a stated PCS rate (either a stated renewal rate or a stated rate for the first year PCS bundled with the software license); and contracts which do not state a PCS rate. For contracts which include a stated renewal rate, we use the contractually stated renewal rate to allocate arrangement consideration to the undelivered PCS at the inception of the arrangement and recognize such consideration ratably over the PCS term provided that the stated rate is substantive and consistent with our customary pricing practices. Historically, there has been a high correlation between the amounts allocated to PCS in the initial software licensing arrangement for such arrangements and the amounts at which PCS is renewed.

  For contracts that have a stated first year PCS rate, we use such stated prices to allocate arrangement consideration to the undelivered PCS at the inception of the arrangement and recognize such consideration ratably over the PCS term, provided that it is substantive and consistent with our customary pricing practices, as this is typically the rate at which PCS will be renewed. Historically, there has been a high correlation between the amounts allocated to PCS in the initial software licensing arrangement for such arrangements and the amounts at which PCS is renewed.

  For contracts which do not state a PCS rate, we allocate a consistent percentage of the license fee to PCS in the first year of such arrangements based on a substantive rate at which our customer experience indicates customers will typically agree to renew PCS. Historically, there has been a high correlation between the mean of amounts allocated to PCS in the initial software licensing arrangement for such arrangements and the mean of amounts at which PCS is renewed.

7

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

  We stratify our customers into three classes in determining VSOE of fair value for PCS. The classifications are based on the amount of software license business (i.e., software license revenues), life-to-date, that has previously been obtained from the respective customers. For each class of customer, a range of prices exists which represents VSOE of fair value for PCS for that class of customer.

  When PCS in individual arrangements is stated below the lower limits of our acceptable ranges by customer class, we adjust the percentage allocated for support upwards to the low end of the applicable range by customer class. This adjustment allocates additional revenue from license revenue to deferred PCS revenue which is amortized over the life of the PCS contract, which is typically one year. If the stated PCS is above the reasonable range, no adjustment is made and the deferred PCS revenue is measured at the contracted percentage.

  The Corporation recognizes revenue for resellers in a similar manner to revenue for end-users. The Corporation recognizes revenue on physical transfer of the master copy to the reseller if the license fee is a one-time up-front fixed irrevocable payment and all other revenue recognition criteria have been met. If there are multiple license fee payments based on the number of copies made or ordered, delivery occurs and revenue is recognized when the copies are licensed and delivered to an end-user. It is the Corporation’s general business practice not to offer or agree to exchanges or returns with resellers. If a reseller is newly formed, undercapitalized or in financial difficulty, or if uncertainties about the number of copies to be sold by the reseller exist, revenue is deferred and recognized when cash is received if all other revenue recognition criteria have been met.

3.

Stock-Based Compensation


  The Corporation adopted FAS 123R on March 1, 2006 to account for its stock option, stock purchase, deferred share, and restricted share unit plans. This standard addresses the accounting for stock-based payment transactions in which a corporation receives employee services in exchange for either equity instruments of the corporation or liabilities that are based on the fair value of the corporation’s equity instruments or that may be settled by the issuance of such equity instruments. Under this standard, companies are required to account for such transactions using a fair value method and recognize the expense over the requisite service period of the award in the consolidated statements of income.

  The Corporation previously accounted for stock-based compensation transactions using the intrinsic value method in accordance with Accounting Principles Board (“APB”) Opinion 25, Accounting for Stock Issued to Employees (“APB 25”) and provided the pro forma disclosures prescribed by FASB Statement No. 123, Accounting for Stock-based Compensation (“FAS 123”), the predecessor to FAS 123R. Except for certain acquisition-related options, the exercise price of all stock options is equal to the closing market price of the stock on the trading day preceding the date of grant. Accordingly, with the exception of certain acquisition-related compensation and awards granted under the Corporation’s deferred share and restricted share unit plans, no compensation cost had been recognized in the financial statements prior to fiscal 2007.

  The Corporation has elected the modified retrospective method of transition provided by FAS 123R and, accordingly, financial statement amounts for all prior periods presented herein reflect results as if the fair value method of expensing had been applied on a basis consistent with the pro forma disclosures required in those periods by FAS 123.

8

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

  In March 2005, the Securities and Exchange Commission (“SEC”) issued SEC Staff Accounting Bulletin No. 107, Share-based Payment (“SAB 107”) regarding the application of FAS 123R. The Corporation has applied the provisions of SAB 107 in its adoption of FAS 123R.

  The following tables set forth the increase (decrease) to the Corporation’s consolidated statements of income and balance sheets as a result of the adoption of FAS 123R for the three and six months ended August 31, 2005 and for the years ended February 28, 2006 and 2005: (000s, except per share amounts)

  Impact of Change for Adoption of FAS 123R
  For the three
months ended
August 31, 2005		 For the six
months ended
August 31, 2005		 For the year ended
  February 28,
2006		 February 28,
2005
  Consolidated Statement of Income          
  Operating Income   $(4,391 ) $(8,305 ) $(18,820 ) $(17,138 )
  Net income   (3,819 ) (7,272 ) (16,226 ) (15,130 )
  Net income per share (basic)   $(0.05 ) $(0.08 ) $(0.18 ) $(0.17 )
  Net income per share (diluted)   $(0.04 ) $(0.08 ) $(0.18 ) $(0.17 )

  Impact of Change for Adoption of
FAS 123R
February 28,
2006		 February 28,
2005
  Consolidated Balance Sheet      
  Deferred income tax asset  $     6,792   $     6,018  
  Stockholders' equity: 
  Common shares and additional paid-in 
     capital  159,737   142,962  
  Deferred stock-based compensation  501   277  
  Retained Earnings  (153,446 ) (137,221 )
     $     6,792   $     6,018  
  The Corporation uses the straight-line attribution method to recognize stock-based compensation expense over the requisite service period of its awards with service conditions only and the graded attribution method for its performance-based awards. Stock-based compensation expense is recorded, consistent with other compensation expenses, in cost of support, cost of services, selling, general and administrative expenses or research and development expenses, depending on the employee’s job function.

  When recording compensation cost for equity awards, FAS 123R requires corporations to estimate the number of equity awards granted that are expected to be forfeited. Prior to the adoption of FAS 123R, the Corporation recognized forfeitures when they occurred, rather than using an estimate at the grant date, and subsequently adjusting the estimated forfeitures to reflect actual forfeitures.

9

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

  Stock-based compensation expense recognized for the three and six months ended August 31, 2006 and 2005 is as follows:

Three months ended
August 31,		 Six months ended
August 31,
2006 2005 2006 2005
($000s)
  Compensation cost recognized          
  Cost of Product Support  $     65   $   117   $    161   $    231  
  Cost of Services  159   194   346   401  
  Selling, General and Administrative  5,100   3,253   9,404   6,123  
  Research and Development  433   994   924   1,885  
Total   5,757   4,558   10,835   8,640  
Tax benefit recognized  (528 ) (572 ) (1,459 ) (1,033 )
Net Stock-based Compensation Cost  $5,229   $3,986   $ 9,376   $ 7,607  

  Stock Options

  The fair value of the options granted after March 1, 2005 was estimated at the date of grant using a binomial lattice option-pricing model. Prior to March 1, 2005, the Corporation used the Black-Scholes option-pricing model to estimate the fair value of options at the grant date. The following weighted average assumptions were used for options granted during the following periods:

  Three months ended
August 31,		 Six months ended
August 31,
  2006   2005   2006   2005  
  Risk-free interest rates   4.3 % 3.8 % 4.4 % 3.8 %
Expected volatility   43 % 33 % 41 % 33 %
Dividend yield   0 % 0 % 0 % 0 %
Expected life of options (years)   4.0   3.8   3.9   3.8  

  Expected volatilities are based on historical volatility of the Corporation’s stock, implied volatilities from traded options on the Corporation’s stock, and other relevant factors. The Corporation uses historical data to estimate option exercise and employee termination within the valuation model. Separate groups of employees that have similar exercise behavior and turnover rates are considered separately for valuation purposes. The expected life of the options granted is derived from the output of the option valuation model and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option are determined by the US Treasury yields for US dollar options and the Government of Canada benchmark bond yields for Canadian dollar options in effect at the time of the grant.

10

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

  Options outstanding that have vested and are expected to vest as of August 31, 2006 are as follows:

    Number of
Awards
(000s)		 Weighted-
average
exercise
price
(in $)		 Aggregate
intrinsic
value(1)
($000s)		 Weighted-
average
remaining
contractual
term
(in years)
  Outstanding, March 1, 2006   11,255   $32.60   $75,347   3.3  
  Granted   326   33.40  
  Cancelled   (261 ) 33.96  
  Exercised   (534 ) 23.57  
  Outstanding, August 31, 2006   10,786   33.85   23,874   2.9  
  Exercisable, August 31, 2006   7,738   33.23   22,792   2.6  
  Unvested, August 31, 2006   3,048   35.42   1,082   3.5  

  (1)   The intrinsic value of an option represents the amount by which the market value of the stock exceeds the exercise price of the option of in-the-money options only. The aggregate intrinsic value is based on the closing price of $38.25 and $32.52 for the Corporation’s stock on the NASDAQ on February 28, 2006 and August 31, 2006, respectively.

  Additional information with respect to stock option activity is as follows:

Number of Awards
(in 000s)		 Weighted-average grant
date fair value
(in $)
  Unvested at March 1, 2006   4,594   $11 .17 
  Granted   326   10 .85 
  Vested   (1,733 ) 11 .80 
  Forfeited   (139 )
  Unvested at August 31, 2006   3,048   11 .11 

  The weighted-average grant date fair value of options granted during the six month period ended August 31, 2006 was $10.85 for a total fair value of $3,538,000. Options with a fair value of $20,455,000 completed vesting during the six month period ended August 31, 2006. The total intrinsic value of options exercised during the six month period ended August 31, 2006 was $8,170,000. The actual tax benefit realized for the tax deductions from option exercises in certain jurisdictions and the deduction of stock-based compensation in others for the six month period ended August 31, 2006 was $876,000.

11

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

  As of August 31, 2006, there was $33,693,000 of total unrecognized compensation cost related to nonvested stock options; that cost is expected to be recognized over a weighted-average period of 1.9 years.

  Restricted Share Unit Plan

  The Corporation also maintains a Restricted Share Unit Plan pursuant to which employees, officers, and directors of the Corporation and its subsidiaries are eligible to participate. Subject to performance and/or service provisions set out in each participant’s award agreement, each restricted share unit (“RSU”) will be exchangeable for one common share of the Corporation. Performance targets are based on company-wide performance goals such as operating margin and revenue growth and may include indexes to competitors’ performance. RSUs contingently vest over a period of 1 to 5 years.

  The fair value of each RSU is determined on the date of issue based on the value of the Corporation’s stock on that day and is remeasured until the performance condition is met or the shares are repurchased. The Corporation assumes that the performance goals will be achieved according to the Corporation’s business plan approved by the Board of Directors. Compensation cost will only be recognized to the extent that performance goals are achieved.

  The common shares for which RSUs may be exchanged will be purchased on the open market by a trustee appointed and funded by the Corporation. As no common shares will be issued by the Corporation pursuant to the plan, the plan is non-dilutive to existing shareholders.


12

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

Activity in the RSU plan for the six month period ended August 31, 2006 was as follows:

  Restricted
Share
Units		 Weighted-
Average
Grant Day
Fair Value		 Weighted-
Average
Remaining
Contractual
Term
(in years)		 Aggregate
Intrinsic
Value
  (000s)        ($000)   
  Outstanding, March 1, 2006   43   $37.05   2.6   $1,630  
    Granted – service conditions only   12 38.58
    Granted – performance conditions   178 32.03
    Vested   (12 ) 30.46
    Forfeited   --  
 
  Outstanding, August 31, 2006  221   $32.77 4.2 $7,203  
 

  The weighted-average grant date fair value of RSUs granted with service conditions only during the six month period ended August 31, 2006 was $38.58. The fair value of the Corporation’s stock at August 31, 2006 was $32.52. The total intrinsic value of RSUs that vested during the six month period ended August 31, 2006 was $414,000.

  As of August 31, 2006, there was $5,716,000 of total unrecognized compensation cost related to nonvested RSUs; that cost is expected to be recognized over a weighted-average period of 2.0 years.

  In September 2006, after the end of the quarter, the Board of Directors of the Corporation decided to replace the annual key employee stock option award with an award of RSUs. As a result, the Corporation advised the trustee of these RSU grants to purchase approximately 437,000 shares in the third quarter of fiscal year 2007 in order to fulfill this RSU award. In addition, the Corporation expects to purchase up to 216,000 shares in the upcoming year to meet RSU commitments if certain performance goals are achieved.

  Employee Stock Purchase Plan

  The Corporation sponsors the Cognos Employee Stock Purchase Plan (“ESPP”). A participant in the ESPP authorizes the Corporation to deduct an amount per pay period that cannot exceed five (5) percent of annual target salary divided by the number of pay periods per year. Deductions are accumulated during each of the Corporation’s fiscal quarters (“Purchase Period”) and, on the first trading day following the end of any Purchase Period, these deductions are applied toward the purchase of common shares. The purchase price per share is ninety (90) percent of the lesser of the fair market value of Cognos stock on the Toronto Stock Exchange as of the beginning and the end of the Purchase Period. As the ESPP is considered a compensatory plan under FAS 123R, the Corporation recognized $100,000 and $274,000 of ESPP compensation expense in the three and six month periods ended August 31, 2006, respectively and $36,687 and $174,511 for the three and six months ended August 31, 2005, respectively.


13

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

Deferred Share Plan for Non-employee Directors

  The Corporation has established a deferred share plan for its non-employee directors (“DSU Plan”). A DSU is a unit, equivalent in value to a share of the Corporation, credited by means of a bookkeeping entry in the books of the Corporation to an account in the name of the non-employee director. DSUs represent the variable (at risk) component of the directors’ compensation. At the end of the director’s tenure, the director must redeem the DSUs and, at the option of the Corporation, is either (i) paid the market value of the shares represented by the DSUs, or (ii) receives the whole number equivalent of the number of DSUs in shares of the Corporation purchased on the open market. A director is required to hold 5,000 DSUs and/or shares which must be attained within three (3) years of the director commencing service on the Board. At August 31, 2006, the Corporation had a liability of $3,393,000 in relation to the DSU Plan based on the value of the Corporation’s stock at that date.

4.   Intangible Assets

  As at August 31,
2006 		  As at February 28,
2006
 
  Cost   Accumulated
Amortization 		  Cost   Accumulated
Amortization		   Amortization
Rate
 
  ($000s)   ($000s)
  Acquired technology $ 41,611   $ 30,928    $41,611   $28,194    20%  
  Contractual relationships 9,654   3,991    9,654   3,328    12.5%
  Trademarks and patents 6,420   3,838    5,724   3,342    20%
 
 
 
 
    57,685   $38,757    56,989   $34,864 
     
     
  Accumulated Amortization (38,757 )     (34,864 )
 
     
  Net book value $ 18,928       $ 22,125
 
     
  During the three months ended August 31, 2006 and August 31, 2005, there were additions to trademarks and patents in the amount of $371,000 and $200,000, respectively, and $696,000 and $445,000 in the six months ended August 31, 2006 and August 31, 2005, respectively.


14

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

  The amortization of trademarks and patents is included in selling, general, and administrative expenses and the amortization of acquired technology and contractual relationships is included in income as amortization of acquisition-related intangibles. The following table sets forth the allocations:

    Three months ended
August 31,		 Six months ended August 31,
 
  2006 2005 2006 2005
 
  ($000s) ($000s)
Amortization of acquisition-related intangibles $1,702  $1,637  $3,403  $3,274 
  Selling, general, and administrative expenses 248  201    490  386 
 
  Total $1,950  $1,838    $3,893  $3,660 
 

  The estimated amortization expense related to intangible assets in existence as at August 31, 2006, over the next five years, is as follows ($000s):

  2007 (Q3 to Q4) $3,832 
  2008 7,030 
  2009 3,502 
  2010 2,716 
  2011 1,811 
  2012 37 

5.   Goodwill

  During the three and six months ended August 31, 2006, there were no changes to goodwill. During the three and six months ended August 31, 2005, there were reductions to goodwill of $871,000 and $1,002,000, respectively, resulting from adjustments to the accounts receivable in the purchase price allocation for Frango AB (“Frango”).

    Three months ended August 31, Six months ended
August 31,
 
  2006 2005 2006 2005
 
  ($000s) ($000s)
Beginning balance $225,709  $ 221,359    $225,709  $ 221,490 
  Adjustments --  (871)   --  (1,002)
 
  Closing balance $225,709  $ 220,488    $225,709  $ 220,488 
 


15

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

6.   Commitments and Contingencies

Legal Proceedings

  The Corporation and its subsidiaries may, from time to time, be involved in legal proceedings, claims, and litigation that arise in the ordinary course of business. In the event that any such claims or litigation are resolved against Cognos, such outcomes or resolutions could have a material adverse effect on the business, financial condition, or results of operations of the Corporation.

Customer Indemnification

  The Corporation has entered into licensing agreements with customers that include limited intellectual property indemnification clauses. These clauses are typical in the software industry and require the Corporation to compensate the customer for certain liabilities and damages incurred as a result of third party intellectual property claims arising from these transactions. The Corporation also issues letters of credit for a range of global contingent and firm obligations including insurance, custom obligations, real estate leases, and support obligations. The Corporation has not made any significant payments as a result of these indemnification clauses or letters of credit and, in accordance with FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, has not accrued any amounts in relation to these indemnification clauses.

7. Income Taxes

  The Corporation provides for income taxes in its quarterly unaudited financial statements based on the estimated effective tax rate for the full fiscal year. The estimated effective tax rate is adjusted on a quarterly basis when a tax asset or exposure is ultimately resolved.

  The Corporation estimates its effective tax rate for fiscal 2007 to be 23.5%, exclusive of any one-time events. This estimated effective tax rate was reduced for the three and six-month periods ended August 31, 2006 to 20.6% and 21.7%, respectively due to adjustments related to a modification of an intercompany commercial arrangement and an election in respect of the functional currency of a subsidiary. For the three and six months ended August 31, 2005, the Corporation estimated its effective tax rate for fiscal 2006 to be 22%, exclusive of any one-time events. This estimated effective tax rate was reduced for the three-month period ended August 31, 2005 to 21.2% due to adjustments relating to various tax audits and prior period tax provisions. The effective tax rate for the six month period ended August 31, 2005 was adjusted to 17.4% due to the adjustments in the quarter as well as the recognition of one-time benefits in the previous quarter resulting from (i) a tax court decision that allowed corporations to claim investment tax credits on stock-based compensation for research and development personnel relating to fiscal years 2004 and 2005 and (ii) a change in tax withholding legislation relating to one of the Corporation’s subsidiaries.


16

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

8.   Stockholders’ Equity

  The Corporation issued 19,000 common shares for proceeds of $576,000, and 239,000 common shares for proceeds of $5,802,000 during the three-month periods ended August 31, 2006, and August 31, 2005, respectively. The Corporation issued 556,000 common shares for proceeds of $13,511,000 and 766,000 common shares for $17,586,000 during the six months ended August 31, 2006 and August 31, 2005, respectively. The issuance of shares in fiscal 2007 and 2006 was pursuant to the Corporation’s stock purchase plan and the exercise of stock options by employees, officers and directors.

  The Corporation repurchases shares under a share repurchase program and under a restricted share unit plan. During the three months ended August 31, 2006, the Corporation did not repurchase any shares under its share repurchase program. During the six months ended August 31, 2006, the Corporation repurchased 652,000 shares at a value of $24,998,000 in the open market under the Corporation’s share repurchase program. During the three and six month periods ended August 31, 2006, the Corporation repurchased 80,000 shares valued at $2,545,000 under its restricted share unit plan.

  During the three and six-months ended August 31, 2005, the Corporation repurchased 649,000 shares at a value of $23,694,000 and 1,266,000 shares at a value of $48,948,000, respectively, in the open market under its share repurchase program. During the three and six-month periods ended August 31, 2005, the Corporation repurchased 5,000 shares valued at $177,000 under its restricted share unit plan.

  Net Income per Share

  The reconciliation of the numerator and denominator for the calculation of basic and diluted net income per share is as follows: (000s except per share amounts)

    Three months ended
August 31,		 Six months ended
August 31,
 
  2006    2005    2006    2005   
 
Basic Net Income per Share          
     Net income $23,760  $24,900    $38,298  $45,272 
 
     Weighted average number of shares
     outstanding		 89,718  90,740    89,805  90,909 
 
     Basic net income per share $0.26  $0.27    $0.43  $0.50 
 
  Diluted Net Income per Share
     Net income $23,760  $24,900    $38,298  $45,272 
 
     Weighted average number of shares
     outstanding		 89,718  90,740    89,805  90,909 
     Dilutive effect of stock options 503  2,066    718  2,441 
 
     Adjusted weighted average number of shares
     outstanding		 90,221  92,806    90,523  93,350 
 
     Diluted net income per share $0.26  $0.27    $0.42  $0.48 
 


17

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

9. Comprehensive Income

  Comprehensive income includes net income and other comprehensive income (“OCI”). OCI refers to changes in net assets from transactions and other events, and circumstances not included in net income and other than transactions with stockholders. These changes are recorded directly as a separate component of Stockholders’ Equity. OCI includes the foreign currency translation adjustments for subsidiaries that do not use the U.S. dollar as their functional currency net of gains or losses on derivatives designated as a hedge of the net investment in foreign operations and the effective portion of cash flow hedges where the hedged item has not yet been recognized in income. Tax effects of foreign currency translation adjustments pertaining to those subsidiaries are generally included in OCI.

The components of comprehensive income were as follows ($000’s):

    Three months ended
August 31,		 Six months ended
August 31,
 
  2006    2005    2006    2005   
 
Net income $23,760  $24,900    $38,298  $45,272 
  Other comprehensive income (loss):
      Foreign currency translation adjustments (1,246) 2,179    135  2,769 
      Change in net unrealized loss on
        derivative instruments 496  (633)   324  (869)
 
  Comprehensive income $23,010  $26,446    $38,757  $47,172 
 

10. Segmented Information

The Corporation operates in one business segment as one reporting unit – computer software solutions.


18

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

11. Liabilities in Connection with Acquisition

  In September 2004, in conjunction with the acquisition of Frango, the Corporation undertook a restructuring plan. In accordance with Emerging Issues Task Force (“EITF”) No. 95-3, Recognition of Liabilities in Connection with a Business Combination (“EITF 95-3”), the liability associated with this restructuring is considered a liability assumed in the purchase price allocation. The Corporation recorded restructuring costs of approximately $5,445,000 in relation to this restructuring plan. This restructuring primarily related to involuntary employee separations of approximately 20 employees of Frango and accruals for vacating leased premises of Frango. The employee separations impacted all functional groups, primarily in Europe. The restructuring accrual is included on the balance sheet as accrued charges and salaries, commissions, and related items. All amounts excluding lease payments will be paid by the end of fiscal 2007. Outstanding balances for the lease payments will be paid over the lease term unless settled earlier. The Corporation does not believe that any unresolved contingencies, purchase price allocation issues, or additional liabilities exists that would result in a material adjustment to the acquisition cost allocation.

  The following table sets forth the activity in the Corporation’s restructuring accrual for the six month period ended August 31, 2006: ($000s)

  Employee
separations		 Other
restructuring
accruals		 Total
accrual
 
  Balance as at February 28, 2006 $  277  $  481  $  758 
  Cash payments during the first six months of fiscal 2007   (220)   (132)   (352)
  Adjustment     (13)       --      (13)
  Foreign exchange adjustment       17        29        46 
 
  Balance as at August 31, 2006 $    61  $  378  $  439 
 

12. Subsequent Events

  On September 7, 2006, in order to streamline the organization and improve its operating margin on a long term basis, the Corporation announced a restructuring plan. The plan includes a planned reduction of approximately 210 personnel or 6% of the Corporation’s global workforce, focused primarily on management and non-revenue-generating positions. The Corporation expects to substantially complete the activities relating to the plan within the Corporation’s fiscal year 2007.

  As part of this plan, and in accordance with FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities, the Corporation expects to incur approximately $28,000,000 in total pre-tax charges in the third quarter of fiscal year 2007. The plan is not yet finalized and as a result the Corporation could incur additional liabilities. Substantially all of the expected pre-tax charges are one-time employee terminations benefits.


19

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

13. New Accounting Pronouncements

  In September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 requires companies to evaluate the materiality of identified unadjusted errors on each financial statement and related financial statement disclosure using both the rollover approach and the iron curtain approach. The rollover approach quantifies misstatements based on the amount of the error in the current year financial statement whereas the iron curtain approach quantifies misstatements based on the effects of correcting the misstatement existing in the balance sheet at the end of the current year, irrespective of the misstatement’s year(s) of origin. Financial statements would require adjustment when either approach results in quantifying a misstatement that is material. Correcting prior year financial statements for immaterial errors would not require previously filed reports to be amended. SAB 108 is effective for interim periods of the first fiscal year ending after November 15, 2006. The Corporation is currently evaluating the impact of SAB 108 on its consolidated results of operation and financial position.

  In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”). This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes that a company should use a more-likely-than-not recognition threshold based on the technical merits of the tax position taken. Tax positions that meet the more-likely-than-not recognition threshold should be measured in order to determine the tax benefit to be recognized in the financial statements. FIN 48 is effective in fiscal years beginning after December 15, 2006. The Corporation is currently evaluating the impact of FIN 48 on its consolidated results of operations and financial condition.

  In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Instruments – an Amendment of SFAS No. 140 (“SFAS 156”). This Statement amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. This Statement is effective for fiscal years beginning after September 15, 2006. The Corporation does not expect the adoption of SFAS 156 to have a material impact on its consolidated results of operations and financial condition.

  In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments – an Amendment to SFAS Nos. 133 and 140 (“SFAS 155”). SFAS 155 permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation and clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133. This statement also establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation and clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives. In addition, SFAS 155 amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Corporation does not expect the adoption of SFAS 155 to have a material impact on its consolidated results of operations and financial condition.


20

COGNOS INCORPORATED
CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(All amounts in U.S. dollars, unless otherwise stated)
(In accordance with U.S. GAAP)

  In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS 154”) which supersedes APB No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154 changes the requirements for the accounting for and reporting of changes in accounting principle. The statement requires the retroactive application to prior periods’ financial statements of changes in accounting principles, unless it is impracticable to determine either the period specific effects or the cumulative effect of the change. SFAS 154 does not change the guidance for reporting the correction of an error in previously issued financial statements or the change in an accounting estimate. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS 154 did not have a material impact on the Corporation’s consolidated results of operations and financial condition.


21

Item 2.

COGNOS INCORPORATED

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(in United States dollars, unless otherwise indicated, and in accordance with U.S. GAAP)

FORWARD-LOOKING STATEMENTS/SAFE HARBOR

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the unaudited Consolidated Financial Statements and Notes included in Item 1 of this Quarterly Report and can also be read in conjunction with the audited Consolidated Financial Statements and Notes, and MD&A contained in our Annual Report on Form 10-K (“Annual Report”) for the fiscal year ended February 28, 2006 (“fiscal 2006”). Certain statements made in this MD&A, including in the “Outlook” section, that are not based on historical information are forward-looking statements which are made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934 and Section 138.4(9) of the Ontario Securities Act.  Terms and phrases such as, “opportunity”, “expected”, “plans”, “aimed at”, “intends” and similar terms and phrases are intended to identify these forward-looking statements. Such forward-looking statements relate to and include, among other things future revenues and earnings; our products, including Cognos 8 Business Intelligence (“Cognos 8”) and Cognos Planning and their contributions to our revenues and earnings; market trends; new and existing product innovations and developments; operational performance; our sales force structure and model; our anticipated hiring needs and our use of subcontractors; the impact of our relationship with systems integrators; the importance of identifying, hiring, engaging and retaining personnel and contractors; the impact of Statement of Financial Accounting Standard No. 123 (revised), Share-based Payment, (“FAS 123R”) on our financial results; the charges from and the impact of our margin improvement plan on our financial results, our expected payments under the plan, and our expected time frame for completion of our restructuring activities; our effective tax rate; our plans with respect to our share repurchase program; the revenue mix between product license, support and services; the decline in license revenue from stand alone products incorporated into Cognos 8; improvements in gross margins; the growth of corporate performance management (“CPM”) in the software industry; the trend towards standardization and larger transactions; product and technological improvements by our competitors and consolidation in our industry and the expansion of larger software vendors including enterprise resource planning software vendors, into our markets; the strength of the Canadian and U.S. dollars and their effects; our plans to retain earnings to reinvest in Cognos; drivers of growth in the business intelligence (“BI”) market; our ability to meet our working capital needs; and our investments in personnel and technology.

These forward-looking statements are neither promises nor guarantees, but involve risks and uncertainties that may cause actual results to differ materially from those in the forward-looking statements. Factors that may cause such differences include, but are not limited to, Cognos’ transition to new products and releases, including Cognos 8 and customer acceptance and implementation of Cognos 8; a continuing increase in the number of larger customer transactions and the related lengthening of sales cycles and challenges in executing on these sales opportunities; the incursion of enterprise resource planning and other major software companies into the BI market; continued BI and software market consolidation and other competitive changes in the BI and software market; currency fluctuations; our ability to identify, hire, train, motivate, retain, and incent highly qualified management/other key personnel (including sales personnel) and our ability to manage changes and transitions in management/other key personnel; our ability to achieve our expected cost savings from our margin improvement plan; the impact of the implementation of FAS 123R; our ability to develop, introduce and implement new products as well as enhancements or improvements for existing products that respond, in a timely fashion, to customer/product requirements and rapid technological change; our ability to maintain or accurately forecast revenue or to anticipate and accurately forecast a decline in revenue from any of our products or services; our ability to compete in an intensely competitive market; new product introductions and enhancements by competitors; our ability to select and implement appropriate business models, plans and strategies and to execute on them; fluctuations in our quarterly and annual operating results; fluctuations in our tax exposure; the impact of natural disasters on the overall economic condition of North America; unauthorized use or misappropriation of our intellectual property; claims by third parties that our software infringes their intellectual property; the risks inherent in international operations, such as the impact of the laws, regulations, rules and pronouncements of jurisdictions outside of Canada and their interpretation by courts, tribunals, regulatory and similar bodies of such jurisdictions; our ability to identify, pursue, and complete acquisitions with desired business results; as well as the risk factors discussed in this quarterly report, our Annual Report and in other periodic reports filed with the Securities and Exchange Commission (“SEC”) and the Canadian Securities Administrators. Readers should not place undue reliance on any such forward-looking statements, which speak only as of the date they are made. We disclaim any obligation to publicly update or revise any such statement to reflect any change in our expectations or in events, conditions, or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those contained in the forward-looking statements.


22

Discussion of Non-GAAP Financial Measures

In addition to our GAAP results, Cognos discloses adjusted operating margin percentage, net income and net income per share, referred to respectively as “non-GAAP operating margin percentage,” “non-GAAP net income,” and “non-GAAP net income per diluted share.” These items, which are collectively referred to as “Non-GAAP Measures,” exclude the impact of stock-based compensation and the amortization of acquisition-related intangible assets. From time to time, subject to the review and approval of the audit committee of the Board of Directors, management may make other adjustments for expenses and gains that it does not consider reflective of core operating performance in a particular period and may modify the Non-GAAP Measures by excluding these expenses and gains. For example, the charges related to the restructuring plan announced September 7, 2006 will be excluded as part of Non-GAAP Measures for our fiscal third quarter ending November 30, 2006 and fiscal year ending February 28, 2007. The costs related to the restructuring plan have not been excluded from our Non-GAAP Measures discussed in this MD&A as no cost related to this restructuring plan were incurred during the quarter.

Management defines its core operating performance to be the revenues recorded in a particular period and the expenses incurred within that period which management has the capability of directly affecting in order to drive operating income. Non-cash stock-based compensation and amortization of acquisition-related intangible assets are excluded from our core operating performance because the decisions which gave rise to these expenses were not made to drive revenue in a particular period, but rather were made for our long term benefit over multiple periods. While strategic decisions, such as the decisions to issue stock-based compensation or to acquire a company, are made to further our long term strategic objectives and do impact our income statement under GAAP, these items affect multiple periods and management is not able to change or affect either item within any particular period. Therefore, management excludes these impacts in its planning, monitoring, evaluation and reporting of our underlying revenue-generating operations for a particular period.


23

Prior to the adoption of FAS 123R on March 1, 2006, the beginning of our fiscal year 2007, management’s practice was to exclude stock-based compensation internally to evaluate performance. With the adoption of FAS 123R, management concluded that the Non-GAAP Measures could provide relevant disclosure to investors as contemplated by Staff Accounting Bulletin 107. As of the beginning of our current fiscal year, management also began excluding amortization of acquisition-related intangible assets when assessing appropriate adjustments for non-GAAP presentations. While both of these items are recurring and affect GAAP net income, management does not use them to assess the business’ operational performance for any particular period because: each item affects multiple periods and is unrelated to business performance in a particular period; management is not able to change either item in any particular period; and neither item contributes to the operational performance of the business for any particular period.

In the case of stock-based compensation, as disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2006 (“2006 Form 10-K”), our compensation strategy is to use stock-based compensation “as a key tool for ensuring that key employees and executives are engaged and motivated to remain at the Company for the long term.” It is aimed at long term employee retention, rather than to motivate or reward operational performance for any particular period. Thus, stock-based compensation expense varies for reasons that are generally unrelated to operational performance in any particular period. As further discussed in our 2006 Form 10-K, we use annual cash bonus payouts for executives and other employees to motivate and reward annual operational performance in the areas of revenue and operating margin achievement. Since the beginning of fiscal year 2007, operating margin achievement has been measured on a non-GAAP basis, excluding stock-based compensation and amortization of acquisition-related intangible assets expenses.

Management views amortization of acquisition-related intangible assets, such as the amortization of an acquired company’s research and development efforts, customer lists and customer relationships, as items arising during the time that preceded the acquisition. It is a cost that is determined at the time of the acquisition. While it is continually viewed for impairment, amortization of the cost is a static expense, one that is typically not affected by operations during any particular period and does not contribute to operational performance in any particular period.

The restructuring plan reflects a fundamental realignment of our business, including significant personnel reductions within higher levels of management. The restructuring charges are excluded in our Non-GAAP measures because they are significantly different in magnitude and character from routine personnel adjustments that management makes when monitoring and conducting the Company’s core operations during any particular period.  The restructuring decision and related expenses are not related to operating performance for any particular period, and are not subject to change by management in any particular period.  Instead, the restructuring is intended to align our business model and expense structure to our position in the market we are experiencing, and expect to experience, over the long term.

Management also uses these Non-GAAP Measures to operate the business because the excluded expenses are not under the control of, and accordingly are not used in evaluating the performance of, operations personnel within their respective areas of responsibility. In the case of stock-based compensation expense, the award of stock options is governed by the human resources and compensation committee of the Board of Directors. With respect to acquisition-related intangible assets and charges associated with the restructuring plan, these charges arise from acquisitions and a restructuring that are the result of strategic decisions which are not the responsibility of most levels of operational management. The restructuring charges, like our stock-based compensation charges and amortization of acquisition-related intangible assets, are excluded in management’s internal evaluations of our operating results and are not considered for management compensation purposes.


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Ultimately, stock-based compensation, amortization of acquisition-related intangible assets and restructuring expenses are incurred to further our long-term strategic objectives, rather than to achieve operational performance objectives for any particular period. As such, supplementing GAAP disclosure with non-GAAP disclosure using the Non-GAAP Measures provides management with an additional view of operational performance by excluding expenses that are not directly related to performance in any particular period. Further, management considers this supplemental information to be beneficial to shareholders because it shows our operating performance without the impact of charges that are largely unrelated to the performance of our underlying revenue-generating operations during the period in which the charges are recorded.  Including such disclosure in our filings also provides investors with greater transparency on period-to-period performance and the manner in which management views, conducts and evaluates the business.

Because the Non-GAAP Measures are not calculated in accordance with GAAP, they are used by management as a supplement to, and not an alternative to, or superior to, financial measures calculated in accordance with GAAP. There are a number of limitations on the Non-GAAP Measures, including the following:

  • The Non-GAAP Measures do not have standardized meanings and may not be comparable to similar non-GAAP measures used or reported by other software companies.

  • The Non-GAAP Measures do not reflect all costs associated with our operations determined in accordance with GAAP. For example:

  • Non-GAAP operating margin performance and non-GAAP net income do not include stock-based compensation expense related to equity awards granted to our workforce. Cognos’ stock incentive plans are important components of our employee incentive compensation arrangements and are reflected as expenses in our GAAP results under FAS 123R. While we include the dilutive impact of such equity awards in weighted average shares outstanding, the expense associated with stock-based awards is excluded from our non-GAAP Measures.

  • Although amortization of acquisition-related intangible assets does not directly impact our current cash position, such expense represents the declining value of the technology or other intangible assets that we have acquired. These assets are amortized over their respective expected economic lives or impaired, if appropriate. The expense associated with this decline in value is excluded from our non-GAAP disclosures and therefore our Non-GAAP Measures do not include the costs of acquired intangible assets that supplement our research and development.

  • With respect to periods beginning with the third quarter of fiscal 2007, the restructuring charges primarily represent severance charges associated with our “operating margin improvement plan” announced September 7, 2006. These charges are a significant expense from a GAAP perspective and the costs associated with the restructuring would be operational in nature absent the restructuring plan. Most of the charges are cash expenditures which are excluded from our Non-GAAP Measures.

  • Excluded expenses for stock-based compensation and amortization of acquisition-related intangible assets will recur and will impact our GAAP results. The Non-GAAP Measures should not be construed as an inference that the excluded items are unusual, infrequent or non-recurring.


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As a result of these limitations, management recognizes that the Non-GAAP Measures should not be considered in isolation or as an alternative to our results as reported under GAAP. Management compensates for theses limitations by relying on the Non-GAAP Measures only as a supplement to our GAAP results.

ABOUT COGNOS

Cognos is a global leader in business intelligence (“BI”) and corporate performance management (“CPM”) software solutions. Our solutions help our customers improve their business performance by enabling planned performance management through the consistent reporting and analysis of data derived from various sources. Management believes that organizations that use our software gain valuable insights that can be used to improve operational effectiveness, enhance customer satisfaction, reduce corporate response times and, ultimately, increase revenues and profits. Our integrated software solutions consist of our suite of BI components, performance management applications, and analytical applications.

Cognos brings together technology, analytical applications, best practices, and a broad network of partners to give customers a complete performance system. The Cognos performance system is an open and adaptive solution that leverages an organization’s enterprise resource planning (“ERP”), packaged applications, and database investments. It gives customers the ability to answer the questions – How are we doing? Why are we on or off track? What should we do about it? – and enables them to understand and monitor current performance while planning future business strategies.

Our revenue is derived primarily from the licensing of our software and the provision of related services for BI and CPM solutions. These related services include product support, education, and consulting. We generally license software and provide services subject to terms and conditions consistent with industry standards. For an annual fee, customers may contract with us for product support, which includes product and documentation enhancements, as well as tele-support and web-support.

OVERVIEW OF THE QUARTER

We delivered solid results for the second quarter of fiscal 2007. Overall revenue growth was 8% driven by growth in both product support and professional services revenue. We saw strength in large deals and a good balance in license revenue across our product portfolio as our BI and Office of Finance solutions both contributed to our performance during the quarter. In addition, we exited the quarter with a strong balance sheet.

Looking forward to the second half of fiscal year 2007, we feel our solutions are strong, and our recent actions to improve margins while at the same time increasing the number of sales personnel, position us well to take full advantage of the opportunities in front of us.

On March 1, 2006, we adopted FAS 123R. FAS 123R requires all companies to measure compensation costs for all share-based payments (including stock options) at fair value and to recognize such costs in the statement of income. As a result of the adoption of FAS 123R, our operating income, net income, and earnings per share have been significantly impacted. We have elected the modified retrospective method of transition provided by FAS 123R and, accordingly, financial statement amounts for all prior periods presented herein reflect results as if the fair value method of expensing had been applied from the original effective date of FASB Statement No. 123, Accounting for Stock-based Compensation (“FAS 123”), the predecessor to FAS 123R. See Note 3 of the Condensed Notes to the Consolidated Financial Statements.


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Operating Performance

Revenue for the three-month period ended August 31, 2006 was $229.9 million, an increase of 8% from $212.0 million for the corresponding period last year. License revenue decreased 1% to $78.0 million, compared with $78.6 million in the second quarter last fiscal year. License revenue was down slightly due to a combination of factors including sales representatives hiring taking place later in the quarter than anticipated and a slow start to the quarter as the SEC review created a distraction both internally and with our customers. Product support revenue increased 12% to $103.3 million as we expand our customer base and continue to experience solid renewal rates. Services revenue also contributed to the growth in revenue during the quarter increasing 18% to $48.6 million from $41.3 million for the same quarter last year.

Net income for the three-month period ended August 31, 2006 was $23.8 million or $0.26 per diluted share compared to net income of $24.9 million or $0.27 per diluted share for the same period last year, representing a decrease of 5%. The decrease in net income for the quarter is primarily due to the unfavorable effect of foreign currency, predominantly the stronger Canadian dollar, and a shift in sales mix from our higher margin license revenue towards our lower margin product support and services revenue. The decrease in net income was partially offset by an increase in interest and other income.

Non-GAAP net income for the three months ended August 31, 2006 was $30.0 million and non-GAAP net income per diluted share was $0.33 compared to non-GAAP net income of $29.9 million and non-GAAP net income per diluted share of $0.32 for the corresponding period last year. The Non-GAAP Measures presented herein, including non-GAAP net income, exclude the impact of stock-based compensation and the amortization of acquisition-related intangible assets. Management uses the Non-GAAP Measures to measure core operating performance in individual periods. Management’s use of the Non-GAAP Measures is further discussed in the section entitled “Discussion of Non-GAAP Financial Measures” and a reconciliation between the Non-GAAP Measures and GAAP is in the section entitled “Non-GAAP Financial Measures”.

Our balance sheet remains strong, ending the quarter with $618.1 million in cash, cash equivalents, and short-term investments. This represents an increase of $7.9 million from May 31, 2006.

We signed 10 contracts in excess of one million dollars during the quarter, compared with 9 contracts in the corresponding period last year. The number of contracts greater than $200,000 decreased slightly while contracts greater than $50,000 increased 9% compared to the corresponding period last year. Average license order size for orders greater than $50,000 was $181,000 for the three months ended August 31, 2006, compared to $172,000 last year. We believe that order size is an indication of enterprise-scale investment in our products by our customers which creates a foundation for future growth as it enables us to generate additional software licensing and ongoing maintenance renewals.

Recent Announcements

During the quarter, we released the second maintenance release of Cognos 8, our recently released enterprise software that facilitates all BI activity, including production and business reporting, dashboarding, query, analysis, metrics management and interactive scorecarding. This new release, which is provided free of charge to supported Cognos 8 users, offers enhanced quality, upgradeability and performance.


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We also recently previewed Cognos 8 Go! Mobile, a new BI solution that will bring decision-support information directly to mobile device users for right-time decision making. Cognos 8 Go! Mobile follows the recent announcement of Cognos Go! Search Service and represents Cognos’ next milestone in making BI accessible to more people and enabling higher adoption of business intelligence for enhanced decision making and improved organizational performance.

On September 7, 2006, in order to streamline our organization and improve our operating margin on a long term basis, we announced a restructuring plan. The plan includes a planned reduction of approximately 210 personnel or 6% of our global workforce, focused primarily on management and non-revenue-generating positions. We will continue to increase our investment in customer facing resources. We expect to substantially complete the activities relating to the plan within our fiscal year 2007.

Outlook for the balance of the fiscal year

Our outlook for the balance of fiscal year 2007 is based on our internal sales forecast (which management believes to be reasonable) and assumes continued growth in the BI market, continued strength of the Canadian dollar and the euro compared to the U.S. dollar, and no significant changes in the economy.

We continue to expect revenue to increase for the full fiscal year as compared to fiscal 2006. We believe that the BI market remains strong and with the general availability of Cognos 8 and its second maintenance release, we believe that we are well positioned to benefit from licensing revenue from new customers, as well as provide existing customers with the opportunity to add to their current reporting and analysis capabilities. We have received a positive response to Cognos 8 since its release and we believe that Cognos 8 will continue to make a significant contribution to fiscal 2007 license revenue.

We continue to experience a healthy market for our other products, including our performance management applications. Cognos 8 and Cognos Planning are the key components of our product strategy and we believe that the strength of these two products in the market will be significant contributors to our business. We will continue to focus on bringing innovative new products to market and we continue to develop new releases of our products.

The BI and performance management markets continue to be very competitive and we expect our competitors to continue to improve the performance of their current products and to introduce new products (or integrated products) or new technologies to compete with our strong product portfolio. In addition, the software market continues to consolidate by acquisition and larger software vendors, including ERP software vendors, may continue to expand their product offering into our markets, creating stronger competitors.

As part of the restructuring plan mentioned above and in accordance with FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“FAS 146”), we expect to incur approximately $28.0 million in total pre-tax charges in the third quarter of fiscal year 2007. Substantially all of the expected pre-tax charges are one-time employee termination benefits.

The Canadian dollar continues to be strong compared to the U.S. dollar. This has put pressure on our business and operating margin percentage as a disproportionate amount of our expenses are incurred in Canadian dollars.


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RESULTS OF OPERATIONS

Recently Adopted Accounting Principle

We adopted FAS 123R on March 1, 2006 to account for our stock option, stock purchase, and deferred share and restricted share unit plans. This standard addresses the accounting for share-based payment transactions in which a company receives services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. Under this standard, companies are required to account for such transactions using a fair value method and to recognize the expense over the vesting period of the award in the consolidated statements of income.

We previously accounted for share-based compensation transactions using the intrinsic value method in accordance with Accounting Principles Board (“APB”) Opinion 25, Accounting for Stock Issued to Employees (“APB 25”) and provided the pro forma disclosures prescribed by FAS 123, the predecessor to FAS 123R. Except for certain acquisition-related options, the exercise price of all stock options is equal to the closing market price of the stock on the trading day preceding the date of grant. Accordingly, with the exception of this acquisition-related compensation and awards granted under our deferred share and restricted share unit plans, no compensation cost had been recognized in the financial statements prior to fiscal 2007.

We have elected the modified retrospective method of transition provided by FAS 123R and, accordingly, financial statement amounts for all prior periods presented herein reflect results as if the fair value method of expensing had been applied from the original effective date of FAS 123 (See Note 3).

We use the straight-line attribution method to recognize share-based compensation costs over the requisite service period of our awards with service conditions only and the graded attribution method for our performance-based awards. Stock-based compensation expense is recorded, consistent with other compensation expenses, in cost of support, cost of services, selling, general and administrative expenses or research and development expenses, by employee job function.

Stock-based compensation expense recognized for the three and six months ended August 31, 2006 and 2005 is as follows:

  Three months ended
August 31, 		Six months ended
August 31,
2006    2005    2006    2005   
($000s)
Compensation cost recognized          
   Cost of Product Support $     65  $   117    $      161  $    231 
   Cost of Services 159  194    346  401 
   Selling, General and Administrative 5,100  3,253    9,404  6,123 
   Research and Development 433  994    924  1,885 
Total 5,757  4,558    10,835  8,640 
Tax benefit recognized (528) (572)   (1,459) (1,033)
Net Stock-based Compensation Cost $5,229  $3,986    $   9,376  $ 7,607 


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GAAP Operating Performance

Percentage Change
 
(000s, except per share amounts) Three months ended
August 31,		 Six months ended
August 31,		 Three months ended
August 31,		 Six months ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Revenue   $229,890   $212,042   $446,930   $      412,117   8 .4% 8 .4%
Cost of revenue   52,634   43,028   103,134   85,543   22 .3 20 .6
 
 
Gross margin   177,256   169,014   343,796   326,574   4 .9 5 .3
Operating expenses   153,552   140,484   306,124   277,601   9 .3 10 .3
 
 
Operating income   $  23,704   $  28,530   $  37,672   $       48,973   (16 .9) (23 .1)
 
Gross margin percentage   77.1 % 79.7 % 76.9 % 79.2 %
Operating margin percentage   10.3 % 13.5 % 8.4 % 11.9 %
   
Net income   $  23,760   $  24,900   $  38,298   $       45,272   (4 .6) (15 .4)
 
 
Net income per share  
   Basic   $0.26 $0.27 $0.43 $0.50
 
 
   Diluted   $0.26 $0.27 $0.42 $0.48
 
 

Revenue for the quarter ended August 31, 2006 was $229.9 million, an 8% increase from revenue of $212.0 million for the same quarter last year. Net income for the current quarter was $23.8 million, compared to net income of $24.9 million for the same quarter last year, a decrease of 5%. Diluted net income per share was $0.26 for the current quarter, compared to diluted net income per share of $0.27 for the same quarter last year. Basic net income per share was $0.26 and $0.27 for the quarters ended August 31, 2006 and August 31, 2005, respectively.

Revenue for the six months ended August 31, 2006 was $446.9 million, an 8% increase from revenue of $412.1 million for the same period last year. Net income for the current six-month period was $38.3 million, compared to net income of $45.3 million for the same period last year, a decrease of 15%. Diluted net income per share was $0.42 for the current six-month period, compared to diluted net income per share of $0.48 for the same period last year. Basic net income per share was $0.43 and $0.50 for the six-month periods ended August 31, 2006 and August 31, 2005, respectively.

Gross margin for the three months ended August 31, 2006 was $177.3 million, an increase of 5% over gross margin of $169.0 million for the same quarter last year. Gross margin percentage was 77% for the quarter ended August 31, 2006, compared to 80% for the corresponding quarter last fiscal year. Gross margin for the six months ended August 31, 2006 was $343.8 million, an increase of 5% over gross margin of $326.6 million for the same period last year. Gross margin percentage for the six months ended August 31, 2006 was 77% compared to 79% for the corresponding period last year. The decrease in gross margin percentage is attributable to a shift in revenue mix towards lower margin services revenue.



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Total operating expenses for the quarter ended August 31, 2006 were $153.6 million, a 9% increase from operating expenses of $140.5 million for the same quarter last year. The operating margin for the quarter ended August 31, 2006 was 10.3% compared to 13.5% for the corresponding quarter of the previous fiscal year. Total operating expenses for the six months ended August 31, 2006 were $306.1 million, a 10% increase from operating expenses of $277.6 million for the same period last year. Included in operating expenses for the quarter were $1.8 million of expenses related to a review of our Annual Report on Form 10-K for the period ended February 28, 2005 by the Staff of the Division of Corporation Finance of the Securities and Exchange Commission. Operating margin for the six months ended August 31, 2006 was 8.4% compared to 11.9% for the same period last year. The decrease in operating margin for the three and six month periods ended August 31, 2006 is primarily attributable to fluctuations in foreign currency, predominantly the Canadian dollar which continues to be strong compared to the U.S. dollar, and a shift in revenue mix from our higher margin license revenue towards our lower margin product support and services revenue. Also contributing to the decline in operating margin was a growth in our infrastructure and head count which along with the foreign exchange impact resulted in our expenses growing at a faster rate than our revenues.

On September 7, 2006, in order to streamline our organization and improve our operating margin on a long term basis, we announced a restructuring plan. The plan includes a planned reduction of approximately 210 personnel or 6% of our global workforce, focused primarily on management and non-revenue-generating positions. We will continue to increase our investment in customer facing resources. We expect to substantially complete the activities relating to the plan within our fiscal year 2007. As part of this plan, and in accordance with FAS 146, we expect to incur approximately $28.0 million in total pre-tax charges in the third quarter of fiscal year 2007. Substantially all of the expected pre-tax charges are one-time employee termination benefits.

The decrease in net income for the three and six months ended August 31, 2006, compared to the same periods in the prior fiscal year, is primarily due to the unfavorable effect of foreign currency, predominantly the stronger Canadian dollar, and a shift in revenue mix from our higher margin license revenue towards our lower margin product support and services revenue. The decrease in net income was partially offset by an increase in interest and other income.

We operate internationally and, as a result, a substantial portion of our business is conducted in foreign currencies. Accordingly, our results are affected by exchange rate fluctuations of the U.S. dollar relative to the Canadian dollar, to various European currencies, and, to a lesser extent, other foreign currencies. The following table breaks down the year-over-year percentage change in revenue and expenses between change attributable to growth and change attributable to fluctuations in the value of the U.S. dollar.



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Year-over-year Percentage Change in Revenue and Expenses

Three Months Ended August 31,
2006 over 2005 		Six Months Ended August 31,
2006 over 2005
 
Growth
Excluding
Foreign
Exchange 		Foreign
Exchange 		Net
Change 		Growth
Excluding
Foreign
Exchange 		Foreign
Exchange 		Net
Change
Revenue   6 .2% 2 .2% 8 .4% 7 .1% 1 .3% 8 .4%
Cost of Revenue and Operating
   Expenses		  8 .4 4 .0 12 .4 9 .6 3 .1 12 .7
Operating Income   (9 .3) (7 .6) (16 .9) (13 .3) (9 .8) (23 .1)


Non-GAAP Financial Measures

Percentage Change
 
(000s, except per share amounts) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006       2005       2006       2005         2005 to
2006		 2005 to
2006
Non-GAAP Operating Income   $31,163   $34,725   $51,910   $60,887   (10.2 )% (14.7 )%
Non-GAAP Operating Margin   13.6 % 16.4 % 11.6 % 14.8 %
Non-GAAP Net Income   $30,045   $29,899   $49,806   $54,904   0.5   (9.3 )
Non-GAAP Net Income
   per Diluted Share		   $0.33 $0.32 $0.55 $0.59

Non-GAAP operating margin for the quarter ended August 31, 2006 was 13.6% compared to 16.4% for the corresponding quarter of the previous fiscal year. Non-GAAP operating margin for the six months ended August 31, 2006 was 11.6% compared to 14.8% for the same period last year. The decrease in non-GAAP operating margin for the three and six-month periods ended August 31, 2006 is primarily attributable to fluctuations in foreign currency, predominantly the Canadian dollar which continues to be strong compared to the U.S. dollar, and a shift in revenue mix from our higher margin license revenue towards our lower margin product and services revenue. Also contributing to the decline in non-GAAP operating margin was growth in our infrastructure and head count which resulted in our expenses growing faster than our revenues.

Non-GAAP net income for the current quarter was $30.0 million, compared to $29.9 million for the same quarter last year. Non-GAAP net income per diluted share was $0.33 for the current quarter, compared to non-GAAP net income per diluted share of $0.32 for the same quarter last year. Non-GAAP net income for the current six-month period was $49.8 million, compared to $54.9 million for the same period last year. Non-GAAP net income per diluted share was $0.55 for the current six-month period, compared to non-GAAP net income per diluted share of $0.59 for the same period last year.



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The decrease in non-GAAP net income for the three and six months ended August 31, 2006, compared to the same periods in the prior fiscal year, is primarily due to the unfavorable effect of foreign currency, predominantly the stronger Canadian dollar, and a shift in sales mix towards lower margin services revenue. The decrease in non-GAAP net income was partially offset by an increase in interest and other income.

The following tables reflect Cognos’ Non-GAAP Measures reconciled to GAAP results:

Three months ended
August 31, 		Six months ended
August 31,
2006       2005       2006       2005      
Operating Income        
GAAP Operating Income $ 23,704    $ 28,530    $ 37,672    $ 48,973   
Plus:
   Amortization of acquisition-related intangible assets 1,702    1,637    3,403    3,274   
   Stock-based compensation expense 5,757    4,558    10,835    8,640   
Non-GAAP Operating Income $ 31,163    $ 34,725    $ 51,910    $ 60,887   
Operating Margin Percentage
GAAP Operating Margin Percentage 10.3% 13.5% 8.4% 11.9%
Plus:
   Amortization of acquisition-related intangible assets 0.8    0.8    0.8    0.8   
   Stock-based compensation expense 2.5    2.1    2.4    2.1   
Non-GAAP Operating Margin Percentage 13.6% 16.4% 11.6% 14.8%
Net Income
GAAP Net Income $ 23,760    $ 24,900    $ 38,298    $ 45,272   
Plus:
   Amortization of acquisition-related intangible assets 1,702    1,637    3,403    3,274   
   Stock-based compensation expense 5,757    4,558    10,835    8,640   
Less:
   Income tax effect of amortization of acquisition-related
   intangible assets (646)   (624)   (1,271)   (1,249)  
   Income tax effect of stock-based compensation expense (528)   (572)   (1,459)   (1,033)  
Non-GAAP Net Income $ 30,045    $ 29,899    $ 49,806    $ 54,904   
Net Income per diluted share
GAAP Net Income per diluted share $0.26    $0.27    $0.42    $0.48   
Plus:
   Amortization of acquisition-related intangible assets 0.02    0.02    0.04    0.04   
   Stock-based compensation expense 0.06    0.05    0.12    0.09   
Less:
   Income tax effect of amortization of acquisition-related
   intangible assets (0.01)   (0.01)   (0.01)   (0.01)  
   Income tax effect of stock-based compensation expense --    (0.01)   (0.02)   (0.01)  
Non-GAAP Net Income per diluted share $0.33    $0.32    $0.55    $0.59   
Shares used in computing diluted net income per share 90,221    92,806    90,523    93,350   


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Percentage of Revenue Table

The following table sets out, for the periods indicated, the percentage that each income and expense item bears to revenue, and the percentage change of each item compared to the indicated prior period.

Percentage of Revenue Percentage Change
 
Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Revenue   100 .0% 100 .0% 100 .0% 100 .0% 8 .4% 8 .4%
Cost of revenue  22 .9 20 .3 23 .1 20 .8 22 .3 20 .6
Gross margin  77 .1 79 .7 76 .9 79 .2 4 .9 5 .3
Operating expenses 
  Selling, general, and administrative  51 .3 51 .6 52 .7 52 .2 7 .9 9 .5
  Research and development  14 .7 13 .9 15 .0 14 .3 14 .7 13 .3
  Amortization of acquisition-related
    intangible assets		  0 .8 0 .7 0 .8 0 .8 4 .0 3 .9
Total operating expenses  66 .8 66 .2 68 .5 67 .3 9 .3 10 .3
Operating income  10 .3 13 .5 8 .4 11 .9 (16 .9) (23 .1)
Interest and other income, net  2 .7 1 .4 2 .5 1 .4 103 .7 92 .5
Income before taxes  13 .0 14 .9 10 .9 13 .3 (5 .3) (10 .8)
Income tax provision  2 .7 3 .2 2 .3 2 .3 (7 .8) 11 .2
Net income  10 .3% 11 .7% 8 .6% 11 .0% (4 .6) (15 .4)


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REVENUE

Percentage Change
 
($000s) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Product License   $  78,005   $  78,649   $151,740   $149,795   (0 .8)% 1 .3%
Product Support  103,262   92,062   203,443   180,567   12 .2 12 .7
Services  48,623   41,331   91,747   81,755   17 .6 12 .2
 
Total Revenue  $229,890   $212,042   $446,930   $412,117   8 .4 8 .4
 

Our total revenue was $229.9 million for the quarter ended August 31, 2006, an increase of $17.8 million or 8%, compared to the quarter ended August 31, 2005. Our total revenue was $446.9 million for the six months ended August 31, 2006, an increase of $34.8 million or 8%, compared to the six months ended August 31, 2005.

Our total revenue was derived primarily from our suite of BI products now combined into one single product, Cognos 8. Although we continue to generate license revenue from PowerPlay, Impromptu, Cognos ReportNet, Cognos DecisionStream, Cognos Metrics Manager, Cognos Visualizer, NoticeCast, and Cognos Query, the functionality of these products has now been combined on a single platform and as a single product in Cognos 8 and therefore we expect a continuing decline in license revenue from these products in the future more than offset by increased revenue from Cognos 8. During the quarter, we also generated license revenue from Cognos Planning, Cognos Controller, Cognos Analytic Applications, and Cognos Finance, which we will continue to license as standalone products.

The overall change in total revenue from our three revenue categories in the quarter ended August 31, 2006 from August 31, 2005 was as follows: a 1% decrease in product license revenue, a 12% increase in product support revenue, and an 18% increase in services revenue. The increase for the same categories for the six months was as follows: 1%, 13%, and 12%, respectively.

Industry Trends and Geographic Information

We believe that growth in the BI market continues to be driven by three main factors: (1) a desire by enterprises to standardize on one BI platform, (2) investment in the Office of Finance driven by the increasing importance of compliance and transparency, and (3) a growing focus on CPM.

First, we believe BI has become a leading priority within IT budgets as businesses try to leverage their investments in enterprise applications and expand the use of BI within their organizations. In particular, businesses are looking to standardize on one BI platform to reduce the number of platforms and vendors they support and to better align their operations with their strategy. We believe that the breadth and depth of functionality of our BI offering make it the solution of choice.

Second, there is increased investment in systems within the Office of Finance of most enterprises driven by our customers’ continued focus on compliance and transparency. Organizations are looking to replace spreadsheet-based applications and legacy systems with single instance planning, consolidation, and financial reporting solutions that reduce the effort and cost of compliance. Further, these organizations are looking to extend these solutions beyond compliance to achieve best practices, specifically in the areas of rolling plans, planning standardization, and reduced time to close. This focus allows the Office of Finance to extend beyond managing pure financial goals and towards overall performance goals and CPM. We believe that our planning and consolidation products help improve the accuracy, transparency, and timeliness of financial information. For this reason, we believe, we are seeing increased demand for these products.



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Finally, CPM is a growing segment in the software industry. It blends BI with planning, budgeting, and scorecarding to provide management performance visibility and to support the corporate decision-making process. We believe that our market-leading BI, planning, consolidation, and scorecarding products deliver a complete CPM solution. These separate agendas provide multiple entry points into a CPM solution that are appealing to both the finance and operational segments of enterprises. Our single platform for BI differentiates us from our competition by enabling enterprises to easily integrate new and existing IT assets into their CPM plan.

We believe these trends are leading to an increase in the number of large customer contracts, an increase in enterprise-wide deployment of BI products, and a strengthening of our relationships with some of the world’s largest companies, and with our strategic partners. We expect the trend towards larger contracts to continue as a result of the growing demand for standardization and the deepening strategic importance of performance management within our customers’ businesses. While we are becoming involved in more and more of these larger contracts, small and medium-sized contracts continue to be important contributors to our success.

We believe that order size is an indication of enterprise–scale investment in our products by our customers which creates a foundation for future growth. We use the following summary of key revenue indicators to track order size:

Key Revenue Indicators

  Three months ended
August 31, 		Six months ended
August 31,
2006 2005 2006 2005
Orders (License, Support, Services)        
    Transactions greater than $1 million   10      9      23      15 
    Transactions greater than $200,000 120  124     238    228 
    Transactions greater than $50,000 819  754  1,547 1,422 
Average selling price (License orders only) ($000s)
    Greater than $50,000 181  172     184    173 

As the number of large sales opportunities increases, specifically with regard to our customers’ standardization agenda, our sales cycles have become longer as these larger transactions typically require greater scrutiny, a more extensive proof of concept, and a longer decision cycle by our customers because these transactions are more complex and represent a larger proportion of our customers’ investment budgets.



36

Our operations are divided into three main geographic regions: (1) the Americas (consisting of Canada, Mexico, the United States, and Central and South America), (2) EMEA (consisting of the U.K., Continental Europe, the Middle East, and Africa), and (3) Asia/Pacific (consisting of Australia and countries in the Far East). The following table sets out, for each fiscal period indicated, the revenue attributable to each of our three main geographic regions and the percentage change in the dollar amount in each region compared to the prior fiscal period.

Revenue by Geography

Percentage Change
 
($000s) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
The Americas   $137,155   $122,593   $267,068   $238,109   11 .9% 12 .2%
EMEA  72,311   67,596   144,536   134,057   7 .0 7 .8
Asia/Pacific  20,424   21,853   35,326   39,951   (6 .5) (11 .6)
 
Total  $229,890   $212,042   $446,930   $412,117   8 .4 8 .4
 

This table sets out, for each fiscal period indicated, the percentage of total revenue earned in each geographic region.

Revenue by Geography as a Percentage of Total Revenue

  Three months ended
August 31, 		Six months ended
August 31,
2006 2005 2006 2005
The Americas      59.7%      57.8%      59.8%      57.8%
EMEA   31.4   31.9   32.3   32.5
Asia/Pacific     8.9   10.3     7.9     9.7
Total    100.0%    100.0%    100.0%    100.0%

The growth rates of our revenue in EMEA, Asia/Pacific and, to a much lesser extent, in the Americas can be affected by foreign exchange rate fluctuations. The following table breaks down the year-over-year percentage change in revenue for the three and six months ended August 31, 2006 by geographic area between change attributable to growth and change due to fluctuations in the value of the U.S. dollar.



37

Year-over-year Percentage Change in Revenue by Geography

Three Months Ended August 31,
2006 over 2005 		Six Months Ended August 31,
2006 over 2005
 
Growth
Excluding
Foreign
Exchange 		Foreign
Exchange 		Net
Change 		Growth
Excluding
Foreign
Exchange 		Foreign
Exchange 		Net
Change
The Americas   10 .6% 1 .3% 11 .9% 10 .8% 1 .4% 12 .2%
EMEA  2 .3% 4 .7% 7 .0% 5 .9% 1 .9% 7 .8%
Asia/Pacific  (7 .0)% 0 .5% (6 .5)% (10 .7)% (0 .9)% (11 .6)%
Total  6 .2% 2 .2% 8 .4% 7 .2% 1 .2% 8 .4%

The growth rate of our revenue in the Americas and EMEA during the six months ended August 31, 2006 was mostly attributable to increases in volume and size of transactions as there was only a slight impact from fluctuations in foreign currencies. The decrease in revenue in Asia Pacific was largely due to a very strong performance in that region in the comparative period last fiscal year as we closed several large contracts in the region last year. Changes in the valuation of the U.S. dollar relative to other currencies will continue to impact our revenue in the future.

Product License Revenue

Percentage Change
 
($000s) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Product license revenue   $78,005   $78,649   $151,740   $149,795   (0 .8)% 1.3 %
Percentage of total revenue   33.9 % 37.1 % 34.0 % 36.4 %

Product license revenue was $78.0 million in the quarter ended August 31, 2006, a decrease of $0.6 million or 1% from the quarter ended August 31, 2005; and was $151.7 million for the six months ended August 31, 2006, an increase of $1.9 million or 1% compared to the corresponding period in the prior fiscal year. License revenue for the quarter was down slightly due to a combination of factors including sales representatives hiring taking place later in the quarter than anticipated and a slow start to the quarter as the SEC review created a distraction both internally and with our customers. Product license revenue accounted for 34% of total revenue in the three months ended August 31, 2006 compared to 37% for the corresponding quarter in the prior fiscal year, and 34% and 36% for the six months ended August 31, 2006 and August 31, 2005, respectively.

The breadth of our solution is also allowing us to develop long-term strategic relationships with our customers which, in turn, enables us to generate additional software licensing and ongoing maintenance renewals. These relationships are a significant asset as approximately 69% of our license revenue came from existing customers in the three-month period ended August 31, 2006.



38

We license our software through our direct sales force and value-added resellers, system integrators, and OEMs. Direct sales accounted for approximately 72% and 74% of our license revenue for the second quarter of fiscal 2007 and 2006, respectively.

We believe that a direct sales force is an effective way of building long-term relationships with our customers. In addition, as enterprise-wide deployments become larger and more strategic, we believe that our relationships with systems integrators will help us succeed as the role of systems integrators in these large standardization opportunities is increasing. We are also expending resources developing our indirect sales activities in order to have coverage in every desirable market. We will continue to commit management time and financial resources to developing relationships with systems integrators and direct and indirect international sales and support channels.

Product Support Revenue

Percentage Change
 
($000s) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Product support revenue   $103,262   $92,062   $203,443   $180,567   12 .2% 12.7 %
Percentage of total revenue  44.9 % 43.4 % 45.5 % 43.8 %

Product support revenue was $103.3 million in the quarter ended August 31, 2006, an increase of $11.2 million or 12% from the quarter ended August 31, 2005; and was $203.4 million in the six months ended August 31, 2006, an increase of $22.9 million or 13% compared to the corresponding period in the prior fiscal year. The increase in support revenue was the result of our strong renewal rates on our support contracts and the expansion of our customer base. Exchange rate fluctuations had a negligible impact on product support revenue during the quarter.

Product support revenue accounted for 45% and 43% of our total revenue in the quarters ended August 31, 2006 and August 31, 2005, respectively, and was 46% and 44% of total revenue in the six months ended August 31, 2006 and August 31, 2005, respectively.



39

Services Revenue

Percentage Change
 
($000s) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Services revenue   $48,623   $41,331   $91,747   $81,755   17.6 % 12.2 %
Percentage of total revenue   21.2 % 19.5 % 20.5 % 19.8 %

Services revenue (training, consulting, and other revenue) was $48.6 million in the quarter ended August 31, 2006, an increase of $7.3 million or 18% from the quarter ended August 31, 2005; and was $91.7 million in the six months ended August 31, 2006, an increase of $10.0 million or 12% compared to the corresponding period in the prior fiscal year. Services revenue accounted for 21% and 20% of our total revenue for the three months ended August 31, 2006 and August 31, 2005, respectively, and accounted for 20% for both the six months ended August 31, 2006 and August 31, 2005.

The increase in services revenue was primarily attributable to an increase in consulting revenue as we move more towards large enterprise-wide deployments and financial applications-based software. Exchange rate fluctuations had a negligible impact on services revenue for the quarter.

As our business moves more towards these larger enterprise-wide deployments and financial applications-based software, our customers require an increased level of technical expertise and support to meet their specific needs. Successful installation and deployment of our solutions has, we believe, become critical to our customers’ success. As a result, our customers have increasingly required services such as project management, analysis and design, technical advisory, and instruction to effectively deploy our solutions.

COST OF REVENUE

Cost of Product License

Percentage Change
 
($000s) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Cost of product license   $1,445   $1,409   $3,202   $2,631   2.6 % 21.7 %
Percentage of license revenue  1.9 % 1.8 % 2.1 % 1.8 %

The cost of product license revenue was $1.4 million, a negligible difference in the quarter ended August 31, 2006, and was $3.2 million, an increase of $0.6 million or 22% in the six months ended August 31, 2006, compared to the corresponding periods in the prior fiscal year. These costs represented 2% of product license revenue for the three and six months ended August 31, 2006, the same as for both comparative periods in the prior fiscal year.



40

The cost of product license consists primarily of royalties for technology licensed from third parties, as well as the costs of materials and distribution related to licensed software. The change in cost of product license is as follows:

($000s) Year-over-year Change
from August 31,
2005 to 2006
Three months Six months
Royalty cost $ (3) $455 
Other   39    116 
Total year-over-year change $36  $571 

The increase in these costs for the six months ended August 31, 2006 was the result of increases in royalties related to suppliers whose technology is embedded in our software.

Cost of Product Support

Percentage Change
 
($000s) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Cost of product support   $11,384   $8,914   $22,611   $17,910   27.7 % 26.2 %
Percentage of support revenue   11.0 % 9.7 % 11.1 % 9.9 %

The cost of product support revenue was $11.4 million, an increase of $2.5 million or 28% in the quarter ended August 31, 2006, and was $22.6 million, an increase of $4.7 million or 26% in the six months ended August 31, 2006, compared to the corresponding periods in the prior fiscal year. The cost of product support represented 11% of total product support revenue for both the three and six months ended August 31, 2006, compared to 10% for the corresponding periods in the prior fiscal year.

The cost of product support includes the costs associated with resolving customer inquiries and other tele-support and web-support activities, royalties in respect of technological support received from third parties, and the cost of materials delivered in connection with enhancement releases. The change in cost of product support is as follows:



41

($000s) Year-over-year Change
from August 31,
2005 to 2006
Three months Six months
Staff-related costs $1,028  $1,913 
Computer-related costs      863    1,704 
Other      579    1,084 
Total year-over-year change $2,470  $4,701 

The increase in the cost of product support for the three and six month periods ended August 31, 2006 was primarily the result of increases in staff-related costs and computer-related costs to service our growing customer base. The average number of employees within the support organization increased 12% and 9% in the three and six months ended August 31, 2006, respectively compared to the same periods last year. Other includes direct selling and travel and living expenses. The unfavorable effect of fluctuations of foreign currencies relative to the U.S. dollar increased cost of product support by approximately 7% and 6% for the three and six months ended August 31, 2006, respectively, compared to the same periods last year.

Cost of Services

Percentage Change
 
($000s) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Cost of services   $39,805   $32,705   $77,321   $65,002   21.7 % 19.0 %
Percentage of services revenue  81.9 % 79.1 % 84.3 % 79.5 %

The cost of services was $39.8 million, an increase of $7.1 million or 22% in the quarter ended August 31, 2006 and was $77.3 million, an increase of $12.3 million or 19% in the six months ended August 31, 2006 compared to the corresponding periods in the prior fiscal year. The cost of services represented 82% and 84% of services revenue for the three and six months ended August 31, 2006, respectively, compared to 79% for both the corresponding periods in the prior fiscal year.



42

The cost of services includes the costs associated with delivering education, consulting, and other services in relation to our products. The change in cost of services is as follows:

($000s) Year-over-year Change
from August 31,
2005 to 2006
Three months Six months
Staff-related costs $2,569  $  4,872 
Services purchased externally   1,471       2,741 
Travel and living      669       1,741 
Other   2,391       2,965 
Total year-over-year change $7,100  $12,319 

The increase in cost of services for the three and six month periods ended August 31, 2006 was primarily attributable to increases in staff-related costs. The average number of employees within the services organization increased 9% and 8% in the three and six months ended August 31, 2006, respectively, compared to the same periods last year. We continue to invest in services staff as we believe the availability and positioning of services is a key factor in the timing, closure, and success for large transactions. Also contributing to the increase were services purchased externally and travel and living expenses. Subcontractors are an important part of our services offering and are engaged to fill excess demand that cannot be met by internal Cognos service consultants. This demand can be in the form of increased volume or requirements for industry specialization. While we continue to hire new employees in this area, we intend to continue to supplement our skills by engaging subcontractors. Other includes recruiting fees, staff development costs and direct selling costs. The effect of fluctuations of foreign currencies had a 2% and 1% impact on cost of services during the three and six months ended August 31, 2006, respectively.

OPERATING EXPENSES

Selling, General, and Administrative

Percentage Change
 
($000s) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Selling, general, and administrative   $117,981   $109,327   $235,573   $215,042   7.9 % 9.5 %
Percentage of total revenue  51.3 % 51.6 % 52.7 % 52.2 %

Selling, general, and administrative (“SG&A”) expenses were $118.0 million, an increase of $8.7 million or 8% in the quarter ended August 31, 2006, and were $235.6 million, an increase of $20.5 million or 10% in the six months ended August 31, 2006 compared to the corresponding periods in the prior fiscal year. These costs represented 51% and 53% of total revenue for the three and six months ended August 31, 2006, respectively, compared to 52% for both the corresponding periods in the prior fiscal year.



43

SG&A expenses include staff related costs and travel and living expenditures for sales, marketing, management, and administrative personnel. These expenses also include costs associated with the sale and marketing of our products, professional services, and other administrative costs. The change in SG&A expenses is as follows:

($000s) Year-over-year Change
from August 31,
2005 to 2006
Three months Six months
Staff-related costs  $ 8,056  $15,707 
Professional services     1,357      3,539 
External contractors     1,340      2,005 
Travel & living        426      2,446 
Marketing       (742)   (1,094)
Staff development    (1,120)      (352)
Other       (663)   (1,720)
Total year-over-year change $ 8,654  $ 20,531 

The increase in SG&A expenses in the three and six months ended August 31, 2006 was the result of increases in staff-related costs resulting from higher compensation related expenses, as well as associated benefits, compared to the same periods last year. The average number of employees within SG&A increased by 4% in both the three and six months ended August 31, 2006, when compared to the corresponding periods in the prior fiscal year. Contributing to the increase for both the three and six months ended August 31, 2006 were increases in professional services, including expenses related to the SEC review, external contractors and travel and living expenditures. This was partially offset by a decrease in marketing and staff development. The unfavorable effect of fluctuations of foreign currencies relative to the U.S. dollar increased SG&A expenses by approximately 3% and 2% for the three and six months ended August 31, 2006, respectively, when compared to the corresponding periods in the prior fiscal year.

Research and Development

Percentage Change
 
($000s) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Research and development   $33,869   $29,520   $67,148   $59,285   14.7 % 13.3 %
Percentage of total revenue  14.7 % 13.9 % 15.0 % 14.3 %

Research and development (“R&D”) expenses were $33.9 million, an increase of $4.3 million or 15% in the quarter ended August 31, 2006, and were $67.1 million, an increase of $7.9 million or 13% for the six months ended August 31, 2006 compared to the corresponding periods in the prior fiscal year. R&D costs were 15% of revenue for both the three and six months ended August 31, 2006, compared to 14% of revenue for both of the corresponding periods in the prior fiscal year.



44

R&D expenses are primarily staff-related costs attributable to the design and enhancement of existing products along with the creation of new products. The change in R&D expenses is as follows:

($000s) Year-over-year Change
from August 31,
2005 to 2006
Three months Six months
Staff-related costs $2,665  $4,919 
Other   1,684    2,944 
Total year-over-year change $4,349  $7,863 

The increase in R&D expenses for the three and six months ended August 31, 2006 was the result of increases in staff-related costs resulting from higher compensation related expenses, as well as associated benefits, compared to the previous fiscal year, driven by an increase in personnel. The average number of employees within R&D increased by 7% for both the three and six months ended August 31, 2006, when compared to the corresponding periods of the prior fiscal year. The unfavorable effect of fluctuations of foreign currencies, especially the Canadian dollar, relative to the U.S. dollar increased R&D expenses by approximately 7% and 6% for the three and six months ended August 31, 2006, respectively, when compared to the corresponding periods of the prior fiscal year.

We continue to invest significantly in R&D activities for our next generation of BI solutions which are the foundation of our CPM vision. During the quarter, we shipped the second maintenance release for Cognos 8. This new version of Cognos 8 includes enhanced quality, upgradeability and performance. In addition, we released Cognos 8 Workforce Performance during our second quarter. Building on the Cognos 8 architecture, this product helps organizations better manage and optimize their human capital assets by allowing customers to quickly construct analytic applications for Workforce Performance based on user roles and report requirements, rather than the traditional approach of building specific reports one at a time.

We also recently previewed Cognos 8 Go! Mobile, a new BI solution that will bring decision-support information directly to mobile device users for right-time decision making. Cognos 8 Go! Mobile follows the recent announcement of Cognos Go! Search and represents Cognos’ next milestone in making BI accessible to more people and enabling higher adoption of business intelligence for enhanced decision making and improved organizational performance. Cognos Go! Search, announced in the previous quarter, is a new BI search capability that will enable users to instantly find relevant, strategic enterprise information available through Cognos 8.

We currently do not have any software development costs capitalized on our balance sheet. Software development costs are expensed as incurred unless they meet the requirements of generally accepted accounting principles for deferral and amortization. Software development costs incurred prior to the establishment of technological feasibility do not meet these criteria, and are expensed as incurred. Capitalized costs would be amortized over a period not exceeding 36 months. No costs were deferred in the three and six months ended August 31, 2006 and August 31, 2005. Costs were not deferred in the periods because either no projects met the criteria for deferral or, if met, the period between achieving technological feasibility and the general availability of the product was short, rendering the associated costs immaterial.



45

Amortization of Acquisition-related Intangible Assets

Percentage Change
 
($000s) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Amortization of acquisition-related
   intangible assets		   $1,702   $1,637   $3,403   $3,274   4 .0% 3 .9%

Amortization of acquisition-related intangible assets was $1.7 million, an increase of $0.1 million or 4% for the quarter ended August 31, 2006 and was $3.4 million, an increase of $0.1 million or 4% for the six months ended August 31, 2006 compared to the corresponding periods in the prior year. The increase in this expense in the three and six months ended August 31, 2006 was due to the amortization of acquired technology relating to the acquisitions of Databeacon Inc. and Digital Aspects Ltd. during the third quarter of fiscal 2006.

On September 7, 2006, in order to streamline our organization and improve our operating margin on a long term basis, we announced a restructuring plan. The plan includes a planned reduction of approximately 210 personnel or 6% of our global workforce, focused primarily on management and non-revenue-generating positions. We will continue to increase our investment in customer facing resources. We expect to substantially complete the activities relating to the plan within our fiscal year 2007. As part of this plan, and in with FAS 146, we expect to incur approximately $28.0 million in operating expenses in the third quarter of fiscal year 2007. Substantially all of the expected pre-tax charges are one-time employee termination benefits.

INTEREST AND OTHER INCOME, NET

Percentage Change
 
($000s) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Interest and other income, net   $6,216   $3,051   $11,227   $5,831   103.7 % 92.5 %

Net interest income was $6.2 million, an increase of $3.2 million or 104% in the quarter ended August 31, 2006 and was $11.2 million, an increase of $5.4 million or 93% in the six months ended August 31, 2006 compared to the corresponding periods in the prior fiscal year. The change in net interest and other income is as follows:



46

($000s) Year-over-year Change
from August 31,
2005 to 2006
Three months Six months
Increase in interest revenue $3,108  $5,494 
Decrease in interest and other expenses      514       749 
Loss on foreign exchange     (457)     (847)
Total year-over-year change $3,165  $5,396 

The increase in interest revenue during the three and six months ended August 31, 2006 was attributable to an increase in the average portfolio size accompanied by an increase in the average yield on investments compared to the corresponding periods in the prior fiscal year.

INCOME TAX PROVISION

Percentage Change
 
($000s) Three months ended
August 31,		 Six months ended
August 31,		 Three
months
ended
August 31,		 Six
months
ended
August 31,
2006 2005 2006 2005 2005 to
2006		 2005 to
2006
Income tax provision   $6,160   $6,681   $10,601   $9,532   (7.8 )% 11.2 %
Effective tax rate  20.6 % 21.2 % 21.7 % 17.4 %

As we operate globally, we calculate our income tax provision in each of the jurisdictions in which we conduct business. Our tax rate is therefore affected by the relative profitability of our operations in various geographic regions. In the three and six months ended August 31, 2006, we recorded an income tax provision of $6.2 million and $10.6 million, respectively, representing an effective income tax rate of 21% and 22%, respectively. Comparatively, in the three and six months ended August 31, 2005, we recorded an income tax provision of $6.7 million and $9.5 million, respectively, representing an effective income tax rate of 21% and 17%, respectively. We estimate our effective tax rate for the current fiscal year to be 23.5%, exclusive of any one-time events. This estimated effective tax rate was reduced for the three and six-month periods ended August 31, 2006 to 20.6% and 21.7%, respectively due to adjustments related to a modification of an intercompany commercial arrangement and an election in respect of the functional currency of a subsidiary. For the three and six months ended August 31, 2005, the Corporation estimated its effective tax rate for fiscal 2006 to be 22%, exclusive of any one-time events. This estimated effective tax rate was reduced for the three-month period ended August 31, 2005 to 21.1% due to adjustments relating to various tax audits and prior period tax provisions. The effective tax rate for the six-month period ended August 31, 2005 was adjusted to 17.4% due to the adjustments in the quarter as well as the recognition of one-time benefits in the previous quarter resulting from (i) a tax court decision that allowed corporations to claim investment tax credits on stock-based compensation for research and development personnel relating to fiscal years 2004 and 2005 and (ii) a change in tax withholding legislation relating to one of the Corporation’s subsidiaries.



47

LIQUIDITY AND CAPITAL RESOURCES

($000s) As at
August 31,
2006		 As at
February 28,
2006		 Percentage Change
Cash and cash equivalents   $417,499   $398,634              4.7%
Short-term investments   200,585   152,368         31.6
 
Cash, cash equivalents, and short-term investments  $618,084   $551,002         12.2
Working capital  457,180   419,437           9.0

($000s) Six months ended
August 31,		 Percentage Change
Six months ended
August 31,
2006 2005 2005 to 2006
Net cash provided by (used in):        
  Operating activities  $ 88,771   $ 24,446          263.1%  
  Investing activities  (58,983 ) 37,065      (259.1)
  Financing activities  (14,032 ) (31,539 )      (55.5)

As at
August 31,
2006		 As at
August 31,
2005
Days sales outstanding (DSO)              57              60    

Cash, Cash Equivalents, and Short-term Investments

As at August 31, 2006, we held $618.1 million in cash, cash equivalents, and short-term investments, an increase of $67.1 million from February 28, 2006. This increase is primarily attributable to net income for the period and the collection of accounts receivable which were seasonally high at the end of fiscal 2006. Cash and cash equivalents include investments which are highly liquid and held to maturity. Cash equivalents typically include commercial paper, term deposits, banker’s acceptances and bearer deposit notes issued by major international banks. All cash equivalents have terms to maturity of ninety days or less. Short-term investments are investments that are highly liquid and held to maturity with terms to maturity greater than ninety days, but less than twelve months. Short-term investments typically consist of commercial paper, corporate bonds, bearer deposit notes, and government securities.

We group cash and cash equivalents with short-term investments when analyzing our total cash position. These balances may fluctuate from quarter to quarter depending on the renewal terms of the investments.



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Working Capital

Working capital represents our current assets less our current liabilities. As of August 31, 2006, working capital was $457.2 million, an increase of $37.7 million from February 28, 2006. The increase in working capital can be attributed to an increase in short-term investments and a net decrease in current liabilities, especially accounts payable and deferred revenue. Offsetting this increase were decreases in accounts receivable.

Days sales outstanding (DSO) was 57 days at August 31, 2006, compared to 60 days as at August 31, 2005. We calculate our days sales outstanding ratio based on ending accounts receivable balances and quarterly revenue.

Long-term Liabilities

As at August 31, 2006 and February 28, 2006, we had no long-term debt.

Cash Provided by Operating Activities

Cash provided by operating activities (after changes in non-cash working capital items) for the six months ended August 31, 2006 was $88.8 million, an increase of $64.3 million compared to the same period last year. The increase is primarily attributable to changes in working capital, most notably the collection of accounts receivable and a reduction of the amount paid for year end bonuses, commissions and income taxes, compared to the same period last year.

Cash Provided by (Used in) Investing Activities

Cash used in investing activities was $59.0 million for the six months ended August 31, 2006, compared to cash provided by investing activities of $37.1 million in the corresponding period last fiscal year. During the six months ended August 31, 2006, we had a net increase in short-term investments, while during the six months ended August 31, 2005, we had a net decrease in short-term investments as many of our investments matured during this period. In the six months ended August 31, 2006, our purchases of short-term investments, net of maturities, were $47.2 million. In comparison, during the six months ended August 31, 2005, our proceeds on maturity of short-term investments, net of purchases, were $48.4 million. During both the six months ended August 31, 2006 and August 31, 2005, we spent $10.9 million on fixed asset additions. The additions for both periods related primarily to computer equipment and software, office furniture and leasehold improvements.

Cash Used in Financing Activities

Cash used in financing activities was $14.0 million for the six months ended August 31, 2006, a decrease in financing activities of $17.5 million compared to the same period of the prior fiscal year. We issued 556,000 common shares for proceeds of $13.5 million, during the six months ended August 31, 2006, compared to the issuance of 766,000 shares for proceeds of $17.6 million during the corresponding period in the prior fiscal year. The issuance of shares in the six months ended August 31, 2006 was pursuant to our stock purchase plan and the exercise of stock options by employees, officers, and directors.



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We also paid $25.0 million during the six months ended August 31, 2006 to repurchase 652,000 shares on the open market. Comparatively, for the six months ended August 31, 2005 we repurchased 1,266,000 shares at a value of $48.9 million. The share repurchases made during both periods were part of distinct open market share repurchase programs through The Nasdaq Global Market or The Toronto Stock Exchange. The share repurchase programs have historically been adopted in October of each year and run for one year. They allow the Corporation to purchase no more than 5% (10% in the 2005-2006 plan) of the issued and outstanding shares of the Corporation on the date the plan is adopted. These programs do not commit the Corporation to make any share repurchases. Purchases can be made on The Nasdaq Global Market or The Toronto Stock Exchange at prevailing open market prices and are paid out of general corporate funds. We cancel all shares repurchased under the bid. A copy of the Notice of Intention to Make an Issuer Bid is available from the Corporate Secretary.

From June 1, 2006 to August 3, 2006, all of the directors and executives officers of Cognos along with certain of our employees were prohibited from trading in our securities pursuant to a management cease trade order issued by the Ontario Securities Commission and the Quebec Securities Commission in connection with the delay in the filing of certain of our financial statements. During this management cease trade order, we did not repurchase any of our shares in the open market. We expect to resume repurchasing shares in the open market under our share repurchase program.

It has been the Corporation’s practice to make an annual grant of options to key employees following its annual meeting of shareholders, typically held in late June. However, our annual meeting for June 2006 was postponed due to a review of our revenue recognition practices by the Staff of the Division of Corporation Finance of the Securities and Exchange Commission. The review was resolved without any objection by the Staff. However, on September 7, 2006, we announced an operating margin improvement plan which would result in a reduction of our global workforce by approximately 210 personnel. In light of this action and the prolonged delay in granting stock options to employees, the Board of Directors of the Corporation determined that it was imperative to accelerate the award of equity grants to employees in September. Accordingly, we awarded 240,000 options and 436,192 RSUs on September 26, 2006. We advised the trustee of these RSU grants and the trustee has purchased approximately 437,000 common shares to fulfill this RSU award.

Contracts and Commitments

We have unsecured credit facilities subject to annual renewal. These credit facilities permit us to borrow funds or issue letters of credit or guarantee up to Cdn $39.5 million (U.S. $31.3 million), subject to certain covenants. As of August 31, 2006 and 2005, there were no direct borrowings under these facilities.

We do not enter into off-balance sheet financing as a matter of practice except for the use of operating leases for office space, computer equipment, and vehicles. In accordance with GAAP, neither the lease liability nor the underlying asset is carried on the balance sheet, as the terms of the leases do not meet the thresholds for capitalization.

During fiscal 2005, we entered into cash flow hedges in order to offset the risk associated with the effects of certain foreign currency exposures related to an intercompany loan and the corresponding interest payments between subsidiaries with different functional currencies. As at August 31, 2006, we had cash flow hedges, with maturity dates between February 28, 2007 and January 14, 2008, to exchange the U.S. dollar equivalent of $74.4 million in foreign currency. At August 31, 2006, we had an unrealized loss in the amount of $3.0 million in relation to these contracts with an offsetting gain on the hedged loan. We entered into these foreign currency exchange forward contracts with major Canadian chartered banks, and therefore we do not anticipate non-performance by these counterparties. The amount of the exposure on account of any non-performance is restricted to the unrealized gains in such contracts.



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We may enter into foreign exchange contracts that we choose not to designate as a hedge for accounting purposes. We carry these contracts at their fair value with any gain or loss included in income. At August 31, 2006, we had three such contracts to exchange the U.S. dollar equivalent of $5.8 million. We entered into these contracts to offset the foreign exchange risk on trade account receivables that were not in the functional currency of the subsidiary which held them. The estimated fair value of these contracts at August 31, 2006 was not material.

On September 7, 2006, in order to streamline our organization and improve our operating margin on a long term basis, we announced a restructuring plan. The plan includes a planned reduction of approximately 210 personnel or 6% of our global workforce, focused primarily on management and non-revenue-generating positions. We will continue to increase our investment in customer facing resources. We expect to substantially complete the activities relating to the plan within our fiscal year 2007. As part of this plan, and in accordance with FAS 146, we expect to incur approximately $28.0 million in total pre-tax charges in the third quarter of fiscal year 2007. We expect that $26.0 million will be paid in cash. The remaining $2.0 million in pre-tax charges are expected to be non-cash expenses resulting primarily from employee termination costs related to non-cash stock-based compensation costs.

Our contractual obligations have not changed materially from those included in our Annual Report on Form 10-K for the year ended February 28, 2006.

We have never declared or paid any cash dividends on our common shares. Our current policy is to retain our earnings to finance expansion and to develop, license, and acquire new software products, and to otherwise reinvest in Cognos.

Given our historical profitability and our ability to manage expenses, we believe that our current resources are adequate to meet our requirements for working capital and capital expenditures through the foreseeable future.

Inflation has not had a significant impact on our results of operations.

CRITICAL ACCOUNTING ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The estimates form the basis for making judgments about the carrying values of assets and liabilities that may not be readily apparent from other sources. These judgments may change based upon changes in business conditions. As a result, actual results may differ from these estimates under different assumptions, conditions, and experience.



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The following critical accounting policies and significant estimates are used in the preparation of our consolidated financial statements:

• Revenue Recognition

• Stock-based Compensation

• Allowance for Doubtful Accounts

• Accounting for Income Taxes

• Business Combinations

• Impairment of Goodwill and Long-lived Assets

Revenue Recognition – We recognize revenue in accordance with Statement of Position (“SOP”) No. 97-2, Software Revenue Recognition as amended by SOP No. 98-9, Software Revenue Recognition with Respect to Certain Arrangements (collectively “SOP 97-2”). As such, we exercise judgment and use estimates in connection with the determination of the amount of software license, post-contract customer support (“PCS”), and professional services (“services”) revenues to be recognized in each accounting period.

We sell off-the shelf software generally bundled with PCS and, on occasion, services in multiple-element arrangements. SOP 97-2 requires that judgment be applied to distinguish whether multiple elements in an arrangement can be treated as separate accounting units. In order to account separately for the services element of an arrangement that includes both product license and services, the services (a) must not be essential to the functionality of any other element of the transaction and (b) must be stated separately such that the total price of the arrangement can be expected to vary as a result of the inclusion or exclusion of the services. If these two criteria are not met, the entire arrangement is accounted for using the percentage of completion method in accordance with SOP 81-1, Accounting for Performance of Construction Type and Certain Production Type Contracts. While the service element must be stated separately, the service element does not have to be priced separately in the contract in order to separately account for the services as a separate element of the transaction.

For substantially all of our software arrangements, we defer revenue for the PCS and services to be provided to the customer based on vendor-specific objective evidence (“VSOE”) of fair value and recognize revenue for the product license when persuasive evidence of an arrangement exists and delivery of the software has occurred, provided the fee is fixed or determinable and collection is deemed probable.

We evaluate each of these criteria as follows:

• Persuasive evidence of an arrangement exists:    Our standard business practice is that persuasive evidence exists when we have a binding contract between ourselves and a customer for the provision of software or services.

• Delivery has occurred:    Delivery is considered to occur when media containing the licensed programs is provided to a common carrier or, in the case of electronic delivery, the customer is given access to download the licensed program. Our typical end user license agreement does not include customer acceptance provisions. We recognize revenue from resellers in the same fashion as end-user licenses unless fee payments are based upon the number of copies made or ordered. In cases where the fees are linked to the number of copies, revenue is recognized upon sell-through to the end customer based on the number of copies sold.



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• The fee is fixed or determinable:    A fee is fixed or determinable if it is a fixed amount of money or an amount that can be determined at the commencement of the contract, and is payable on Cognos’ standard payment terms. Fees are generally considered fixed or determinable unless a significant portion (more than 10%) of the licensing fee is due more than 12 months after delivery, in which case revenue is recognized when payment becomes due from the customer. In addition, we only consider the fee to be fixed or determinable if the fee is not subject to refund or adjustment. Our typical end user and reseller license agreements do not allow for refunds, returns or adjustments to the licensing fee. However, in the rare circumstance where this might occur and a refund, return or adjustment is agreed upon, revenue is recognized upon the expiration of the rights of exchange or return. For resellers, if they are newly formed, undercapitalized, or in financial difficulty, or if uncertainties about the number of copies to be sold by the reseller exist, fees are not considered fixed or determinable. If the arrangement fee is not fixed or determinable, we recognize the revenue as amounts become due and payable.

• Collectibility is probable:    We extend credit to credit worthy customers in order to facilitate our business. Credit is extended through the process of risk identification, evaluation, and containment. In practical terms, this process will take the form of: customer credit checks; established credit limits for customers (where necessary); and predetermined terms of sale. Collection is deemed probable if we expect that the customer will be able to pay amounts under the arrangement as payments become due. If we determine that collection is not probable, we defer the revenue and recognize the revenue upon cash collection.

Under the residual method prescribed by SOP 97-2, a portion of the arrangement fee is first allocated to undelivered elements included in the arrangement (i.e., PCS and services) based on VSOE of fair value, with the remainder of the arrangement fee being allocated to the delivered elements of the arrangement. Our contracts commonly include product license, PCS, and services (e.g., education and consulting). Each product license arrangement requires careful analysis to ensure that each of the individual elements in the transaction has been identified, along with VSOE of the fair value of each element. If VSOE of fair value cannot be established for the undelivered elements of a product license agreement, the entire amount of revenue from the arrangement is deferred and recognized over the period that these elements are delivered.

Services revenue primarily consists of implementation services related to the installation of our products and training revenues. Our software is ready to use by the customer upon receipt. While many of our customers may choose to configure the software to fit their specific needs, our implementation services do not involve significant customization to or development of the underlying software code. Substantially all of our services arrangements are billed on a time and materials basis and, accordingly, are recognized as the services are performed. The fair value of the services portion of the arrangement is established according to our standard price list, which includes quantity discounts, and it is based on our history of separate sales using such price lists.

Our customers typically pre-pay PCS for the first year in connection with a new product license. In such cases, an amount equal to VSOE of fair value for PCS is deferred and recognized ratably over the term of the initial PCS contract, typically 12 months. PCS is renewable by the customer on an annual basis thereafter. We use two methods to determine VSOE of fair value for PCS in a multi-element arrangement: stated price and the price when an element is sold separately. If a stated rate (either a stated renewal rate or a stated rate for the first year PCS bundled with the software license) is included in a contract (i.e., the first method), that rate is used to account for the PCS provided to that customer, provided that the rate is substantive and consistent with our customary pricing practices. Historically, there has been a high correlation between the amounts allocated to PCS in the initial software licensing arrangement for such arrangements and the amounts at which PCS is renewed. The second method is the price charged when the same element is sold separately. We account for PCS using the first method when a stated PCS rate is included in a contract. For all other contracts, we establish VSOE of fair value for PCS based upon the price charged when PCS is sold separately (i.e., the second method).



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Our customer experience has shown that our contractual arrangements have historically used two forms of contract terms regarding PCS; contracts which include a stated PCS rate (either a stated renewal rate or a stated rate for the first year PCS bundled with the software license); and contracts which do not state a PCS rate. For contracts which include a stated renewal rate, we use that contractually stated renewal rate to allocate arrangement consideration to the undelivered PCS at the inception of the arrangement and recognize such consideration ratably over the PCS term provided that the stated rate is substantive and consistent with our customary pricing practices. Historically, there has been a high correlation between the amounts allocated to PCS in the initial software licensing arrangement for such arrangements and the amounts at which PCS is renewed.

For contracts that state a first year PCS rate, we use that stated rate to allocate arrangement consideration to the undelivered PCS at the inception of the arrangement and recognize such consideration ratably over the PCS term, provided that it is consistent with our customary pricing practices. Our customer experience based on our continual monitoring of the process has been that this stated rate is typically the rate at which PCS will be renewed and is a substantive rate. Historically, there has been a high correlation between the amounts allocated to PCS in the initial software licensing arrangement for such arrangements and the amounts at which PCS is renewed. If our renewals history began to indicate that renewals were not highly correlated to the first year PCS amounts that we use to allocate revenue to PCS at the inception of the arrangement, then we would not be able to establish VSOE of fair value for PCS for such contracts and revenue attributable to the software license and PCS would be recognized ratably over the PCS period.

For contracts which do not state a PCS rate, we allocate a consistent percentage of the license fee to PCS in the first year of such arrangements based on a substantive rate at which our customer experience indicates customers will typically agree to renew PCS. Historically, there has been a high correlation between the mean of amounts allocated to PCS in the initial software licensing arrangement for such arrangements and the mean of amounts at which PCS is renewed.

We allocate arrangement consideration to PCS included in a software licensing arrangement based upon contemporaneous evidence of stand-alone prices and the application of controlled processes. These controlled processes include making judgments about the amount of arrangement consideration to allocate to PCS in contracts which do not state a PCS rate. Such judgments include continual monitoring of customer acceptance of renewal rates by other customers of the same customer class and evaluating customer tolerance for rate changes from a business standpoint at the time the initial license arrangement is established. On an historical basis, the contemporaneous evidence used has enabled us to establish the first year deferral consistent with the amount at which PCS has actually been renewed in the second and subsequent years. We use these renewals, which represent separate contemporaneous sales of PCS, as a basis to establish VSOE of fair value. Our process has historically provided experience to establish VSOE for PCS due to our continual monitoring of the process. If there are changes in the customers’ acceptance of renewal rates or tolerance for rate change or our related ability to monitor and evaluate those changes, we may no longer be able to establish VSOE of fair value for PCS and accordingly revenue attributable to the software license and PCS would be recognized ratably over the PCS period.

We stratify our customers into three classes in determining VSOE of fair value for PCS. The classifications are based on the amount of software license business (i.e., software license revenues), life-to-date, that has previously been obtained from the respective customers. For each class of customer, a range of prices exists which represents VSOE of fair value for PCS for that class of customer based upon substantive renewals and our experience that there is a high correlation between the mean of amount allocated to PCS in the initial software licensing arrangement for such arrangements and the mean of amounts at which PCS is renewed.



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When a PCS rate in individual arrangements is stated below the lower limits of our acceptable ranges by customer class, we allocate an amount for PCS equal to the low end of the applicable range by customer class. This adjustment allocates additional revenue from license revenue to deferred PCS revenue which is amortized over the life of the PCS contract, which is typically one year. If the stated PCS rate is above the reasonable range, no adjustment is made and the deferred PCS revenue is measured at the contracted percentage.

In determining VSOE of fair value for PCS, we conduct our analysis on the basis of customer classes as described above. We do not consider other factors, such as: geographic regions or locations; type and nature of products; distribution channel (i.e. direct and resellers); stage of licensed product life cycle; other arrangement elements; overall economics; term of the license arrangement; or other factors. We do not differentiate our pricing policies based on these factors and our customer experience has indicated no difference in customer renewal behavior based on these factors. While our renewal experience has not shown differences in renewal behavior based on these discriminate factors, it is possible that changes related to these factors or our related ability to monitor and evaluate those changes could occur. In such circumstances, we may come to the determination that we can no longer substantiate VSOE of fair value for PCS for some or all of our software license agreements and revenue related to software licenses and PCS in such agreements would be recognized ratably over the PCS period.

We recognize revenue for resellers, value added resellers, original equipment manufacturers, and strategic system integrators (collectively “resellers”) in a similar manner to our recognition of revenue for end-users.

Stock-based Compensation – Effective March 1, 2006, we adopted FAS 123R to account for our stock option, stock purchase, deferred share and restricted share unit plans. We elected to implement FAS 123R using the modified retrospective method of transition provided by FAS 123R and, accordingly, financial statement amounts for all prior periods presented herein reflect results as if the fair value method of expensing had been applied from the original effective date of FAS 123, the predecessor to FAS 123R.

Under this standard, companies are required to account for stock-based transactions using a fair value method and recognize the expense in the consolidated statements of income. We previously accounted for stock-based compensation transactions using the intrinsic value method in accordance with APB 25 and provided the pro forma disclosures prescribed by FAS 123. Except for certain acquisition-related options, the exercise price of all stock options is equal to the closing market price of the stock on the trading day preceding the date of grant. Accordingly, with the exception of this acquisition-related compensation and awards granted under our deferred share and restricted share unit plans, no compensation cost had been recognized in the financial statements prior to fiscal 2007.

In order to calculate the fair value of stock-based payment awards, we use a binomial lattice model. This model requires the input of subjective assumptions, including stock price volatility, the expected exercise behavior and forfeiture rate. Expected volatilities are based on the historical volatility of our stock, implied volatilities from traded options on our stock and other relevant factors. We use historical data to estimate option exercise and employee termination within the valuation model: separate groups of employees that have similar exercise behavior and turnover rates are considered separately for valuation purposes. The expected life of options granted is derived from the output of the option valuation model and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option are determined by the US Treasury yields and the Government of Canada benchmark bond yields for U.S. dollar and Canadian dollar options, respectively, in effect at the time of the grant.



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The assumptions used in calculating the fair value of stock-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change or we use different assumptions, our stock-based compensation expense could be materially different in the future. Further, the liability incurred as a result of our performance-based restricted share units and our deferred share unit plans is based on the fair value of our stock on the balance sheet date. If the value of our stock were to change significantly, our stock-based compensation expense could be significantly different in the future. We are also required to estimate the forfeiture rate and only recognize the expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, our stock-based compensation expense could be significantly different from what we have recorded in the period such determination is made.

Allowance for Doubtful Accounts – We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We regularly review our accounts receivable and use our judgment to assess the collectibility of specific accounts and, based on this assessment, an allowance is maintained for 100% of all accounts over 360 days and specific accounts deemed to be uncollectible. For those receivables not specifically identified as uncollectible, an allowance is maintained for 2% of those receivables at August 31, 2006. In order to determine the percentage used, we analyze, on an annual basis, the geographical aging of the accounts, the nature of the receivables (i.e. license, maintenance, consulting), our historical collection experience, and current economic conditions.

In the past, changes in these factors have resulted in adjustments to our allowance for doubtful accounts. These adjustments have been accounted for as changes in estimates, the effect of which has not been significant on our results of operations and financial condition. As these factors change, the estimates made by management will also change, which will impact our provision for doubtful accounts in the future. Specifically, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, an additional provision for doubtful accounts may be required.

Accounting for Income Taxes – As an entity which operates globally, we calculate our income tax liabilities in each of the jurisdictions in which we conduct business. Our tax rate is therefore affected by the relative profitability of our operations in various geographic regions. We are subject to ongoing tax examinations and assessments in various jurisdictions. Accordingly, we may incur additional tax expense based upon our assessment of the probable outcomes of such matters. In addition, when applicable, we adjust the previously recorded tax expense to reflect examination results. Our ongoing assessments of the probable outcome of the examinations and related tax positions require judgment and can materially increase or decrease our effective tax rate as well as impact our operating results.

We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Although we have considered forecasted taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, there is no assurance that the valuation allowance will not need to be adjusted to cover changes in deferred tax assets that may not be realized.



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Our valuation allowance pertains primarily to net operating loss carryforwards. A portion of these loss carryforwards resulted from acquisitions. In the event we were to subsequently determine that we would be able to realize deferred tax assets related to acquisitions in excess of the net purchase price allocated to those deferred tax assets, we would record a credit to goodwill.

If we were to determine that we would be able to realize deferred tax assets unrelated to acquisitions in excess of the net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Should we determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax asset would reduce income in the period such determination was made.

We provide for withholding taxes on the undistributed earnings of our foreign subsidiaries where applicable. The ultimate tax liability related to the undistributed earnings could differ materially from the liabilities recorded in our financial statements. These differences could have a material effect on our income tax liabilities and our net income.

Business Combinations – We account for acquisitions of companies in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations. We allocate the purchase price to tangible assets, intangible assets, and liabilities based on fair values with the excess of purchase price amount being allocated to goodwill.

Historically, our acquisitions have resulted in the recognition of significant amounts of goodwill and acquired intangible assets. In order to allocate a purchase price to these intangible assets and goodwill, we make estimates and judgments based on assumptions about the future income producing capabilities of these assets and related future expected cash flows. We also make estimates about the useful life of the acquired intangible assets. Should different conditions prevail, we could incur write-downs of goodwill, write-downs of intangible assets, or changes in the estimation of useful life of those intangible assets. In the past, we have made adjustments to the valuation allowance on deferred tax assets related to loss carry forwards acquired through acquisitions and the restructuring accrual related to acquisitions. These adjustments did not affect our result of operations. Instead, these adjustments were applied to goodwill.

In accordance with SFAS No.142, Goodwill and Other Intangible Assets (“SFAS 142”), goodwill is not amortized, but is subject to annual impairment testing which is discussed in greater detail below under Impairment of Goodwill and Long-lived Assets.

Intangible assets currently include acquired technology, contractual relationships, and trademarks and patents. Acquired technology is initially recorded at fair value based on the present value of the estimated net future income-producing capabilities of the software products acquired. Acquired technology is amortized over its estimated useful life on a straight-line basis. Contractual relationships represent contractual and separable relationships that we have with certain customers and partners that we acquired through acquisitions. These contractual relationships were initially recorded at their fair value based on the present value of expected future cash flows and are amortized over their estimated useful life. Trademarks and patents are initially recorded at cost. Cost includes legal fees and other expenses incurred in order to obtain these assets. They are amortized over their estimated useful life on a straight-line basis.



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In accordance with SFAS 142, we continuously evaluate the remaining useful life of our intangible assets being amortized to determine whether events or circumstances warrant a revision to the estimated remaining amortization period.

Other estimates associated with the accounting for acquisitions include restructuring costs. Restructuring costs primarily relate to involuntary employee separations and accruals for vacating duplicate premises. Restructuring costs associated with the pre-acquisition activities of an entity acquired are accounted for in accordance with Emerging Issues Task Force No. 95-3, Recognition of Liabilities in Connection with a Business Combination (“EITF 95-3”). To calculate restructuring costs accounted for under EITF 95-3, management estimates the number of employees that will be involuntarily terminated and the associated costs and the future costs to operate and sublease duplicate facilities once they are vacated. Changes to the restructuring plan could result in material adjustments to the restructuring accrual.

Impairment of Goodwill and Long-lived Assets – In accordance with SFAS 142, goodwill is subject to annual impairment tests, or on a more frequent basis if events or conditions indicate that goodwill may be impaired. Goodwill is tested for impairment at a level of reporting referred to as a reporting unit. The Corporation as a whole is considered one reporting unit. Quoted market prices in active markets are considered the best evidence of fair value. Therefore, the first step of our annual test is to compare the fair value of our shares on The Nasdaq Stock Market to the carrying value of our net assets. If we determine that our carrying value exceeds our fair value, we would conduct a second step to the goodwill impairment test. The second step compares the implied fair value of the goodwill (determined as the excess fair value over the fair value assigned to our other assets and liabilities) to the carrying amount of goodwill. To date, we have not needed to perform the second step in testing goodwill impairment. If the carrying amount of goodwill were to exceed the implied fair value of goodwill, an impairment loss would be recognized.

We evaluate all of our long-lived assets, including intangible assets other than goodwill and fixed assets, periodically for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets (“SFAS 144”). SFAS 144 requires that long-lived assets be evaluated for impairment when events or changes in facts and circumstances indicate that their carrying value may not be recoverable. Events or changes in facts or circumstances can include a strategic change in business direction, decline or discontinuance of a product line, a reduction in our customer base, or a restructuring. If one of these events or circumstances indicates that the carrying value of an asset may not be recoverable, the amount of impairment will be measured as the difference between the carrying value and the fair value of the impaired asset as calculated using a net realizable value methodology. An impairment will be recorded as an operating expense in the period of the impairment and as a reduction in the carrying value of that asset.

NEW ACCOUNTING PRONOUNCEMENTS

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 requires companies to evaluate the materiality of identified unadjusted errors on each financial statement and related financial statement disclosure using both the rollover approach and the iron curtain approach. The rollover approach quantifies misstatements based on the amount of the error in the current year financial statement whereas the iron curtain approach quantifies misstatements based on the effects of correcting the misstatement existing in the balance sheet at the end of the current year, irrespective of the misstatement’s year(s) of origin. Financial statements would require adjustment when either approach results in quantifying a misstatement that is material. Correcting prior year financial statements for immaterial errors would not require previously filed reports to be amended. SAB 108 is effective for interim periods of the first fiscal year ending after November 15, 2006. The Corporation is currently evaluating the impact of SAB 108 on its consolidated results of operation and financial position.

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”). This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes that a company should use a more-likely-than-not recognition threshold based on the technical merits of the tax position taken. Tax positions that meet the more-likely-than-not recognition threshold should be measured in order to determine the tax benefit to be recognized in the financial statements. FIN 48 is effective in fiscal years beginning after December 15, 2006. We are currently evaluating the impact of FIN 48 on our consolidated results of operations and financial condition.



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In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Instruments – an Amendment of SFAS No. 140 (“SFAS 156”). This Statement amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. This Statement is effective for fiscal years beginning after September 15, 2006. We do not expect the adoption of SFAS 156 to have a material impact on our consolidated results of operations and financial condition.

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments – an Amendment to SFAS Nos. 133 and 140 (“SFAS 155”). SFAS 155 permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation and clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133. This statement also establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation and clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives. In addition, SFAS 155 amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We do not expect the adoption of SFAS 155 to have a material impact on our consolidated results of operations and financial condition.

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS 154”) which supersedes APB No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154 changes the requirements for the accounting for and reporting of changes in accounting principles. The statement requires the retroactive application to prior periods’ financial statements of changes in accounting principles, unless it is impracticable to determine either the period specific effects or the cumulative effect of the change. SFAS 154 does not change the guidance for reporting the correction of an error in previously issued financial statements or the change in an accounting estimate. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS 154 did not have a material impact on our consolidated results of operations and financial condition.



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Item 3.   Quantitative and Qualitative Disclosure about Market Risk

Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates and foreign currency exchange rates. We do not hold or issue financial instruments for trading purposes.

Interest Rate Risk

Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. The investment of cash is regulated by our investment policy of which the primary objective is security of principal. Among other selection criteria, the investment policy states that the term to maturity of investments cannot exceed two years in length. As a result, we do not expect any material loss with respect to our investment portfolio. We do not use derivative financial instruments in our investment portfolio.

Interest income on our cash, cash equivalents, and short-term investments is subject to interest rate fluctuations, but we believe that the impact of these fluctuations does not have a material effect on our financial position due to the short-term nature of these financial instruments. We have no long-term debt. Our interest income and interest expense are most sensitive to the general level of interest rates in Canada and the United States. Sensitivity analysis is used to measure our interest rate risk. For the three and six months ending August 31, 2006, a 100 basis-point adverse change in interest rates would have had a $0.01 and $0.02 impact on diluted earnings per share, respectively, and would not have had a material effect on our consolidated financial position or cash flows.

Foreign Currency Risk

We operate internationally. Accordingly, a substantial portion of our financial instruments are held in currencies other than the U.S. dollar. Our policy with respect to foreign currency exposure, as it relates to financial instruments, is to manage financial exposure to certain foreign exchange fluctuations with the objective of neutralizing some of the impact of foreign currency exchange movements. Sensitivity analysis is used to measure our foreign currency exchange rate risk. As of August 31, 2006, a 10% adverse change in foreign exchange rates versus the U.S. dollar would have decreased our reported cash, cash equivalents, and short-term investments by approximately one percent.

Also, as we conduct a substantial portion of our business in foreign currencies other than the U.S. dollar, our results are affected, and may be affected in the future, by exchange rate fluctuations of the U.S. dollar relative to the Canadian dollar, various European currencies, and, to a lesser extent, other foreign currencies. Revenues and expenses generated in foreign currencies are translated at exchange rates during the month in which the transaction occurs. We cannot predict the effect foreign exchange fluctuations will have on our results going forward; however, if there is an adverse change in foreign exchange rates versus the U.S. dollar, it could have a material adverse effect on our business, results of operations, and financial condition.



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Item 4.   Controls and Procedures

a) Evaluation of disclosure controls and procedures.

Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer conclude that the disclosure controls and procedures (as defined in Rules 13a-15(e) and 15(d)-15(e) of the Securities Exchange Act of 1934) effectively ensure that information required to be disclosed in our filings and submissions under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure and is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

b) Changes in internal control over financial reporting

There have been no changes in the Corporation’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.



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PART II – OTHER INFORMATION

Item 1A.    Risk Factors

Certain Factors That May Affect Future Results

This report contains forward-looking statements, including statements regarding the future success of our business and technology strategies, our research and development, our future market opportunities, our revenues, and our intellectual property. These statements are neither promises nor guarantees, but involve known and unknown risks and uncertainties that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed in or implied by these forward-looking statements. These risks include risks related to our revenue growth, operating results, industry, products including the integration and customer acceptance of Cognos 8, and litigation, as well as the other factors discussed below and elsewhere in this report. Readers should not place undue reliance on any such forward-looking statements, which speak only as of the date they were made. Except to the extent required by applicable law, we disclaim any obligation to publicly update or revise any such statements to reflect any change in our expectations or in events, conditions, or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements.

Our dependence on larger transactions continues and the time required to complete a sales cycle is lengthy, complex, and unpredictable.

As existing and potential customers seek to standardize on a single BI vendor and as our business continues to evolve toward larger transactions at the enterprise level and larger transactions account for a greater proportion of our business, the presence or absence of one or more of these large transactions in a particular period may have a material positive or negative effect on our revenue in that period. For example, in fiscal years 2006 and 2005, we closed 585 and 535 contracts greater than $200,000, representing 32% and 33% of our revenue for these periods, respectively, compared to 394 contracts greater than $200,000, representing 27% of our revenue for fiscal 2004. In addition, during the first half of fiscal 2007, we closed 23 contracts greater than $1 million, compared with 15 such contracts in the same period last fiscal year. These significant transactions represent significant business and financial decisions for our customers and require a considerable effort on the part of customers to assess alternative products and require additional levels of management approvals before being concluded. They are also often more complex than smaller transactions. These factors generally lengthen the typical sales cycle and increase the risk that the customer’s purchasing decision may be postponed or delayed from one period to another subsequent or later period or that the customer will alter his purchasing requirements. The sales effort and service delivery scope for larger transactions also require additional resources to execute the transaction. These factors, along with any other foreseen or unforeseen event, could result in lower than anticipated revenue for a particular period or in the reduction of estimated revenue in future periods.

Our restructuring plan may not achieve its intended results and may harm our business.

On September 7, 2006, in order to streamline our organization and improve our operating margin on a long term basis, we announced a restructuring plan. The plan includes a planned reduction of approximately 210 personnel or 6% of our global workforce, focused primarily on management and non-revenue-generating positions. Workforce reductions may have negatively impacted, and could continue to negatively impact, our remaining employees, including those directly responsible for sales, and could limit our ability to pursue new revenue opportunities. Further, any failure to retain and effectively manage our remaining employees could increase our costs, hurt our sales efforts, and impact the quality of our customer service. This could continue to harm our business, results of operations and financial condition.



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We face intense and increasing competition and we may not compete successfully.

We face substantial and increased competition throughout the world. We expect our competitors to continue to improve the performance of their current products and to introduce new products (or integrated products) or new technologies. The software market may continue to consolidate by merger or acquisition and larger software vendors, including ERP software vendors, may continue to expand their product offering into our markets. For example, ERP vendor, Oracle Corporation, acquired Siebel Systems, Inc. in January 2006 and also acquired one of its major ERP competitors, PeopleSoft, Inc. in 2005. In addition, Microsoft has increased its presence in our markets and has announced that it will continue expansion into business intelligence. As our competitors continue to merge or partner with other of our competitors or ERP vendors or if we were to become the subject of an unsolicited acquisition initiative by another enterprise, such changes in the competitive landscape could adversely affect our ability to compete, either because of an improvement in one of our competitor’s competitive position, or due to distraction caused by an unsolicited acquisition. Entry or expansion of other large software vendors, including ERP vendors, into this market may establish competitors which have larger existing customer bases and substantially greater financial and other resources with which to pursue research and development, manufacturing, marketing, and distribution of their products. Their current customer base and relationships may also provide them with a competitive advantage. New product announcements or introductions by our competitors, including the continuing emergence of open source software offerings, could cause a decline in sales, a reduction in the sales price, or a loss of market acceptance of our existing products. To the extent that we are unable to effectively compete against our current and future competitors, our ability to sell products could be harmed. Any erosion of our competitive position could have a material adverse effect on our business, results of operations, and financial condition.

The introduction of Cognos 8 and other new products or major releases could erode revenue from existing products and a delay in the release schedule for a product or a major release may have a material adverse impact on our financial results.

We may develop technology or a product that constitutes a marked advance over both our own products and those of our competitors. We believe Cognos 8 is an example of such a product. With the introduction of such a product, we may experience a decline in revenues of our existing products that is not fully matched by the new product’s revenue. For example, customers may delay making purchases of a new product to permit them to make a more thorough evaluation of the product, or until the views of the industry analysts and the marketplace become widely available. Customers may also delay making purchases of a new product in anticipation of the availability of a major release. In addition, some customers may hesitate migrating to a new product out of concerns regarding the complexity of migration and product infancy issues on performance. In addition, we may lose existing customers who choose a competitor’s product rather than upgrade or migrate to our new product. This could result in a temporary or permanent revenue shortfall and materially affect our business. A delay in our release schedule for a new product or a major release may also result in us not being able to recognize revenue as previously anticipated during a particular period and it may delay the purchase of the product by customers. Despite our efforts to minimize the impact of these events, these events could result in a temporary or permanent revenue shortfall and materially affect our business and financial results. For example, in the third quarter of fiscal year 2006, we believe confusion in the market regarding the availability of Cognos 8 had a negative impact on our overall performance for the quarter.



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Currency fluctuations may adversely affect us.

A substantial portion of both our revenues and expenditures are generated in currencies other than the U.S. dollar, such as the Canadian dollar and the euro. Fluctuations in the exchange rate between the U.S. dollar and other currencies, particularly the euro and the Canadian dollar, may have a material adverse effect on our business, financial condition, and operating results as we report in U.S. dollars. For example, the Canadian dollar has continued to strengthen during the first half of fiscal 2007, leading to higher than anticipated expenses when reported in U.S. dollars. Please see further discussion on foreign currency risk included in Item 3, Quantitative and Qualitative Disclosure about Market Risk, in this Form 10-Q.

Economic conditions could adversely affect our revenue growth and ability to forecast revenue.

The revenue growth and profitability of our business depends on the overall demand for BI and CPM products and services. Because our sales are primarily to major corporate customers in the high technology, telecommunications, financial services (including insurance), pharmaceutical, utilities, and consumer packaged goods industries, our business depends on the overall economic conditions and the economic and business conditions within these industries. A weakening of one or more of the global economy, the information technology industry, or the business conditions within the industries listed above may cause a decrease in our software license revenues. A decrease in demand for computer software caused, in part, by a continued weakening of the economy, domestically or internationally, may result in a decrease in our revenues and growth rates.

We may not be able to hire, integrate, retain, or incent key personnel essential to our business or we may not be able to manage changes and transitions in our key personnel.

We believe that our success depends on our ability to hire, retain, and incent senior management and other key employees to develop, market, and support our products and manage our business. The loss of any one of their services could have a material adverse effect on our business. Our success is also highly dependent on our continuing ability to hire, integrate, and retain highly qualified personnel as well as our ability to train and develop personnel. The failure to attract and retain or to train and develop key personnel could adversely affect our future growth and profitability. In an effort to streamline our organization and improve our operating margin, we recently announced a restructuring plan which resulting in a planned reduction of approximately 210 personnel, or 6% of our workforce. This workforce reduction could make it more difficult for us to retain the employees we have kept, or to attract new employees in the future. In addition, changes in senior management or other key personnel can also cause temporary disruption in our operations during such transition periods.

If we do not respond effectively to rapid technological change, our products may become obsolete.

The markets for our products are characterized by: rapid and significant technological change; frequent new product introductions and enhancements; changing customer demands; and evolving industry standards. We cannot provide assurance that our products and services will remain competitive in light of future technological change or that we will be able to respond to market demands and developments or new industry standards. If we are unable to identify a shift in market demand or industry standards quickly enough, we may not be able to develop products to meet those new demands or standards, or to bring them to market in a timely manner. In addition, failure to respond successfully to technological change may render our products and services obsolete and thus harm our ability to attract and retain customers. Even if we do respond to technological changes, our solutions may be less appealing to customers than those of our competitors, or our customers may not accept our new products and services.



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Our sales forecasts may not match actual revenues in a particular period.

The basis of our business budgeting and planning process is the estimation of revenues that we expect to achieve in a particular quarter and is based on a common industry practice known as the “pipeline” system. Under this system, information relating to sales prospects, the anticipated date when a sale will be completed and the potential dollar amount of the sale are tracked and analyzed to provide a “pipeline” of future business. These pipeline estimates are not necessarily reliable predictors of revenues in a particular quarter because of, among other things, the events identified in these risk factors, as well as the subjective nature of the estimates themselves. In particular, a slowdown in technology spending or a deterioration in economic conditions is likely to result in the delay or cancellation of prospective orders in our pipeline. Also, an increase in the complexity and importance of large transactions and the resulting increase in time to complete these large transactions makes forecasting more difficult. A variation from our historical or expected conversion rate of the pipeline could adversely affect our budget or planning and could consequently materially affect our operating results and our stock price could suffer.

We operate internationally and face risks attendant to those operations.

We earn a significant portion of our total revenues from international sales generated through our foreign direct and indirect operations. These sales operations face risks arising from local political, legal and economic factors such as the general economic conditions in each country or region, varying regulatory requirements, compliance with international and local trade, labor and other laws, and reduced intellectual property protections in certain jurisdictions. We may also face difficulties in managing our international operations, collecting receivables in a timely fashion, and repatriating earnings. Any of these factors, either individually or in combination, could materially impact our international operations and adversely affect our business as a whole.

Our total revenue and operating results may fluctuate, which could result in fluctuations in the price of our common stock.

We have experienced revenue growth from our products in the past. We cannot, however, provide assurance that revenue from these products will continue to grow, or grow at previous rates or rates projected by management. For example, during the second quarter of fiscal 2007, our license revenue declined 1% compared to the same period last fiscal year. Anticipated revenue may be reduced by any one, or a combination of, unforeseen market, economic, or competitive factors some of which are discussed in this section. We have experienced and in the future may experience a shortfall in revenue or earnings or otherwise fail to meet public market expectations, which could materially and adversely affect our business and result in fluctuations in the market price of our common stock.

Our quarterly and annual operating results may vary between periods.

Historically, our quarterly operating results have varied from quarter to quarter, and we anticipate this pattern will continue. We typically realize a larger percentage of our annual revenue and earnings in the fourth quarter of each fiscal year, and lower revenue and earnings in the first quarter of the following fiscal year. As well, in each quarter we typically close a larger percentage of sales transactions near the end of that quarter. As a result, it is difficult to anticipate the revenue and earnings that we will realize in any particular quarter until near the end of the quarter. Some of the causes of this difficulty are explained in other risk factors – in particular those entitled ‘Our sales forecasts may not match actual revenues in a particular period’, ‘Our dependence on larger transactions is increasing and the length of time required to complete a sales cycle has become lengthy, complex and unpredictable’ and ‘Our expenses may not match anticipated revenues’.



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Our expenses may not match anticipated revenues or we may fail to accurately predict our expenses.

We base our operating expenses on anticipated revenue trends. Since a high percentage of these expenses are relatively fixed in the short term, a delay in completing license transactions could cause significant variations in operating results from quarter to quarter and could result in operating losses. If these expenses precede, or are not subsequently followed by, increased revenues, our business, financial condition, or results of operations could be materially and adversely affected. For example, in fiscal year 2006, our revenues were lower than expected while our expenses were in line with our projections. This resulted in a lower operating margin for the fiscal year. In addition, we expect our restructuring plan to result in a savings of approximately $13 million in the second half of fiscal 2007. If our estimates are incorrect, it could result in a lower operating margin for future quarters than we currently anticipate, which could result in lower earnings in these quarters.

Making and integrating acquisitions could impair our operating results.

We have acquired and, if appropriate, will continue to seek to acquire additional products or businesses that we believe are complementary to ours. Acquisitions involve a number of other risks, including: diversion of management’s attention; disruption of our ongoing business; difficulties in integrating and retaining all or part of the acquired business and its personnel; assumption of disclosed and undisclosed liabilities; dealing with unfamiliar laws, customs and practices in foreign jurisdictions; and the effectiveness of the acquired company’s internal controls and procedures. The individual or combined effect of these risks could have a material adverse effect on our business. As well, in paying for an acquisition, we may deplete our cash resources or dilute our shareholder base by issuing additional shares. Furthermore, there is the risk that our valuation assumptions and our models for an acquired product or business may be erroneous or inappropriate due to foreseen or unforeseen circumstances and thereby cause us to overvalue an acquisition target. There is also the risk that the contemplated benefits of an acquisition may not materialize as planned or may not materialize within the time period or to the extent anticipated.

New accounting pronouncements or guidance may require us to change the way in which we account for our operational or business activities.

The Financial Accounting Standards Board (“FASB”), the SEC, and other bodies that have jurisdiction over the form and content of our accounts are constantly discussing and interpreting proposals and existing pronouncements designed to ensure that companies best display relevant and transparent information relating to their respective businesses. The pronouncements and interpretations of pronouncements by FASB, the SEC, and other bodies may have the effect of requiring us to account for revenues and/or expenses in a different manner. For example, beginning with the first quarter of fiscal 2007, we were required to expense the fair value of stock options. As a result, we reported increased expenses in our income statement and a reduction of our net income and earnings per share.



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Our intellectual property may be misappropriated or we may have to defend ourselves against other parties’ claims.

We rely on various intellectual property protections, including contractual provisions, patents, copyright, trademark, and trade secret laws, to preserve our intellectual property rights. Despite our precautions, our intellectual property may be misappropriated causing us to lose potential revenue and competitive advantage. As well, we may ourselves from time to time become subject to claims by third parties that our technology infringes their intellectual property rights. In either case, we may incur expenditures to police, protect, and defend our interests and may become involved in litigation that could divert the attention of our management. Responding to such claims could result in substantial expense and result in damages, royalties, or injunctive relief, or require us to enter into licensing agreements on unfavorable terms, or redesign or stop selling affected products which could materially disrupt the conduct of our business.

We may face liability claims if our software products or services fail to perform as intended.

The sale, servicing, and support of our products entails the risk of product liability, performance or warranty claims, which may be substantial in light of the use of our products in business-critical applications. A successful product liability claim could seriously disrupt our business and adversely affect our financial results. Software products are complex and may contain errors or defects, particularly when first introduced, or when new versions or enhancements are released, or when configured to individual customer requirements. Although we currently have in place procedures and staff to exercise quality control over our products and respond to defects and errors found in current versions, new versions, or enhancements of our products, defects and errors may still occur. If there are defects and errors found in Cognos 8, it could disrupt our business, impact our sales and adversely affect our financial results. We also attempt to contractually limit our liability in accordance with industry practices. However, defects and errors in our products, including Cognos 8, could inhibit or prevent customer deployment and cause us to lose customers or require us to pay penalties or damages.

Natural or other disasters and hostilities or terrorist attacks may disrupt our operations.

Natural or other disasters like the hurricanes in the southeastern United States in 2005, and hostilities or terrorist attacks may disrupt our operations or those of our customers, distributors, and suppliers, which could adversely affect our business, financial condition, or results of operations. The threat of future outbreak or continued escalation of hostilities involving the United States or other countries could adversely affect the growth rate of our software license revenue and have an adverse effect on our business, financial condition, or results of operations.

We may have exposure to greater or lower than anticipated tax liabilities.

We are subject to income taxes and non-income taxes in a variety of jurisdictions and our tax structure is subject to review by both domestic and foreign taxation authorities. The determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results, positively or negatively, in the fiscal year for which such determination is made. For example, our effective tax rate for fiscal year 2006 was lower than anticipated due to the recognition of benefits resulting from a tax court decision that allowed us to claim investment tax credits on stock-based compensation for research and development personnel relating to fiscal years 2004 and 2005 and other tax adjustments.



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Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds

PURCHASES OF EQUITY SECURITIES
 
Period Total Number
of Shares
Purchased		 Average
Price
Paid per
Share		 Total Number of
Shares Purchased
as Part of Publicly
Announced Plans		 Maximum Number of Shares or
Approximate Dollar Value of
Shares that May Yet Be Purchased
Under the Plans
Restricted Share
Unit Plan
(# of shares)		 Share
Repurchase
Program
June 1 to June 30, 2006   NIL   NIL   NIL   2,921,500   $38,410,441  
July 1 to July 31, 2006  NIL  NIL  NIL  2,921,500   $38,410,441  
August 1 to August 31, 2006  80,000  $31.82  NIL  2,841,500   $38,410,441  
Total  80,000  $31.82  NIL  2,841,500   $38,410,441  

On September 25, 2002, the Board of Directors of Cognos adopted a restricted share unit plan under which awards of restricted share units can be granted to employees, officers and directors of Cognos up to an aggregate of 2,000,000 restricted share units. On June 23, 2005, the Corporation’s shareholders approved the extension of the term of the plan to September 30, 2015 and increased the number of authorized shares to 3,000,000. Subject to the vesting provisions set out in each participant’s award agreement, each restricted share unit can be exchanged for one common share of Cognos. The common shares for which the restricted share units may be exchanged are purchased on the open market by a trustee appointed and funded by Cognos. During the quarter ended August 31, 2006, the trustee repurchased 80,000 shares at an average price of $31.82 for the restricted share unit plan.

It has been the Corporation’s practice to make an annual grant of options to key employees following its annual meeting of shareholders, typically held in late June. However, the Corporation’s annual meeting for June 2006 was postponed due to a review of the Corporation’s revenue recognition practices by the Staff of the Division of Corporation Finance of the Securities and Exchange Commission. The review was resolved without any objection by the Staff and the Corporation. However, on September 7, 2006, the Corporation announced its operating margin improvement plan which would result in a reduction of its global workforce by approximately 210 personnel. In light of this action and the prolonged delay in granting stock options to employees, the Board of Directors of the Corporation determined that it was imperative to accelerate the award of equity grants to employees in September. Accordingly, the Corporation awarded 240,000 options and 436,192 RSUs on September 26, 2006. The Corporation advised the trustee of these RSU grants and the trustee has purchased approximately 437,000 common shares to fulfill this RSU award.

On October 6, 2005, Cognos announced that it had adopted a stock repurchase program which commenced on October 10, 2005 and ends on October 9, 2006 (the “2005 Stock Repurchase Program”). The program allows Cognos to repurchase up to 4,000,000 common shares (which is less than 5% of the common shares outstanding on that date) provided that no more than $100,000,000 is expended in total under the program. During the quarter ended August 31, 2006, Cognos did not repurchase any shares under the 2005 Stock Repurchase Program. On September 22, 2006, the Corporation announced that it had adopted a stock repurchase program which commenced on October 10, 2006 and ends on October 9, 2007 (the “2006 Stock Repurchase Program”). The program, subject to regulatory approval, will allow Cognos to repurchase up to 8,000,000 common shares (which is less than 10% of the common shares outstanding on that date) provided that no more than $200,000,000 is expended in total under the program.



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Item 6.   Exhibits

a)   Exhibits
  3 .1 Articles of Incorporation and Amendments thereto (incorporated by reference to Exhibit 3.1 of the Corporation’s Form 10-Q filed for the quarter ended November 30, 2002 and Exhibit 3.1 (i) of Cognos’ Form 10-Q filed for the quarter ended May 31, 2004)  
  3 .2 By-Laws of the Corporation (incorporated by reference to Exhibit 3.2 of the Corporation’s Form 10-K filed for the year ended February 28, 1997)  
  31 .1 Certification of Chief Executive Officer Pursuant to Rule 13a – 14(a) and 15d – 14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002  
  31 .2 Certification of Chief Financial Officer Pursuant to Rule 13a – 14(a) and 15d – 14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002  
  32 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002  


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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

    COGNOS INCORPORATED
  (Registrant)





October 4, 2006   /s/ Tom Manley
  
Date   Tom Manley
Senior Vice President, Finance & Administration and
    Chief Financial Officer (Principal Financial Officer and
    Chief Accounting Officer)


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EXHIBIT INDEX

EXHIBIT NO. DESCRIPTION   PAGE  
 
31 .1 Certification of Chief Executive Officer Pursuant to Rule 13a – 14(a) and 15d – 14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   72  
 
31 .2 Certification of Chief Financial Officer Pursuant to Rule 13a – 14(a) and 15d – 14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   73  
 
32 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002   74  


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 EX-31.1 2 cognosex311_26530.htm CERTIFICATION OF CHIEF EXECUTIVE OFFICER Cognos Form 10-Q Exhibit 31.1

Exhibit 31.1

CERTIFICATION

I, Robert G. Ashe, President and Chief Executive Officer certify that:

1. I have reviewed this quarterly report on Form 10-Q of Cognos Incorporated;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

  c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

  d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize, and report financial information; and

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.



October 4, 2006   /s/ Robert G. Ashe
  
Date   Robert G. Ashe,
President and Chief Executive Officer


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 EX-31.2 3 cognosex312_26530.htm CERTIFICATION OF CHIEF FINANCIAL OFFICER Cognos Form 10-Q - Exhibit 31.2

Exhibit 31.2

CERTIFICATION

I, Tom Manley, Senior Vice President, Finance & Administration and Chief Financial Officer (Principal Financial Officer and Chief Accounting Officer) certify that:

1. I have reviewed this quarterly report on Form 10-Q of Cognos Incorporated;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the registrant and have:

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

  c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

  d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize, and report financial information; and

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.



October 4, 2006   /s/ Tom Manley
  
Date   Tom Manley,
Senior Vice President, Finance & Administration
    and Chief Financial Officer
    (Principal Financial Officer and Chief Accounting
     Officer)


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 EX-32 4 cognosex32_26530.htm CERTIFICATION OF CEO AND CHIEF FINANCIAL OFFICER Cognos Form 10-Q - Exhibit 32

Exhibit 32

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Cognos Incorporated (the “Company”) on Form 10-Q for the period ended August 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), we, Robert G. Ashe, President and Chief Executive Officer of the Company, and Tom Manley, Senior Vice President, Finance & Administration and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of our knowledge:

    (1)        The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

    (2)        The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.




October 4, 2006   /s/ Robert G. Ashe
  
Date   Robert G. Ashe,
President and Chief Executive Officer



October 4, 2006   /s/ Tom Manley
  
Date   Tom Manley
Senior Vice President, Finance &
    Administration and Chief Financial Officer
    (Principal Financial Officer and Chief Accounting
    Officer)

This certification is being submitted solely for the purpose of complying with Section 1350 of Chapter 63 of Title 18 of the United States Code. This certification is not to be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liability of that section, nor will the certification be deemed incorporated by reference in to any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the registrant specifically incorporates it by reference.



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