e10vq

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)


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

For the quarterly period ended June 30, 2006


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

[NO FEE REQUIRED]

For the transition period from to

Commission File Number 0-16439

Fair Isaac Corporation

(Exact name of registrant as specified in its charter)


Delaware (State or other jurisdiction of incorporation or organization)		94-1499887 (I.R.S. Employer Identification No.)

901 Marquette Avenue, Suite 3200 Minneapolis, Minnesota (Address of principal executive offices)		55402-3232 (Zip Code)

Registrant’s telephone number, including area code:
612-758-5200

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 þ No o

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 þ Accelerated Filer o Non-Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No

The number of shares of common stock outstanding on July 31, 2006 was 62,876,783 (excluding 25,980,000 shares held by the Company as treasury stock).

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

FAIR ISAAC CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value data)
(Unaudited)


	June 30,			September 30,
	2006			2005
Assets
Current assets:
Cash and cash equivalents	$	133,964		$	82,880
Marketable securities available for sale, current portion		182,170			146,088
Receivables, net		161,021			156,375
Prepaid expenses and other current assets		20,535			20,249
Deferred income taxes		3,064			7,088


Total current assets		500,754			412,680

Marketable securities available for sale, less current portion		34,856			56,926
Other investments		2,161			2,161
Property and equipment, net		55,433			48,436
Goodwill		692,327			688,683
Intangible assets, net		96,473			114,623
Deferred income taxes		24,758			19,902
Other assets		5,464			7,650

	$	1,412,226		$	1,351,061


Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	16,489		$	11,579
Accrued compensation and employee benefits		30,932			31,373
Other accrued liabilities		51,841			39,368
Deferred revenue		50,364			55,837


Total current liabilities		149,626			138,157

Senior convertible notes		400,000			400,000
Other liabilities		5,339			7,810


Total liabilities		554,965			545,967


Stockholders’ equity:
Preferred stock ($0.01 par value; 1,000 shares authorized; none issued and outstanding)		—			—
Common stock ($0.01 par value; 200,000 shares authorized, 88,857 shares issued and 62,770 and 63,836 shares outstanding at June 30, 2006 and September 30, 2005, respectively)		628			638
Paid-in-capital		1,063,186			1,037,524
Treasury stock, at cost (26,087 and 25,021 shares at June 30, 2006 and September 30, 2005, respectively)		(831,284	)		(775,746	)
Unearned compensation		—			(1,284	)
Retained earnings		624,007			546,450
Accumulated other comprehensive income (loss)		724			(2,488	)


Total stockholders’ equity		857,261			805,094


	$	1,412,226		$	1,351,061

See accompanying notes to condensed consolidated financial statements.

FAIR ISAAC CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)


	Quarter Ended						Nine Months Ended
	June 30,						June 30,
	2006			2005			2006			2005
Revenues	$	207,129		$	203,807		$	618,076		$	595,374


Operating expenses:
Cost of revenues (1)		71,497			68,339			211,686			207,757
Research and development		21,370			21,176			65,794			60,297
Selling, general and administrative (1)		66,338			59,126			193,878			167,779
Amortization of intangible assets (1)		6,302			6,320			18,825			19,640
Restructuring and acquisition-related		5,290			—			6,800			—


Total operating expenses		170,797			154,961			496,983			455,473


Operating income		36,332			48,846			121,093			139,901
Interest income		4,317			2,295			11,333			5,874
Interest expense		(2,155	)		(2,142	)		(6,433	)		(6,206	)
Other income, net		551			8			153			333


Income before income taxes		39,045			49,007			126,146			139,902
Provision for income taxes		13,042			12,395			44,713			41,102

Net income	$	26,003		$	36,612		$	81,433		$	98,800


Earnings per share:
Basic	$	0.41		$	0.55		$	1.27		$	1.47

Diluted	$	0.40		$	0.53		$	1.23		$	1.34


Shares used in computing earnings per share:
Basic		63,664			66,215			64,303			67,247

Diluted		64,973			68,531			66,003			75,661


(1)		Cost of revenues and selling, general and administrative expenses exclude the amortization of intangible assets. See Note 2 to the accompanying condensed consolidated financial statements.

See accompanying notes to condensed consolidated financial statements.

FAIR ISAAC CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME
(In thousands)
(Unaudited)


																			Accumulated
	Common Stock																		Other			Total
				Par			Paid-In-			Treasury			Unearned			Retained			Comprehensive			Stockholders’			Comprehensive
	Shares			Value			Capital			Stock			Compensation			Earnings			Income (Loss)			Equity			Income
Balance at September 30, 2005		63,836		$	638		$	1,037,524		$	(775,746	)	$	(1,284	)	$	546,450		$	(2,488	)	$	805,094
Share-based compensation								30,024			—			—			—			—			30,024
Exercise of stock options		1,779			18			(8,575	)		55,502			—			—			—			46,945
Tax benefit from exercised stock options		—			—			9,260			—			—			—			—			9,260
Reclassification due to the adoption of SFAS No. 123(R)		—			—			(1,284	)		—			1,284			—			—			—
Forfeitures of restricted stock		(22	)		—			51			(51	)		—			—			—			—
Repurchases of common stock		(3,237	)		(32	)		—			(124,075	)		—			—			—			(124,107	)
Issuance of ESPP shares from treasury		300			3			(185	)		9,458			—			—			—			9,276
Issuance of restricted stock to employees from treasury		114			1			(3,629	)		3,628			—			—			—			—
Dividends paid		—			—			—			—			—			(3,876	)		—			(3,876	)
Net income		—			—			—			—			—			81,433			—			81,433		$	81,433
Unrealized gains on investments		—			—			—			—			—			—			37			37			37
Cumulative translation adjustments		—			—			—			—			—			—			3,175			3,175			3,175

Balance at June 30, 2006		62,770		$	628		$	1,063,186		$	(831,284	)	$	—		$	624,007		$	724		$	857,261		$	84,645

See accompanying notes to condensed consolidated financial statements.

FAIR ISAAC CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)


	Nine Months Ended
	June 30,
	2006			2005
Cash flows from operating activities:
Net income	$	81,433		$	98,800
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		36,529			39,261
Share-based compensation		30,024			1,092
Deferred income taxes		(2,724	)		13,575
Tax benefit from exercised stock options		9,260			6,494
Excess tax benefits from share-based payment arrangements		(6,097	)		—
Net amortization of premium on marketable securities		76			340
Provision for doubtful accounts		1,329			2,894
Changes in operating assets and liabilities, net of acquisition effects:
Receivables		(4,869	)		(12,855	)
Prepaid expenses and other assets		1,461			(693	)
Accounts payable		4,480			(1,010	)
Accrued compensation and employee benefits		(598	)		(2	)
Other liabilities		9,355			(15,776	)
Deferred revenue		(5,748	)		18,032

Net cash provided by operating activities		153,911			150,152


Cash flows from investing activities:
Purchases of property and equipment		(24,321	)		(14,009	)
Collections of note receivable from sale of product line		500			500
Cash paid for acquisition, net of cash acquired		—			(32,567	)
Cash proceeds from disposition of London Bridge Phoenix Software, Inc.		—			22,672
Purchases of marketable securities		(134,933	)		(195,137	)
Proceeds from sales of marketable securities		26,240			109,023
Proceeds from maturities of marketable securities		95,128			105,914
Investment in cost-method investee		—			(600	)

Net cash used in investing activities		(37,386	)		(4,204	)


Cash flows from financing activities:
Proceeds from issuances of common stock under employee stock option and purchase plans		56,221			49,353
Dividends paid		(3,876	)		(4,041	)
Repurchases of common stock		(124,107	)		(231,834	)
Excess tax benefits from share-based payment arrangements		6,097			—

Net cash used in financing activities		(65,665	)		(186,522	)

Effect of exchange rate changes on cash and cash equivalents		224			(370	)

Increase (decrease) in cash and cash equivalents		51,084			(40,944	)
Cash and cash equivalents, beginning of period		82,880			134,070

Cash and cash equivalents, end of period	$	133,964		$	93,126


Supplemental disclosures of cash flow information:
Cash paid for income taxes, net	$	22,164		$	21,451
Cash paid for interest	$	3,000		$	3,000

See accompanying notes to condensed consolidated financial statements.

FAIR ISAAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Nature of Business

Fair Isaac Corporation

Incorporated under the laws of the State of Delaware, Fair Isaac Corporation is a provider of analytic, software and data management products and services that enable businesses to automate and improve decisions. Fair Isaac Corporation provides a range of analytical solutions, credit scoring and credit account management products and services to banks, credit reporting agencies, credit card processing agencies, insurers, retailers, telecommunications providers, healthcare organizations and government agencies.

In these condensed consolidated financial statements, Fair Isaac Corporation is referred to as “we,” “us,” “our,” and “Fair Isaac.”

Principles of Consolidation and Basis of Presentation

We have prepared the accompanying unaudited interim condensed consolidated financial statements in accordance with the instructions to Form 10-Q and the standards of accounting measurement set forth in Accounting Principles Board (“APB”) Opinion No. 28 and any amendments thereto adopted by the Financial Accounting Standards Board (“FASB”). Consequently, we have not necessarily included in this Form 10-Q all information and footnotes required for audited financial statements. In our opinion, the accompanying unaudited interim condensed consolidated financial statements in this Form 10-Q reflect all adjustments (consisting only of normal recurring adjustments, except as otherwise indicated) necessary for a fair presentation of our financial position and results of operations. These unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with our audited consolidated financial statements and notes thereto presented in our 2005 Annual Report on Form 10-K. The interim financial information contained in this report is not necessarily indicative of the results to be expected for any other interim period or for the entire fiscal year.

The condensed consolidated financial statements include the accounts of Fair Isaac and its subsidiaries. All intercompany accounts and transactions have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. These estimates and assumptions include, but are not limited to, assessing the following: the recoverability of accounts receivable, goodwill, intangible assets, software development costs and deferred tax assets; estimated losses associated with contingencies and litigation; the ability to estimate hours in connection with fixed-fee service contracts, the ability to estimate transactional-based revenues for which actual transaction volumes have not yet been received, the determination of whether fees are fixed or determinable and collection is probable or reasonably assured; and the development of assumptions for use in the Black-Scholes model that estimates the fair value of our share-based awards and assessing forfeiture rates of share-based awards.

Share-Based Payment

Prior to October 1, 2005, we accounted for our share-based employee compensation plans under the measurement and recognition provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by Financial Accounting Standards Board Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation. We generally recorded no employee compensation expense for options granted prior to October 1, 2005 as options granted generally had exercise prices equal to the fair market value of our common stock on the date of grant. We also recorded no compensation expense in connection with our 1999 Employee Stock Purchase Plan (“Purchase Plan”) as the purchase price of the stock was not less than 85% of the lower of the fair market value of our common stock at the beginning of each offering period or at the end of each offering period. In accordance with SFAS No. 123, we disclosed our net income and earnings per share as if we had applied the fair value-based method in measuring compensation expense for our share-based incentive awards.

FAIR ISAAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

includes expense associated with the fair value of all awards granted on and after October 1, 2005, and expense for the unvested portion of previously granted awards outstanding on October 1, 2005. Results for prior periods have not been restated.

Prior to the adoption of SFAS No. 123(R), we presented all tax benefits for deductions resulting from the exercise of stock options as operating cash flows within our consolidated statements of cash flows. SFAS No. 123(R) requires the cash flows resulting from the tax benefits for tax deductions in excess of the compensation expense recorded for those options (excess tax benefits) to be classified as financing cash flows. Accordingly, the $6.1 million excess tax benefit that is classified as a financing cash inflow on the accompanying condensed consolidated statements of cash flows for the nine months ended June 30, 2006 would have been classified as an operating cash inflow if we had not adopted SFAS No. 123(R).

We maintain the 1992 Long-term Incentive Plan (the “1992 Plan”) under which we may grant stock options, stock appreciation rights, restricted stock and common stock to officers, key employees and non-employee directors. Under the 1992 Plan, a number of shares equal to 4% of the number of shares of Fair Isaac common stock outstanding on the last day of the preceding fiscal year is added to the shares available under this plan each fiscal year, provided that the number of shares for grants of incentive stock options for the remaining term of this plan shall not exceed 5,062,500 shares. As of June 30, 2006, 754,751 shares remained available for grants under this plan. The 1992 Plan will terminate in February 2012. In November 2003, our Board of Directors approved the adoption of the 2003 Employment Inducement Award Plan (the “2003 Plan”). The 2003 Plan reserves 2,250,000 shares of common stock solely for the granting of inducement stock options and other awards, as defined, that meet the “employment inducement award” exception to the New York Stock Exchange’s listing standards requiring shareholder approval of equity-based inducement incentive plans. Except for the employment inducement award criteria, awards under the 2003 Plan will be generally consistent with those made under our 1992 Plan. As of June 30, 2006, 1,449,318 shares remained available for grants under this plan. The 2003 Plan shall remain in effect until terminated by the Board of Directors. We also maintain individual stock option plans for certain of our executive officers and the chairman of the board. There are no shares available for future grants under these plans. Stock option awards granted during the quarter and nine months ended June 30, 2006 have a maximum term of seven years and vest ratably over four years. Stock option awards granted prior to October 1, 2005 typically have a maximum term of ten years and vest ratably over four years.

We assumed all outstanding stock options held by former employees and non-employee directors of HNC Software, Inc. (“HNC”), who as of our acquisition date, held unexpired and unexercised stock option grants under the various HNC stock option plans. As of June 30, 2006, 1,479,987 shares remained available for future grant under these option plans.

Under the Purchase Plan we are authorized to issue up to 5,062,500 shares of common stock to eligible employees. Employees may have up to 10% of their base salary withheld through payroll deductions to purchase Fair Isaac common stock during semi-annual offering periods. The purchase price of the stock is the lower of 85% of (i) the fair market value of the common stock on the enrollment date (the first day of the offering period), or (ii) the fair market value on the exercise date (the last day of each offering period). Offering period means approximately six-month periods commencing (a) on the first trading day on or after January 1 and terminating on the last trading day in the following June, and (b) on the first trading day on or after July 1 and terminating on the last trading day in the following December.

The following table summarizes the share-based compensation expense included in operating expense captions that we recorded within the accompanying condensed consolidated statements of income:


	Quarter Ended				Nine Months Ended
	June 30,				June 30,
	2006		2005		2006		2005
	(In thousands)
Cost of revenues	$	2,722	$	79	$	8,265	$	190
Research and development		1,661		36		5,061		87
Selling, general and administrative		6,001		347		16,698		815

	$	10,384	$	462	$	30,024	$	1,092

We estimate the fair value of options granted using the Black-Scholes option valuation model. We estimate the volatility of our common stock at the date of grant based on a combination of the implied volatility of publicly traded options on our common stock and our historical volatility rate, consistent with SFAS No. 123(R) and Securities and Exchange Commission Staff Accounting Bulletin No. 107 (“SAB 107”). Our decision to use implied volatility was based upon the availability of actively traded options on our

FAIR ISAAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

common stock and our assessment that implied volatility is more representative of future stock price trends than historical volatility. We estimate expected term consistent with the simplified method identified in SAB 107 for share-based awards granted during the quarter and nine months ended June 30, 2006. We elected to use the simplified method as we changed the contractual life for share-based awards from ten to seven years starting in fiscal 2006. The simplified method calculates the expected term as the average of the vesting and contractual terms of the award. Previously, we estimated expected term based on historical exercise patterns. The dividend yield assumption is based on historical dividend payouts. The risk-free interest rate assumption is based on observed interest rates appropriate for the term of our employee options. We use historical data to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest. For options granted, we amortize the fair value on a straight-line basis over the vesting period of the options.

We used the following assumptions to estimate the fair value of share-based payment awards:


	Three Months Ended						Nine Months Ended
	June 30,			June 30,			June 30,			June 30,
Stock Options:	2006			2005			2006			2005
Average expected term (years)		4.75			4.00			4.75			4.00
Expected volatility		30	%		40	%		29	%		48	%
Risk-free interest rate (range)		4.8–5.2	%		3.8	%		4.2–5.2	%		3.2–3.8	%
Expected dividend yield		0.2	%		0.2	%		0.2	%		0.2	%

The following table shows summarizes option activity during the nine months ended June 30, 2006:


						Weighted-
				Weighted-		average
				average		Remaining		Aggregate
				Exercise		Contractual		Intrinsic
	Shares			Price		Term		Value
	(In thousands)							(In thousands)
Outstanding at October 1, 2005		13,815		$	29.14
Granted		3,247			43.25
Exercised		(1,779	)		26.38
Forfeited		(1,071	)		36.70

Outstanding at June 30, 2006		14,212			32.14		6.36	$	87,113

Options exercisable at June 30, 2006		6,676			26.87		5.33	$	68,796

The weighted average fair value of options granted during the nine months ended June 30, 2006 was $13.85. The aggregate intrinsic value of options outstanding at June 30, 2006 is calculated as the difference between the exercise price of the underlying options and the market price of our common stock for the 10.1 million shares that had exercise prices that were lower than the $36.31 market price of our common stock at June 30, 2006. The total intrinsic value of options exercised during the nine months ended June 30, 2006 was $32.2 million, determined as of the date of exercise.

At September 30, 2005 we had 40,219 non-vested restricted stock awards that had a weighted average grant date fair value of $20.40 and at June 30, 2006 we had 151,763 non-vested restricted stock awards that had a weighted average grant date fair value of $31.83.

We recorded $29.3 million in share-based compensation expense for stock options and purchases under the Purchase Plan and $0.7 million in share-based compensation expense for restricted stock awards for the nine months ended June 30, 2006. The total tax benefit related to this share-based compensation expense was $10.7 million for the nine months ended June 30, 2006. As of June 30, 2006, there was $80.0 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under all equity compensation plans. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. We expect to recognize that cost over a weighted average period of 2.3 years.

We received $56.2 million in cash from option exercises and issuances of stock under the Purchase Plan for the nine months ended June 30, 2006. The actual tax benefit that we realized for the tax deductions from option exercises of the share-based payment arrangements totaled $9.8 million for that period.

FAIR ISAAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Due primarily to our ongoing program of repurchasing shares on the open market, at June 30, 2006 we had 26.1 million treasury shares. We satisfy option exercises from this pool of treasury shares.

The following table illustrates the effect on our net income and earnings per share for the quarter and nine months ended June 30, 2005 as if we had applied the fair value recognition provisions of SFAS No. 123(R) to share-based compensation using the Black-Scholes valuation model.


				Nine Months
	Quarter Ended			Ended
	June 30,			June 30,
(In thousands, except per share data)	2005			2005
Net income, as reported	$	36,612		$	98,800
Add: Share-based employee compensation expense included in reported net income, net of tax		284			672
Deduct: Share-based employee compensation expense determined Under fair value based method for all awards, net of tax		(6,746	)		(21,725	)

Proforma net income including share-based compensation	$	30,150		$	77,747


Earnings per share, as reported:
Basic	$	0.55		$	1.47

Diluted	$	0.53		$	1.34


Proforma earnings per share — including share-based compensation:
Basic	$	0.46		$	1.16

Diluted	$	0.44		$	1.06

New Accounting Pronouncement Not Yet Adopted

In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on the derecognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. The accounting provisions of FIN 48 will be effective for the Company beginning October 1, 2007. We are in the process of determining what effect, if any, the adoption of FIN 48 will have on our consolidated financial statements.

2. Amortization of Intangible Assets

Amortization expense associated with our intangible assets, which has been reflected as a separate operating expense caption within the accompanying condensed consolidated statements of income, consisted of the following:


	Quarter Ended				Nine Months Ended
	June 30,				June 30,
	2006		2005		2006		2005
	(In thousands)
Cost of revenues	$	3,741	$	3,696	$	11,169	$	11,149
Selling, general and administrative		2,561		2,624		7,656		8,491

	$	6,302	$	6,320	$	18,825	$	19,640

Cost of revenues reflects our amortization of completed technology, and selling, general and administrative expenses reflects our amortization of other intangible assets. Intangible assets were $96.5 million and $114.6 million, net of accumulated amortization of $78.0 million and $58.9 million, as of June 30, 2006 and September 30, 2005, respectively.

3. Restructuring and Acquisition-Related Expenses

The following table summarizes our restructuring and acquisition-related accruals associated with our June 2006 restructuring

FAIR ISAAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

activities, fiscal 2005 Braun acquisition, fiscal 2004 London Bridge acquisition, and certain other Fair Isaac facility closures. The current portion and non-current portion is recorded in other accrued current liabilities, other compensation and employee benefits and other long-term liabilities within the accompanying condensed consolidated balance sheets.


	Accrual at											Accrual at
	September 30,			Expense		Cash						June 30,
	2005			Additions		Payments			Reversals			2006
	(In thousands)
Facilities charges	$	6,361		$	151	$	(3,374	)	$	(164	)	$	2,974
Employee separation		—			5,139		(1,403	)		—			3,736

	$	6,361		$	5,290	$	(4,777	)	$	(164	)	$	6,710

Less: current portion		(3,721	)										(6,343	)

Non-current	$	2,640										$	367

During the quarter ended June 30, 2006, in connection with a restructuring initiative, we incurred charges totaling $5.3 million. The charges included $5.1 million for severance costs associated with a reduction of 190 employees primarily in product management, delivery and development functions. Cash payments for the majority of these severance costs were either paid in the current quarter or will be paid in the fourth quarter of fiscal 2006. We also recognized a $0.2 million charge associated with the abandonment of leased office space representing future cash obligations under the lease.

During the nine months ended June 30, 2006, we also recorded a $0.7 million gain due to the sublease of office space that we had exited in fiscal 2002. The gain resulted from an adjustment to the liability established for the exit of the lease space and a refund received for past rent paid to the landlord. In addition, we recorded costs of $2.2 million in connection with an abandoned acquisition, consisting of third-party legal, accounting and other professional fees.

In July 2006, we announced our decision to vacate excess leased space in the fourth quarter of fiscal 2006. See Note 8 for additional information.

4. Earnings Per Share

The following table reconciles the numerators and denominators of basic and diluted earnings per share (“EPS”):


	Quarter Ended				Nine Months Ended
	June 30,				June 30,
	2006		2005		2006		2005
	(In thousands, except per share data)
Numerator for basic earnings per share — net income	$	26,003	$	36,612	$	81,433	$	98,800
Interest expense on senior convertible notes, net of tax		1		1		3		2,468

Numerator for diluted earnings per share	$	26,004	$	36,613	$	81,436	$	101,286


Denominator — shares:
Basic weighted-average shares		63,664		66,215		64,303		67,247
Effect of dilutive securities		1,309		2,316		1,700		8,414

Diluted weighted-average shares		64,973		68,531		66,003		75,661


Earnings per share:
Basic	$	0.41	$	0.55	$	1.27	$	1.47

Diluted	$	0.40	$	0.53	$	1.23	$	1.34

The computation of diluted EPS for the quarters ended June 30, 2006 and 2005, excludes options to purchase approximately 3,868,000 and 3,665,000 shares of common stock, respectively, and for the nine months ended June 30, 2006 and 2005, excludes options to purchase approximately 2,349,000 and 3,946,000 shares of common stock, respectively, because the options’ exercise prices exceeded the average market price of our common stock in these periods and their inclusion would be antidilutive. Emerging Issues Task Force (“EITF”) Issue No. 04-8, The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share requires us to consider all instruments with contingent conversion features that are based on the market price of our own stock in our

FAIR ISAAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

diluted earnings per share calculation, regardless of whether the market price conversion triggers are then met. The computation for diluted EPS for the quarter and nine months ended June 30, 2005 includes approximately 7,000 and 6,036,000, respectively, shares of common stock issuable upon conversion of our 1.5% Senior Convertible Notes. Effective with the March 31, 2005 exchange of Senior Convertible Notes for New Senior Convertible Notes (“New Notes”), the dilutive effect of the New Notes is calculated using the treasury stock method.

5. Segment Information

We are organized into the following four reportable segments, to align with the internal management of our worldwide business operations based on product and service offerings:

	•		Strategy Machine Solutions. These are Enterprise Decision Management (“EDM”) applications designed for specific processes such as marketing, account origination, customer account management, fraud and insurance bill review. This segment also includes our myFICO solution for consumers.

	•		Scoring Solutions. These include our scoring services distributed through major credit reporting agencies, as well as services through which we provide our scores to lenders directly.

	•		Professional Services. This segment includes revenues from custom engagements, business solution and technical consulting services, systems integration services and data management services.

	•		Analytic Software Tools. This segment is composed of our business rules management, model development and strategy design software sold to businesses for their use in building their own EDM applications.

Our Chief Executive Officer evaluates segment financial performance based on segment revenues and operating income. Segment operating expenses consist of direct and indirect costs principally related to personnel, facilities, consulting, travel, depreciation and amortization. Indirect costs are allocated to the segments generally based on relative segment revenues, fixed rates established by management based upon estimated expense contribution levels and other assumptions that management considers reasonable. Our Chief Executive Officer does not evaluate the financial performance of each segment based on its respective assets or capital expenditures; rather, depreciation and amortization amounts are allocated to the segments from their internal cost centers as described above.

In fiscal 2006, we changed how we measure operating income by segment to exclude share-based compensation as a result of the adoption of SFAS No. 123(R) on October 1, 2005. We have reclassified prior period segment operating income to reflect this change.

The following tables summarize segment information for the quarters and nine months ended June 30, 2006 and 2005:


	Quarter Ended June 30, 2006
	Strategy									Analytic
	Machine			Scoring			Professional			Software
	Solutions			Solutions			Services			Tools			Total
	(In thousands)
Revenues	$	114,820		$	43,745		$	36,714		$	11,850		$	207,129
Operating expenses		(93,330	)		(16,533	)		(34,272	)		(10,988	)		(155,123	)

Segment operating income	$	21,490		$	27,212		$	2,442		$	862			52,006

Unallocated share-based compensation expense														(10,384	)
Unallocated restructuring and acquisition-related expense														(5,290	)

Operating income														36,332
Unallocated interest income														4,317
Unallocated interest expense														(2,155	)
Unallocated other income, net														551

Income before income taxes													$	39,045

Depreciation and amortization	$	7,707		$	2,011		$	1,779		$	795		$	12,292

FAIR ISAAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


	Quarter Ended June 30, 2005
	Strategy									Analytic
	Machine			Scoring			Professional			Software
	Solutions			Solutions			Services			Tools			Total
	(In thousands)
Revenues	$	115,092		$	40,741		$	33,203		$	14,771		$	203,807
Operating expenses		(100,944	)		(15,690	)		(28,214	)		(9,651	)		(154,499	)

Segment operating income	$	14,148		$	25,051		$	4,989		$	5,120			49,308

Unallocated share-based compensation expense														(462	)

Operating income														48,846
Unallocated interest income														2,295
Unallocated interest expense														(2,142	)
Unallocated other income, net														8

Income before income taxes													$	49,007

Depreciation and amortization	$	7,342		$	2,877		$	1,650		$	853		$	12,722


	Nine Months Ended June 30 , 2006
	Strategy									Analytic
	Machine			Scoring			Professional			Software
	Solutions			Solutions			Services			Tools			Total
	(In thousands)
Revenues	$	345,658		$	131,669		$	108,236		$	32,513		$	618,076
Operating expenses		(281,001	)		(48,419	)		(98,551	)		(32,188	)		(460,159	)

Segment operating income	$	64,657		$	83,250		$	9,685		$	325			157,917

Unallocated share-based compensation expense														(30,024	)
Unallocated restructuring and acquisition related expense														(6,800	)

Operating income														121,093
Unallocated interest income														11,333
Unallocated interest expense														(6,433	)
Unallocated other income, net														153

Income before income taxes													$	126,146

Depreciation and amortization	$	23,706		$	5,805		$	4,805		$	2,213		$	36,529


	Nine Months Ended June 30, 2005
	Strategy									Analytic
	Machine			Scoring			Professional			Software
	Solutions			Solutions			Services			Tools			Total
	(In thousands)
Revenues	$	344,156		$	119,512		$	96,253		$	35,453		$	595,374
Operating expenses		(295,137	)		(50,170	)		(82,840	)		(26,234	)		(454,381	)

Segment operating income	$	49,019		$	69,342		$	13,413		$	9,219			140,993

Unallocated share-based compensation expense														(1,092	)

Operating income														139,901
Unallocated interest income														5,874
Unallocated interest expense														(6,206	)
Unallocated other income, net														333

Income before income taxes													$	139,902

Depreciation and amortization	$	23,246		$	8,995		$	4,951		$	2,069		$	39,261

6. Income Taxes

Our effective tax rate was 33.4% and 25.3% during the quarters ended June 30, 2006 and 2005, respectively, and 35.4% and 29.4% during the nine months ended June 30, 2006 and 2005, respectively. The provision for income taxes during interim quarterly reporting periods is based on our estimates of the effective tax rates for the respective full fiscal year.

FAIR ISAAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Our effective tax rate during the quarter ended June 30, 2005 was impacted by the recognition of $4.4 million of tax benefits related to prior years. These benefits were determined in conjunction with tax studies we performed with outside advisors that identified additional federal and state tax credits and other deductions related to prior years’ tax returns. The tax benefits recognized reflect our estimate of the effect of amended tax returns filed for fiscal 2002 through 2004. These tax benefits reduced our effective tax rate by 8.9% during the quarter ended June 30, 2005.

In addition to the $4.4 million adjustment recorded in the quarter ended June 30, 2005, tax expense for the nine months ended June 30, 2005 was also reduced by a $6.0 million adjustment that resulted from the recognition of tax benefits related to prior years. This adjustment was the result of a tax study we performed with outside advisors that identified additional federal and state tax credits and other deductions related to prior years’ tax returns. The adjustment reflects our estimate of the effect of amended tax returns for fiscal 1998 through 2003. These tax benefits reduced our effective tax rate by 7.4% during the nine months ended June 30, 2005.

7. Contingencies

We are in disputes with certain customers regarding amounts owed in connection with the sale of certain of our products and services. We also have had claims asserted by former employees relating to compensation and other employment matters. We are also involved in various other claims and legal actions arising in the ordinary course of business. We believe that none of these aforementioned claims or actions will result in a material adverse impact to our consolidated results of operations, liquidity or financial condition. However, the amount or range of any potential liabilities associated with these claims and actions, if any, cannot be determined with certainty. Set forth below is additional detail concerning certain ongoing litigation.

Customer Claims

We are party to two separate lawsuits involving two different customers who have asserted that our performance under professional services contracts with such customers has caused them to incur damages. One customer’s lawsuit is pending in the United States District Court for the Central District of California, and the other is pending as a counterclaim to a collection lawsuit that we commenced in the United States District Court for the Southern District of Texas. The customers in these matters have claimed damages in excess of $10 million. We believe that these claims are without merit, and we intend to contest them vigorously. We also believe that the resolution of these claims will not result in a material adverse impact to our consolidated financial condition.

Putative Consumer Class Action Lawsuits

We are a defendant in a lawsuit captioned as Robbie Hillis v. Equifax Consumer Services, Inc. and Fair Isaac, Inc., which is pending in the U.S. District Court for the Northern District of Georgia. The plaintiff claims that the defendants have jointly sold the Score Power^® credit score product in violation of certain procedural requirements under the Credit Repair Organizations Act (“CROA”), and in violation of the antifraud provisions of that statute. The plaintiff also claims that the defendants are “credit repair organizations” under CROA. The plaintiff is seeking certification of a class on behalf of all individuals who purchased products containing Score Power from the defendants in the five year period prior to the filing of the Complaint on November 14, 2004. The plaintiff is seeking unspecified damages, attorneys’ fees and costs. We believe that the claims in this lawsuit are without merit, and we have denied any liability or wrongdoing and have denied that class certification is appropriate. We are vigorously contesting this matter. The plaintiff has brought a motion for class certification and a motion for summary judgment in his favor and against the defendants. We have filed briefs in opposition to the plaintiff’s motions. We believe that the resolution of this claim will not result in a material adverse impact to our consolidated financial condition.

We are a defendant in a lawsuit captioned as Christy Slack v. Fair Isaac Corporation and MyFICO Consumer Services, Inc., which is pending in the United States District Court for the Northern District of California. As in the Hillis matter, the plaintiff is claiming that the defendants violated certain procedural requirements of CROA, and violated the antifraud provisions of CROA, with respect to the sale of credit score products on our myFICO.com website. The plaintiff also claims that the defendants violated the California Credit Services Act (the “CSA”) and were unjustly enriched. The plaintiff has sought certification of a class on behalf of all individuals who purchased credit score products from us on the myFICO.com website in the five year period prior to the filing of the Complaint on January 18, 2005. Plaintiff seeks unspecified damages, attorneys’ fees and costs. We believe that the claims in this lawsuit are without merit and we have denied any liability or wrongdoing and have denied that class certification is appropriate. We are vigorously contesting this matter. On April 22, 2005, we brought a motion to dismiss the plaintiff’s claims. On June 27, 2005, the Court granted our motion, in part, by dismissing certain of the plaintiff’s claims under the CSA. The plaintiff has brought motions for

FAIR ISAAC CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

summary judgment and for class certification. We intend to oppose both motions, and we believe that the resolution of this claim will not result in a material adverse impact to our consolidated financial condition.

Braun Consulting, Inc.

Braun (which we acquired in November 2004) was a defendant in a lawsuit filed on November 26, 2001, in the United States District Court for the Southern District of New York (Case No. 01 CV 10629) that alleges violations of federal securities laws in connection with Braun’s initial public offering in August 1999. This lawsuit is among approximately 300 coordinated putative class actions against certain issuers, their officers and directors, and underwriters with respect to such issuers’ initial public offerings. As successor in interest to Braun, we have entered into a Stipulation and Agreement of Settlement, pursuant to a Memorandum of Understanding, along with most of the other defendant issuers in this coordinated litigation, whereby such issuers and their officers and directors will be dismissed with prejudice, subject to the satisfaction of certain conditions, including, among others, approval of the court. Under the terms of this agreement, we will not pay any amount of the settlement.

8. Subsequent Event

In July 2006, we decided to vacate excess leased space located in California in the fourth quarter of fiscal 2006. As a result of this action, we expect to incur a charge of approximately $13.0 million (or $8.4 million after tax) in the fourth quarter of fiscal 2006, which represents future cash lease obligations, net of anticipated sublease income. We expect that the future lease obligations will be paid out over the next five years, which represents the remaining term of the lease. The charge will be classified in restructuring and acquisition-related expense within our consolidated statement of income.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD LOOKING STATEMENTS

Statements contained in this Report that are not statements of historical fact should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”). In addition, certain statements in our future filings with the Securities and Exchange Commission (“SEC”), in press releases, and in oral and written statements made by us or with our approval that are not statements of historical fact constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenue, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other statements concerning future financial performance; (ii) statements of our plans and objectives by our management or Board of Directors, including those relating to products or services; (iii) statements of assumptions underlying such statements; (iv) statements regarding business relationships with vendors, customers or collaborators; and (v) statements regarding products, their characteristics, performance, sales potential or effect in the hands of customers. Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted,” “should,” “potential,” “goals,” “strategy,” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, those described in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations-Risk Factors, below. The performance of our business and our securities may be adversely affected by these factors and by other factors common to other businesses and investments, or to the general economy. Forward-looking statements are qualified by some or all of these risk factors. Therefore, you should consider these risk factors with caution and form your own critical and independent conclusions about the likely effect of these risk factors on our future performance. Such forward-looking statements speak only as of the date on which statements are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events or circumstances. Readers should carefully review the disclosures and the risk factors described in this and other documents we file from time to time with the SEC, including our reports on Forms 10-K, 10-Q and 8-K.

RESULTS OF OPERATIONS

Overview

We are a leader in Enterprise Decision Management (“EDM”) solutions that enable businesses to automate and improve their decisions. Our predictive modeling, decision analysis, intelligence management, decision management systems and consulting services power billions of customer decisions each year. We help companies acquire customers more efficiently, increase customer value, reduce fraud and credit losses, lower operating expenses and enter new markets more profitably. Most leading banks and credit card issuers rely on our solutions, as do many insurers, retailers, telecommunications providers, healthcare organizations and government agencies. We also serve consumers through online services that enable people to purchase and understand their FICO scores, the standard measure of credit risk, to manage their financial health.

Most of our revenues are derived from the sale of products and services within the consumer credit, financial services and insurance industries, and during the quarter ended June 30, 2006, 72% of our revenues were derived from within these industries. A significant portion of our remaining revenues is derived from the telecommunications, healthcare and retail industries, as well as the government sector. Our clients utilize our products and services to facilitate a variety of business processes, including customer marketing and acquisition, account origination, credit and underwriting risk management, fraud loss prevention and control, and client account and policyholder management. A significant portion of our revenues is derived from transactional or unit-based software license fees, annual license fees under long-term software license arrangements, transactional fees derived under scoring, network service or internal hosted software arrangements, and annual software maintenance fees. The recurrence of these revenues is, to a significant degree, dependent upon our clients’ continued usage of our products and services in their business activities. The more significant activities underlying the use of our products in these areas include: credit and debit card usage or active account levels; lending acquisition, origination and customer management activity; workers’ compensation and automobile medical injury insurance claims; and wireless and wireline calls and subscriber levels. Approximately 74% and 75% of our revenues during the quarters ended June 30, 2006 and 2005, respectively, and 75% and 77% of our revenues for the nine months ended June 30, 2006 and 2005, respectively, were derived from arrangements with transactional or unit-based pricing. We also derive revenues from other sources which generally do not recur and include, but are not limited to, perpetual or time-based licenses with upfront payment terms, non-recurring professional service arrangements and gain-share arrangements where revenue is derived based on percentages of client revenue growth or cost reductions attributable to our products.

Within a number of our sectors there has been a sizable amount of industry consolidation. In addition, many of our sectors are experiencing increased levels of competition. As a result of these factors, we believe that future revenues in particular sectors may decline. However, due to the long-term customer arrangements we have with many of our customers, the near term impact of these declines may be more limited in certain sectors.

One measure used by management as an indicator of our business performance is the volume of new bookings achieved. We define a “new booking” as estimated future contractual revenues, including agreements with perpetual, multi-year and annual terms. New bookings values may include: (i) estimates of variable fee components such as hours to be incurred under new professional services arrangements and customer account or transaction activity for agreements with transactional-based fee arrangements, (ii) additional or expanded business from renewals of contracts, and (iii) to a lesser extent, previous customers that have attrited and been re-sold only as a result of a significant sales effort. During the quarter ended June 30, 2006, we achieved new bookings of $94.5 million, including eight deals with bookings values of $3.0 million or more. In comparison, new bookings in the prior year quarter ended June 30, 2005 were $143.3 million, including nine deals with bookings values of $3.0 million or more.

Management regards the volume of new bookings achieved, among other factors, as an important indicator of future revenues, but they are not comparable to, nor should they be substituted for, an analysis of our revenues, and they are subject to a number of risks and uncertainties, including those described in Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Factors, below, concerning timing and contingencies affecting product delivery and performance. Although many of our contracts have fixed non-cancelable terms, some of our contracts are terminable by the client on short notice or without notice. Accordingly, we do not believe it is appropriate to characterize all of our new bookings as backlog that will generate future revenue.

Our revenues derived from clients outside the United States continue to grow, and may in the future grow more rapidly than our revenues from domestic clients. International revenues totaled $62.2 million and $52.3 million during the quarters ended June 30, 2006 and 2005, respectively, representing 30% and 26% of total consolidated revenues in each of these periods. International revenues totaled $170.5 million and $152.3 million during the nine months ended June 30, 2006 and 2005, respectively, representing 28% and 26% of total consolidated revenues in each of these periods. In addition to clients acquired via our acquisitions, we believe that our international growth is a product of successful relationships with third parties that assist in international sales efforts and our own increased sales focus internationally, and we expect that the percentage of our revenues derived from international clients will increase in the future.

Our reportable segments are: Strategy Machine Solutions, Scoring Solutions, Professional Services and Analytic Software Tools. Although we sell solutions and services into a large number of end user product and industry markets, our reportable business segments reflect the primary method in which management organizes and evaluates internal financial information to make operating decisions and assess performance. Comparative segment revenues, operating income, and related financial information for the quarters and nine months ended June 30, 2006 and 2005, are set forth in Note 5 to the accompanying condensed consolidated financial statements.

Revenues

The following tables set forth certain summary information on a segment basis related to our revenues for the fiscal periods indicated.


	Quarter Ended													Period-to-Period
	June 30,				Percentage of Revenues						Period-to-Period			Percentage
Segment	2006		2005		2006			2005			Change			Change
	(In thousands)										(In thousands)
Strategy Machine Solutions	$	114,820	$	115,092		55	%		57	%	$	(272	)		—
Scoring Solutions		43,745		40,741		21	%		20	%		3,004			7	%
Professional Services		36,714		33,203		18	%		16	%		3,511			11	%
Analytic Software Tools		11,850		14,771		6	%		7	%		(2,921	)		(20	)%

Total revenues	$	207,129	$	203,807		100	%		100	%		3,322			2	%


	Nine Months Ended													Period-to-Period
	June 30,				Percentage of Revenues						Period-to-Period			Percentage
	2006		2005		2006			2005			Change			Change
	(In thousands)										(In thousands)
Strategy Machine Solutions	$	345,658	$	344,156		56	%		58	%	$	1,502			—
Scoring Solutions		131,669		119,512		21	%		20	%		12,157			10	%
Professional Services		108,236		96,253		18	%		16	%		11,983			12	%
Analytic Software Tools		32,513		35,453		5	%		6	%		(2,940	)		(8	)%

Total revenues	$	618,076	$	595,374		100	%		100	%		22,702			4	%

Quarter Ended June 30, 2006 Compared to Quarter Ended June 30, 2005 Revenues

Strategy Machine Solutions segment revenues declined due to a $4.2 million decrease in revenues from our marketing solutions, a $1.7 million decrease in revenues from our insurance and healthcare solutions and a $0.1 million net decrease in revenues from our other strategy machine solutions. The revenue decline was partially offset by a $4.5 million increase in revenues from our fraud solutions and a $1.2 million increase in revenues from our collections and recovery solutions. The decrease in marketing solutions revenues was attributable primarily to the loss of two large financial services customers, which resulted from industry consolidation. The decrease in insurance and healthcare solutions revenues was attributable primarily to a decline in bill review volumes associated with our existing customer base, lower claims volumes at some of our key customers and loss of several customer accounts. The increase in fraud solutions revenues was attributable to an increase in license sales and an increase in transaction volumes. The increase in collections and recovery solutions revenues was due to an increase in perpetual license sales.

Scoring Solutions segment revenues increased primarily due to an increase in revenues derived from risk scoring services at the credit reporting agencies and, to a lesser extent, an increase in revenue derived from our own prescreening services and our expansion scoring product.

During the quarters ended June 30, 2006 and 2005, revenues generated from our agreements with Equifax, TransUnion and Experian, collectively accounted for approximately 22% and 20%, respectively, of our total revenues, including revenues from these customers that are recorded in our other segments.

Professional Services segment revenues increased from industry consulting services and predictive modeling services. The increase in industry consulting services revenue resulted from initiatives to expand our professional service offerings into additional industry markets.

Analytic Software Tools segment revenues decreased due to a decline in sales of perpetual licenses for our Blaze Advisor software product.

Nine Months Ended June 30, 2006 Compared to Nine Months Ended June 30, 2005 Revenues

Strategy Machine Solutions segment revenues increased due to a $10.7 million increase in revenues from our fraud solutions, a $10.0 million increase in revenues from our consumer solutions and a $3.9 million increase in revenues from our collections and recovery solutions. The revenue increase was partially offset by a $15.9 million decrease in revenues from our marketing solutions, a $6.4 million decrease in revenues from our insurance and healthcare solutions, and a $0.8 million decrease in revenues from our other strategy machine solutions. The increase in fraud solutions revenues was attributable to higher license sales and an increase in transaction volumes. The increase in consumer solutions revenues was partially attributable to increases in revenues derived from myFICO.com and our strategic alliance partners. The increase in consumer solutions revenue was also the result of a revision made during the second quarter of fiscal 2006 to the estimated period during which revenue is earned on sales of certain products that provide consumers access to multiple credit scores. The revision, which increased revenues by $3.6 million, resulted from the completion of a study that showed that consumers were accessing their scores over a shorter period of time than initially estimated. The increase in collections and recovery solutions revenues was attributable primarily to an increase in license sales. The decrease in marketing solutions revenues was attributable primarily to the loss of two large financial services customers, which resulted from industry consolidation. The decrease in insurance and healthcare solutions revenues was attributable primarily to a decline in bill review volumes associated with our existing customer base, lower claims volumes at some of our key customers and loss of several customer accounts.

Scoring Solutions segment revenues increased primarily due to an increase in revenues derived from risk scoring services at the credit reporting agencies and an increase in revenue derived from our own prescreening services.

During the nine months ended June 30, 2006 and 2005, revenues generated from our agreements with Equifax, TransUnion and Experian, collectively accounted for approximately 22% and 19%, respectively, of our total revenues, including revenues from these customers that are recorded in our other segments.

Professional Services segment revenues increased from industry consulting services, implementation services for our Blaze Advisor products and predictive modeling services. The increase in industry consulting services revenue resulted from initiatives to expand our professional service offerings into additional industry markets.

Analytic Software Tools segment revenues decreased due to a decline in sales of perpetual licenses for our Blaze Advisor software product. The decline was partially offset by an increase in sales of Model Builder software products.

Operating Expenses and Other Income (Expense)

The following table sets forth certain summary information related to our statements of income for the fiscal periods indicated.


	Quarter Ended															Period-to-Period
	June 30,						Percentage of Revenues						Period-to-Period			Percentage
	2006			2005			2006			2005			Change			Change
	(In thousands)												(In thousands)
Revenues	$	207,129		$	203,807			100	%		100	%	$	3,322			2	%

Operating expenses:
Cost of revenues		71,497			68,339			35	%		34	%		3,158			5	%
Research and development		21,370			21,176			10	%		10	%		194			1	%
Selling, general and administrative		66,338			59,126			32	%		29	%		7,212			12	%
Amortization of intangible assets		6,302			6,320			3	%		3	%		(18	)		—
Restructuring and acquisition-related		5,290			—			2	%		—			5,290			—

Total operating expenses		170,797			154,961			82	%		76	%		15,836			10	%

Operating income		36,332			48,846			18	%		24	%		(12,514	)		(26	)%
Interest income		4,317			2,295			2	%		1	%		2,022			88	%
Interest expense		(2,155	)		(2,142	)		(1	)%		(1	)%		(13	)		—
Other income, net		551			8			—			—			543			—

Income before income taxes		39,045			49,007			19	%		24	%		(9,962	)		(20	)%
Provision for income taxes		13,042			12,395			6	%		6	%		647			5	%

Net income	$	26,003		$	36,612			13	%		18	%		(10,609	)		(29	)%


Number of employees at quarter end		2,840			2,804									36			1	%


	Nine Months Ended															Period-to-Period
	June 30,						Percentage of Revenues						Period-to-Period			Percentage
	2006			2005			2006			2005			Change			Change
	(In thousands)												(In thousands)
Revenues	$	618,076		$	595,374			100	%		100	%	$	22,702			4	%

Operating expenses:
Cost of revenues		211,686			207,757			34	%		36	%		3,929			2	%
Research and development		65,794			60,297			11	%		10	%		5,497			9	%
Selling, general and administrative		193,878			167,779			31	%		28	%		26,099			16	%
Amortization of intangible assets		18,825			19,640			3	%		3	%		(815	)		(4	)%
Restructuring and acquisition-related		6,800			—			1	%		—			6,800			—

Total operating expenses		496,983			455,473			80	%		77	%		41,510			9	%

Operating income		121,093			139,901			20	%		23	%		(18,808	)		(13	)%
Interest income		11,333			5,874			1	%		1	%		5,459			93	%
Interest expense		(6,433	)		(6,206	)		(1	)%		(1	)%		(227	)		(4	)%
Other income, net		153			333			—			—			(180	)		(54	)%

Income before income taxes		126,146			139,902			20	%		23	%		(13,756	)		(10	)%
Provision for income taxes		44,713			41,102			7	%		6	%		3,611			9	%

Net income	$	81,433		$	98,800			13	%		17	%		(17,367	)		(18	)%

Effective October 1, 2005, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment, using the modified prospective transition method. Under this method, share-based compensation expense that we recognized for the quarter and nine months ended June 30, 2006, included expense associated with the fair value of all awards granted on and after October 1, 2005, and expense for the unvested portion of previously granted awards outstanding on October 1, 2005. The fair value of the unvested options outstanding as of October 1, 2005 was based on the fair value estimated on the grant date in accordance with the original provisions of SFAS No. 123. Results for prior periods have not been restated.

In accordance with SFAS No. 123(R), we recorded pre-tax share-based compensation expense of $10.4 million and $30.0 million during the quarter and nine months ended June 30, 2006, respectively. In comparison, we recorded pre-tax share-based compensation expense of $0.5 million and $1.1 million during the quarter and nine months ended June 30, 2005, respectively. Share-based compensation expense was recorded in cost of revenues, research and development, and selling, general and administrative expense.

Cost of Revenues

Cost of revenues consists primarily of employee salaries and benefits for personnel directly involved in creating, installing and supporting revenue products; travel and related overhead costs; costs of computer service bureaus; internal network hosting costs; amounts payable to credit reporting agencies for scores; software costs; and expenses related to our consumer score services through myFICO.com.

The quarter over quarter increase in cost of revenues resulted from a $5.1 million increase in personnel and other labor-related costs, and a $1.1 million net increase in other expenses. The increase was partially offset by a $1.8 million decrease in third-party software and data and a $1.2 million decrease in facilities and infrastructure costs. The increase in personnel and other labor-related costs was partially attributable to a $2.6 million increase in share-based compensation expense due to the adoption of SFAS No. 123(R). The increase in personnel costs was also the result of higher outside consultant costs. The decline in third-party software and data costs was attributable primarily to a decrease in insurance and healthcare solution costs, which resulted from lower revenues and lower costs associated with consumer solutions products. The decrease in facilities and infrastructure costs was attributable primarily to a reduction in information system costs.

The year-to-date period over period increase in cost of revenues resulted from a $10.4 million increase in personnel and other labor-related costs and a $2.3 million net increase in other expenses. The increase was partially offset by a $7.4 million decrease in facilities and infrastructure costs and a $1.4 million decrease in third-party software and data. The increase in personnel and other labor-related costs was attributable primarily to an $8.1 million increase in share-based compensation expense due to the adoption of SFAS No. 123(R). The increase in personnel costs was also the result of higher outside consultant costs. The decrease in facilities and infrastructure costs was attributable primarily to a reduction in depreciation expense, lower outside costs for information systems and that fiscal 2005 included system integration costs associated with our acquisition of London Bridge Software Holdings plc.

Excluding the impact of SFAS No. 123(R), which requires expensing of all share-based awards, we expect that cost of revenues as a percentage of revenues in fiscal 2006 will be slightly lower than those incurred during fiscal 2005.

Research and Development

Research and development expenses include the personnel and related overhead costs incurred in development of new products and services, including primarily the research of mathematical and statistical models and the development of new versions of Strategy Machine Solutions and Analytic Software Tools.

The quarter over quarter increase in research and development expenditures was attributable to a $0.7 million increase in facilities and infrastructure costs, which was driven by higher information system costs. The increase was partially offset by a decline in personnel and related costs of $0.5 million. Personnel costs were impacted by lower salary costs, which offset a $1.6 million increase in share-based compensation expense due to the adoption of SFAS No. 123(R).

The year-to-date period over period increase in research and development expenditures was attributable to an increase in research and development personnel and related costs of $3.5 million, which was driven by a $5.0 million increase in share-based compensation expense due to the adoption of SFAS No. 123(R). The increase was also partially the result of a $2.2 million increase in facilities and infrastructure costs.

Excluding the impact of SFAS No. 123(R), which requires expensing of all share-based awards, we expect that research and development expenditures as a percentage of revenues in fiscal 2006 will be consistent with those incurred during fiscal 2005.

Selling, General and Administrative

Selling, general and administrative expenses consist principally of employee salaries and benefits, travel, overhead, advertising and other promotional expenses, corporate facilities expenses, legal expenses, business development expenses, and the cost of operating computer systems.

The quarter over quarter increase in selling, general and administrative expenses was attributable to a $6.1 million increase in personnel and other labor-related costs and a $1.1 million net increase in other expenses. The increase in personnel and labor-related costs was attributable primarily to a $5.7 million increase in share-based compensation expense due to the adoption of SFAS No. 123(R), and higher salary costs.

The year-to-date period over period increase in selling, general and administrative expenses was attributable to a $24.0 million increase in personnel and other labor-related costs and a $2.1 million net increase in other expenses. The increase in personnel and labor-related costs resulted primarily from a $15.9 million increase in share-based compensation expense due to the adoption of SFAS No. 123(R) and the remaining $8.1 million increase was primarily due to higher salary and commission costs.

Excluding the impact of SFAS No. 123(R), which requires expensing of all share-based awards, we expect that selling, general and administrative expenses as a percentage of revenues in fiscal 2006 will be consistent with those incurred during fiscal 2005.

Amortization of Intangible Assets

Amortization of intangible assets consists of amortization expense related to intangible assets recorded in connection with acquisitions accounted for by the purchase method of accounting. Our definite-lived intangible assets, consisting primarily of completed technology and customer contracts and relationships, are being amortized using the straight-line method or based on forecasted cash flows associated with the assets over periods ranging from two to fifteen years.

The year-to-date period over period decline in amortization expense was attributable to certain intangible assets becoming fully amortized in the prior year.

Restructuring and Acquisition-Related

will be paid in the fourth quarter of fiscal 2006. We also recognized a $0.2 million charge associated with the abandonment of leased office space representing future cash obligations under the lease. These actions are forecasted to result in annualized savings of approximately $22 million, which represents compensation costs for terminated employees. However, as part of the restructuring initiative, we expect that the cost savings will be partially offset by additional staff required to support our new client-centric approach to marketing our products.

At June 30, 2006, accrued restructuring and acquisition-related liabilities were $6.7 million, of which $6.3 million was classified as current.

Interest Income

Interest income is derived primarily from the investment of funds in excess of our immediate operating requirements. The quarter over quarter and year-to-date period over period increase in interest income was attributable to higher interest and investment income yields due to market conditions and to a lesser extent higher average cash and investment balances. The increase in cash and investment balances resulted principally from cash provided by operating activities and proceeds received from the exercise of employee stock options.

Interest Expense

Interest expense recorded during the quarter and nine months ended June 30, 2006, relates to our $400.0 million of 1.5% Senior Convertible Notes (“Senior Notes”), including the amortization of debt issuance costs, and was consistent with the interest expense related to the Senior Notes recorded by us during the quarter and nine months ended June 30, 2005.

Other Income, Net

Other income, net consists primarily of realized investment gains/losses, exchange rate gains/losses resulting from re-measurement of foreign-denominated receivable and cash balances held by our U.S. reporting entities into the U.S. dollar functional currency at period-end market rates, net of the impact of offsetting forward exchange contracts, and other non-operating items.

The quarter over quarter increase in other income was due to a $0.7 million gain on the disposition of investments during the quarter ended June 30, 2006. The increase was partially offset by foreign exchange losses of $0.2 million that were recognized in the quarter ended June 30, 2006, compared to essentially no impact on earnings from foreign exchange in the quarter ended June 30, 2005.

The year-to-date period over period decline in other income was due to foreign exchange losses of $0.6 million that were recognized in the nine months ended June 30, 2006, compared to foreign exchange gains of $0.1 million that were recognized in the nine months ended June 30, 2005. The decline was partially offset by a $0.7 million gain on the disposition of investments during the nine months ended June 30, 2006.

Provision for Income Taxes

Our effective tax rate during the quarter ended June 30, 2005 was impacted by the recognition of $4.4 million of tax benefits related

to prior years. These benefits were determined in conjunction with tax studies we performed with outside advisors that identified additional federal and state tax credits and other deductions related to prior years’ tax returns. The tax benefits recognized reflect our estimate of the effect of amended tax returns filed for fiscal 2002 through 2004. These tax benefits reduced our effective tax rate by 8.9% during the quarter ended June 30, 2005.

Operating Income

The following table sets forth certain summary information on a segment basis related to our operating income for the fiscal periods indicated.


	Quarter Ended									Period-to-Period
	June 30,						Period-to-Period			Percentage
Segment	2006			2005			Change			Change
				(In thousands)
Strategy Machine Solutions	$	21,490		$	14,148		$	7,342			52	%
Scoring Solutions		27,212			25,051			2,161			9	%
Professional Services		2,442			4,989			(2,547	)		(51	)%
Analytic Software Tools		862			5,120			(4,258	)		(83	)%

Segment operating income		52,006			49,308			2,698			5	%
Unallocated share-based compensation		(10,384	)		(462	)		(9,922	)		—
Unallocated restructuring and acquisition-related		(5,290	)		—			(5,290	)		—

Operating income	$	36,332		$	48,846			(12,514	)		(26	)%


	Nine Months Ended									Period-to-Period
	June 30,						Period-to-Period			Percentage
Segment	2006			2005			Change			Change
				(In thousands)
Strategy Machine Solutions	$	64,657		$	49,019		$	15,638			32	%
Scoring Solutions		83,250			69,342			13,908			20	%
Professional Services		9,685			13,413			(3,728	)		(28	)%
Analytic Software Tools		325			9,219			(8,894	)		(96	)%

Segment operating income		157,917			140,993			16,924			12	%
Unallocated share-based compensation		(30,024	)		(1,092	)		(28,932	)		—
Unallocated restructuring and acquisition-related		(6,800	)		—			(6,800	)		—

Operating income	$	121,093		$	139,901			(18,808	)		(13	)%

The quarter over quarter decrease in operating income was attributable primarily to increased share-based compensation expense due to the adoption of SFAS No. 123(R) and the $5.3 million restructuring charge. The decrease in operating income was partially offset by the impact of an increase in segment revenues. At the segment level, the increase in segment operating income was driven by increases of $7.3 million and $2.2 million in segment operating income within our Strategy Machine Solutions and Scoring Solutions segments, respectively, partially offset by a $4.3 million and $2.5 million decrease in segment operating income within our Analytic Software Tools and Professional Services segments, respectively. The increase in Strategy Machine Solutions segment operating income was attributable to increases in sales of higher margin product offerings. Operating expenses for Strategy Machine Solutions have declined due to revenue declines that resulted in reductions in direct costs, such as insurance and healthcare solutions, as well as overall initiatives to reduce costs. The increase in Scoring Solutions segment operating income was attributable primarily to an increase in revenues derived from risk scoring services at the credit reporting agencies and an increase in revenues derived from

our own prescreening services. Operating expenses for Scoring Solutions increased as a result of higher personnel and data costs. We believe that operating income as a percentage of revenues in our Scoring Solutions segment may decline in the future due to lower operating margins on new products. In our Analytic Software Tools segment, the decline in segment operating income was due to a decrease in sales of perpetual licenses, as well as increased product development and sales costs. The decrease in Professional Services segment operating income was the result of higher personnel and outside consultant costs, which more than offset the impact of increased revenue.

The year-to-date period over period decrease in operating income was attributable primarily to increased share-based compensation expense due to the adoption of SFAS No. 123(R) and restructuring charges. The decrease in operating income was partially offset by the impact of an increase in segment revenues. At the segment level, the increase in segment operating income was driven by increases of $15.6 million and $13.9 million in segment operating income within our Strategy Machine Solutions and Scoring Solutions segments, respectively, partially offset by an $8.9 million and $3.7 million decrease in segment operating income within our Analytic Software Tools and Professional Services segments, respectively. The increase in Strategy Machine Solutions segment operating income was attributable to increases in sales of higher margin product offerings and a decline in operating expenses, partially offset by the impact of revenue declines we experienced in marketing solutions and insurance and healthcare solutions. The increase in Scoring Solutions segment operating income was attributable primarily to an increase in revenues derived from risk scoring services at the credit reporting agencies and an increase in revenues derived from our own prescreening services. Operating income for Scoring Solutions also increased due to lower infrastructure costs. In our Analytic Software Tools segment, the decline in segment operating income was due to a decrease in sales of perpetual licenses as well as increased product development and sales costs. The decrease in Professional Services segment operating income was the result of higher personnel and outside consultant costs.

Capital Resources and Liquidity

Cash Flows from Operating Activities

Our primary method for funding operations and growth has been through cash flows generated from operating activities. Net cash provided by operating activities increased from $150.2 million during the nine months ended June 30, 2005, to $153.9 million during the nine months ended June 30, 2006. The increase in operating cash flows was the result of favorable working capital levels, related to the timing of cash receipts from customers and payments to vendors. The increase in operating cash flows was partially offset by a $15.8 million prepayment (net of revenue recognized) that we received in the prior year from a single customer for future services.

Cash Flows from Investing Activities

Net cash used in investing activities totaled $37.4 million during the nine months ended June 30, 2006, compared to net cash used in investing activities of $4.2 million during the nine months ended June 30, 2005. The change in cash flows from investing activities was attributable to a $13.6 million use of cash for the purchase of marketable securities, net of sales and maturities, during the nine months ended June 30, 2006, compared with cash provided of $19.8 million from sales and maturities of marketable securities, net of purchases, during the nine months ended June 30, 2005. The comparison of cash flows from investing activities between periods were also impacted by $32.6 million in cash paid for acquisitions, due to our acquisition of Braun Consulting in November 2004, and $22.7 million in cash proceeds received related to our disposition of London Bridge Phoenix Software, Inc., a subsidiary of London Bridge, in November 2004. In addition, capital expenditures increased by $10.3 million for the nine months ended June 30 2006, which included spending on a new information system data center.

Cash Flows from Financing Activities

Net cash used by financing activities totaled $65.7 million in the nine months ended June 30, 2006, compared to net cash used in financing activities of $186.5 million during the nine months ended June 30, 2005. The decline in cash flows used by financing activities was primarily due to a $107.7 million decrease in common stock repurchased and a $6.9 million increase in cash proceeds from common stock issued under employee stock option and purchase plans.

Repurchases of Common Stock

From time to time, we repurchase our common stock in the open market pursuant to programs approved by our Board of Directors. In August 2005, our Board of Directors approved a common stock repurchase program that allows us to purchase shares of our common stock up to an aggregate cost of $200.0 million. To date, we have repurchased 3,930,100 shares of our common stock under this program for an aggregate cost of $152.7 million, including $124.1 million expended during the nine months ended June 30, 2006.

Dividends

During the quarter ended June 30, 2006, we paid a quarterly dividend of two cents per common share, which is representative of the eight cents per year dividend we have paid in recent years. Our dividend rate is set by the Board of Directors on a quarterly basis taking into account a variety of factors, including among others, our operating results and cash flows, general economic and industry conditions, our obligations, changes in applicable tax laws and other factors deemed relevant by the Board. Although we expect to continue to pay dividends at the current rate, our dividend rate is subject to change from time to time based on the Board’s business judgment with respect to these and other relevant factors.

Credit Agreement

We are party to a credit agreement with a financial institution that provides for a $15.0 million revolving line of credit through February 2007. Under the agreement, as amended, we are required to comply with various financial covenants, which include but are not limited to, minimum levels of domestic liquidity, parameters for treasury stock repurchases, and merger and acquisition requirements. At our option, borrowings under this agreement bear interest at the rate of LIBOR plus 1.25% or at the financial institution’s Prime Rate, payable monthly. The agreement also includes a letter of credit subfeature that allows us to issue commercial and standby letters of credit up to a maximum amount of $5.0 million. As of June 30, 2006, no borrowings were outstanding under this agreement, and we were in compliance with all related covenants. As of June 30, 2006, this credit facility served to collateralize certain letters of credit aggregating $0.7 million, issued by us in the normal course of business. Available borrowings under this credit agreement are reduced by the principal amount of letters of credit.

Capital Resources and Liquidity Outlook

As of June 30, 2006, we had $351.0 million in cash, cash equivalents and marketable security investments. We believe that these balances, including interest to be earned thereon, and anticipated cash flows from operating activities, will be sufficient to fund our working and other capital requirements over the course of the next twelve months and for the foreseeable future. In the normal course of business, we evaluate the merits of acquiring technology or businesses, or establishing strategic relationships with or investing in these businesses. We may elect to use available cash and cash equivalents and marketable security investments to fund such activities in the future. In the event additional needs for cash arise, we may raise additional funds from a combination of sources, including the potential issuance of debt or equity securities. Additional financing might not be available on terms favorable to us, or at all. If adequate funds were not available or were not available on acceptable terms, our ability to take advantage of unanticipated opportunities or respond to competitive pressures could be limited.

We have $400 million of Senior Convertible Notes (the “Senior Notes”) outstanding that mature on August 15, 2023. Holders may require us to repurchase for cash all or part of their Senior Notes on August 15, 2007. Accordingly, we will reclass the $400 million of Senior Notes from non-current to current liabilities in our balance sheet as of September 30, 2006.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.

Critical Accounting Policies and Estimates

We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles. These accounting principles require management to make certain judgments and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We periodically evaluate our estimates including those relating to revenue recognition, the allowance for doubtful accounts, goodwill and other intangible assets resulting from business acquisitions, internal-use software, income taxes and contingencies and litigation. We base our estimates on historical experience and various other assumptions that we believe to be reasonable based on the specific circumstances, the results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

We believe the following critical accounting policies involve the most significant judgments and estimates used in the preparation of our consolidated financial statements:

Revenue Recognition

Software license fee revenue is recognized when persuasive evidence of an arrangement exists, delivery of the product has occurred at our customer’s location, the fee is fixed or determinable and collection is probable. We use the residual method to recognize revenue when an arrangement includes one or more elements to be delivered at a future date and vendor-specific objective evidence of the fair value of all undelivered elements exists. Vendor-specific objective evidence of fair value is based on the normal pricing practices for those products and services when sold separately by us and customer renewal rates for post-contract customer support services. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. If evidence of the fair value of one or more undelivered elements does not exist, the revenue is deferred and recognized when delivery of those elements occurs or when fair value can be established. The determination of whether fees are fixed or determinable and collection is probable involves the use of assumptions. We evaluate contract terms and customer information to ensure that these criteria are met prior to our recognition of license fee revenue. We have not experienced significant variances between our assumptions and actual results in the past and anticipate that we will be able to continue to make reasonable assumptions in the future.

When software licenses are sold together with implementation or consulting services, license fees are recognized upon delivery provided that the above criteria are met, payment of the license fees is not dependent upon the performance of the services, and the services do not provide significant customization or modification of the software products and are not essential to the functionality of the software that was delivered. For arrangements with services that are essential to the functionality of the software, the license and related service revenues are recognized using contract accounting as described below.

If at the outset of an arrangement we determine that the arrangement fee is not fixed or determinable, revenue is deferred until the arrangement fee becomes due. If at the outset of an arrangement we determine that collectibility is not probable, revenue is deferred until the earlier of when collectibility becomes probable or the receipt of payment. If an arrangement provides for customer acceptance, revenue is not recognized until the earlier of receipt of customer acceptance or expiration of the acceptance period.

Revenues from post-contract customer support services, such as software maintenance, are recognized on a straight-line basis over the term of the support period. The majority of our software maintenance agreements provide technical support as well as unspecified software product upgrades and releases when and if made available by us during the term of the support period.

Revenues recognized from our credit scoring, data processing, data management and internet delivery services are recognized as these services are performed, provided persuasive evidence of an arrangement exists, fees are fixed or determinable, and collection is reasonably assured. The determination of certain of our credit scoring and data processing revenues requires the use of estimates, principally related to transaction volumes in instances where these volumes are reported to us by our clients on a monthly or quarterly basis in arrears. In these instances, we estimate transaction volumes based on preliminary customer transaction information, if available, or based on average actual reported volumes for an immediate trailing period. Differences between our estimates and actual final volumes reported are recorded in the period in which actual volumes are reported. We have not experienced significant variances between our estimates and actual reported volumes in the past and anticipate that we will be able to continue to make reasonable estimates in the future. If for some reason we were unable to reasonably estimate transaction volumes in the future, revenue may be deferred until actual customer data was received, and this could have a material impact on our results of operations during the period of time that we changed accounting methods.

Transactional or unit-based license fees under software license arrangements, network service and internally-hosted software agreements are recognized as revenue based on system usage or when fees based on system usage exceed monthly minimum license fees, provided persuasive evidence of an arrangement exists, fees are fixed or determinable and collection is probable. The determination of certain of our transactional or unit-based license fee revenues requires the use of estimates, principally related to transaction usage or active account volumes in instances where this information is reported to us by our clients on a monthly or quarterly basis in arrears. In these instances, we estimate transaction volumes based on preliminary customer transaction information, if available, or based on average actual reported volumes for an immediate trailing period. Differences between our estimates and actual final volumes reported are recorded in the period in which actual volumes are reported. We have not experienced significant variances between our estimates and actual reported volumes in the past and anticipate that we will be able to continue to make reasonable estimates in the future. If for some reason we were unable to reasonably estimate customer account or transaction volumes in the future, revenue would be deferred until actual customer data was received, and this could have a material impact on our consolidated results of operations.

We provide consulting, training, model development and software integration services under both hourly-based time and materials and fixed-priced contracts. Revenues from these services are generally recognized as the services are performed. For fixed-price service contracts, we apply the percentage-of-completion method of contract accounting to determine progress towards completion, which requires the use of estimates. In such instances, management is required to estimate the input measures, generally based on hours incurred to date compared to total estimated hours of the project, with consideration also given to output measures, such as contract milestones, when applicable. Adjustments to estimates are made in the period in which the facts requiring such revisions become known and, accordingly, recognized revenues and profits are subject to revisions as the contract progresses to completion. Estimated losses, if any, are recorded in the period in which current estimates of total contract revenue and contract costs indicate a loss. If substantive uncertainty related to customer acceptance of services exists, we apply the completed contract method of accounting and defer the associated revenue until the contract is completed. If we are unable to accurately estimate the input measures used for percentage-of-completion accounting, revenue would be deferred until the contract is complete, and this could have a material impact on our consolidated results of operations.

Revenue recognized under the percentage-of-completion method in excess of contract billings is recorded as an unbilled receivable. Such amounts are generally billable upon reaching certain performance milestones as defined by individual contracts. Billings collected in advance of performance and recognition of revenue under contracts are recorded as deferred revenue.

In certain of our non-software arrangements, we enter into contracts that include the delivery of a combination of two or more of our service offerings. Typically, such multiple element arrangements incorporate the design and development of data management tools or systems and an ongoing obligation to manage, host or otherwise run solutions for our customer. Such arrangements are divided into separate units of accounting provided that the delivered item has stand-alone value and there is objective and reliable evidence of the fair value of the undelivered items. The total arrangement fee is allocated to the undelivered elements based on their fair values and to the initial delivered elements using the residual method. Revenue is recognized separately, and in accordance with our revenue recognition policy, for each element. If we are unable to determine the fair value of the undeliverable items, revenue on the delivered items would be deferred until revenue can be recognized on the undelivered items, and this could have a material impact on our consolidated results of operations.

As described above, sometimes our customer arrangements have multiple deliverables, including service elements. Generally, our multiple element arrangements fall within the scope of specific accounting standards that provide guidance regarding the separation of elements in multiple-deliverable arrangements and the allocation of consideration among those elements (e.g., American Institute of Certified Public Accountants Statement of Position (“SOP”) No. 97-2, Software Revenue Recognition, as amended). If not, we apply the separation provisions of Emerging Issues Task Force (“EITF”) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. The provisions of EITF Issue No. 00-21 require us to unbundle multiple element arrangements into separate units of accounting when the delivered element(s) has stand-alone value and fair value of the undelivered element(s) exists. When we are able to unbundle the arrangement into separate units of accounting, we apply one of the accounting policies described above to each unit. If we are unable to unbundle the arrangement into separate units of accounting, we apply one of the accounting policies described above to the entire arrangement. Sometimes this results in recognizing the entire arrangement fee when delivery of the last element in a multiple element arrangement occurs. For example, if the last undelivered element is a service, we recognize revenue for the entire arrangement fee as the service is performed, or if no pattern of performance is discernable, we recognize revenue on a straight-line basis over the term of the arrangement.

We record revenue on a net basis for those sales in which we have in substance acted as an agent or broker in the transaction.

Allowance for Doubtful Accounts

We make estimates regarding the collectibility of our accounts receivable. When we evaluate the adequacy of our allowance for doubtful accounts, we analyze specific accounts receivable balances, historical bad debts, customer creditworthiness, current economic trends and changes in our customer payment cycles. Material differences may result in the amount and timing of expense for any period if we were to make different judgments or utilize different estimates. If the financial condition of our customers deteriorates resulting in an impairment of their ability to make payments, additional allowances might be required. We have not experienced significant variances in the past between our estimated and actual doubtful accounts and anticipate that we will be able to continue to make reasonable estimates in the future. If for some reason we did not reasonably estimate the amount of our doubtful accounts in the future, it could have a material impact on our consolidated results of operations.

Business Acquisitions; Valuation of Goodwill and Other Intangible Assets

Our business acquisitions typically result in the recognition of goodwill and other intangible assets, and in certain cases non-recurring charges associated with the write-off of in-process research and development (“IPR&D”), which affect the amount of current and future period charges and amortization expense. Goodwill represents the excess of the purchase price over the fair value of net assets acquired, including identified intangible assets, in connection with our business combinations accounted for by the purchase method of accounting. We amortize our definite-lived intangible assets using the straight-line method or based on forecasted cash flows associated with the assets over the estimated useful lives, while IPR&D is recorded as a non-recurring charge on the acquisition date. Goodwill is not amortized, but rather is periodically assessed for impairment.

The determination of the value of these components of a business combination, as well as associated asset useful lives, requires management to make various estimates and assumptions. Critical estimates in valuing certain of the intangible assets include but are not limited to: future expected cash flows from product sales and services, maintenance agreements, consulting contracts, customer contracts, and acquired developed technologies and patents or trademarks; expected costs to develop the IPR&D into commercially viable products and estimating cash flows from the projects when completed; the acquired company’s brand awareness and market position, as well as assumptions about the period of time the acquired products and services will continue to be used in our product portfolio; and discount rates. Management’s estimates of fair value and useful lives are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. Unanticipated events and circumstances may occur and assumptions may change. Estimates using different assumptions could also produce significantly different results.

We continually review the events and circumstances related to our financial performance and economic environment for factors that would provide evidence of the impairment of our intangible assets. When impairment indicators are identified with respect to our previously recorded intangible assets, then we test for impairment using undiscounted cash flows. If such tests indicate impairment, then we measure the impairment as the difference between the carrying value of the asset and the fair value of the asset, which is measured using discounted cash flows. Significant management judgment is required in forecasting of future operating results, which are used in the preparation of the projected discounted cash flows and should different conditions prevail, material write downs of net intangible assets and other long-lived assets could occur. We periodically review the estimated remaining useful lives of our acquired intangible assets. A reduction in our estimate of remaining useful lives, if any, could result in increased amortization expense in future periods.

We test goodwill for impairment at the reporting unit level at least annually during the fourth quarter of each fiscal year and more frequently if impairment indicators are identified. We have determined that our reporting units are the same as our reportable segments. The first step of the goodwill impairment test is a comparison of the fair value of a reporting unit to its carrying value. We estimate the fair values of our reporting units using discounted cash flow valuation models and by comparing our reporting units to guideline publicly-traded companies. These methods require estimates of our future revenues, profits, capital expenditures, working capital, and other relevant factors, as well as selecting appropriate guideline publicly-traded companies for each reporting unit. We estimate these amounts by evaluating historical trends, current budgets, operating plans, industry data, and other relevant factors. The estimated fair value of each of our reporting units exceeded its respective carrying value in fiscal 2005, indicating the underlying goodwill of each reporting unit was not impaired as of our most recent testing date. Accordingly, we were not required to complete the second step of the goodwill impairment test. The timing and frequency of our goodwill impairment test is based on an ongoing assessment of events and circumstances that would more than likely reduce the fair value of a reporting unit below its carrying value. We will continue to monitor our goodwill balance and conduct formal tests on at least an annual basis or earlier when impairment indicators are present. There are various assumptions and estimates underlying the determination of an impairment loss, and estimates using different, but each reasonable, assumptions could produce significantly different results. Therefore, the timing and recognition of impairment losses by us in the future, if any, may be highly dependent upon our estimates and assumptions. We believe that the assumptions and estimates utilized were appropriate based on the information available to management.

Internal-use Software

Costs incurred to develop internal-use software during the application development stage are capitalized and reported at cost, subject to an impairment test as described below. Application development stage costs generally include costs associated with internal-use software configuration, coding, installation and testing. Costs of significant upgrades and enhancements that result in additional functionality are also capitalized whereas costs incurred for maintenance and minor upgrades and enhancements are expensed as incurred. We assess potential impairment of capitalized internal-use software whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted net cash flows that are expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by

which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. This analysis requires us to estimate future net cash flows associated with the assets, as well as the future costs of selling such assets. If these estimates change, reductions or write-offs of internal-use software costs could result.

Share-Based Compensation

Prior to October 1, 2005, we accounted for our share-based employee compensation plans under the measurement and recognition provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by Financial Accounting Standards Board (“FASB”) SFAS No. 123, Accounting for Stock-Based Compensation. We generally recorded no employee compensation expense for options granted prior to October 1, 2005 as options granted generally had exercise prices equal to the fair market value of our common stock on the date of grant. We also recorded no compensation expense in connection with our 1999 Employee Stock Purchase Plan as the purchase price of the stock was not less than 85% of the lower of the fair market value of our common stock at the beginning of each offering period or at the end of each offering period. In accordance with SFAS No. 123, we disclosed our net income and earnings per share as if we had applied the fair value-based method in measuring compensation expense for our share-based incentive awards.

Effective October 1, 2005, we adopted the fair value recognition provisions of SFAS No. 123(R), Share-Based Payment, using the modified prospective transition method. Under that transition method, compensation expense that we recognize beginning on that date includes expense associated with the fair value of all awards granted on and after October 1, 2005, and expense for the unvested portion of previously granted awards outstanding on October 1, 2005. Results for prior periods have not been restated.

We estimate the fair value of options granted using the Black-Scholes option valuation model and the assumptions shown in Note 1 to the accompanying condensed consolidated financial statements. We estimate the volatility of our common stock at the date of grant based on a combination of the implied volatility of publicly traded options on our common stock and our historical volatility rate, consistent with SFAS No. 123(R) and Securities and Exchange Commission Staff Accounting Bulletin No. 107 (“SAB 107”). Our decision to use implied volatility was based upon the availability of actively traded options on our common stock and our assessment that implied volatility is more representative of future stock price trends than historical volatility. We estimate expected term consistent with the simplified method identified in SAB 107 for share-based awards. We elected to use the simplified method as we changed the contractual life for share-based awards from ten to seven years starting in fiscal 2006. The simplified method calculates the expected term as the average of the vesting and contractual terms of the award. Previously, we estimated expected term based on historical exercise patterns. The dividend yield assumption is based on historical dividend payouts. The risk-free interest rate assumption is based on observed interest rates appropriate for the term of our employee options. We use historical data to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest. For options granted, we amortize the fair value on a straight-line basis. All options are amortized over the requisite service periods of the awards, which are generally the vesting periods. If factors change we may decide to use different assumptions under the Black-Scholes option valuation model in the future, which could materially affect our net income and earnings per share.

Income Taxes

We use the asset and liability approach to account for income taxes. This methodology recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax base of assets and liabilities and operating loss and tax credit carryforwards. We then record a valuation allowance to reduce deferred tax assets to an amount that more likely than not will be realized. We consider future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, which requires the use of estimates. If we determine during any period that we could realize a larger net deferred tax asset than the recorded amount, we would adjust the deferred tax asset to increase income for the period or reduce goodwill if such deferred tax asset relates to an acquisition. Conversely, if we determine that we would be unable to realize a portion of our recorded deferred tax asset, we would adjust the deferred tax asset to record a charge to income for the period or increase goodwill if such deferred tax asset relates to an acquisition. Although we believe that our estimates are reasonable, there is no assurance that our the valuation allowance will not need to be increased to cover additional deferred tax assets that may not be realizable, and such an increase could have a material adverse impact on our income tax provision and results of operations in the period in which such determination is made. In addition, the calculation of tax liabilities also involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with management’s expectations could also have a material impact on our income tax provision and results of operations in the period in which such determination is made.

Contingencies and Litigation

We are subject to various proceedings, lawsuits and claims relating to products and services, technology, labor, shareholder and other matters. We are required to assess the likelihood of any adverse outcomes and the potential range of probable losses in these matters. If the potential loss is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. If the potential loss is considered less than probable or the amount cannot be reasonably estimated, disclosure of the matter is considered. The amount of loss accrual or disclosure, if any, is determined after analysis of each matter, and is subject to adjustment if warranted by new developments or revised strategies. Due to uncertainties related to these matters, accruals or disclosures are based on the best information available at the time. Significant judgment is required in both the assessment of likelihood and in the determination of a range of potential losses. Revisions in the estimates of the potential liabilities could have a material impact on our consolidated financial position or consolidated results of operations.

New Accounting Pronouncement

RISK FACTORS

Risks Related to Our Business

We derive a substantial portion of our revenues from a small number of products and services, and if the market does not continue to accept these products and services, our revenue will decline.

We expect that revenues derived from our scoring solutions, account management solutions, fraud solutions, originations, collections, and insurance solutions products and services will account for a substantial portion of our total revenues for the foreseeable future. Our revenues will decline if the market does not continue to accept these products and services. Factors that might affect the market acceptance of these products and services include the following:

	•		changes in the business analytics industry;

	•		technological change;

	•		our inability to obtain or use state fee schedule or claims data in our insurance products;

	•		saturation of market demand;

	•		loss of key customers;

	•		industry consolidation; and

	•		inability to successfully sell our products in new vertical markets.

If we do not engage in acquisition activity to the extent we have in the past, we may be unable to increase our revenues at historical growth rates.

Our historical revenue growth has been augmented by numerous acquisitions, and we anticipate that acquisitions will continue to be an important part of our revenue growth. Our future revenue growth rate may decline if we do not make acquisitions of similar size and at a comparable rate as in the past.

If we engage in acquisitions or significant investment in new businesses, we will incur a variety of risks, any of which may adversely affect our business.

We have made in the past, and may make in the future, acquisitions of, or significant investments in, businesses that offer complementary products, services and technologies. Any acquisitions or investments will be accompanied by the risks commonly encountered in acquisitions of businesses, which include:

	•		failure to achieve the financial and strategic goals for the acquired and combined business;

	•		overpayment for the acquired companies or assets;

	•		difficulty assimilating the operations and personnel of the acquired businesses;

	•		product liability exposure associated with acquired businesses or the sale of their products;

	•		disruption of our ongoing business;

	•		dilution of our existing stockholders and earnings per share;

	•		unanticipated liabilities, legal risks and costs;

	•		retention of key personnel;

	•		distraction of management from our ongoing business; and

	•		impairment of relationships with employees and customers as a result of integration of new management personnel.

These risks could harm our business, financial condition or results of operations, particularly if they occur in the context of a significant acquisition. Acquisitions of businesses having a significant presence outside the U.S. will increase our exposure to the risks of conducting operations in international markets.

We recently restructured the method by which we sell our products and services to the marketplace.

Previously we sold our products and services in a product-focused manner. We now sell our products and services using a client-centric approach which focuses on delivering complete solutions for our customers through various means, including the use of client teams that focus on customers by market vertical and geography, and the use of an integrated consulting and sales approach. There can be no assurance that our customers and potential customers will react positively to this new selling approach and, as a result, that we will continue to maintain or increase revenue through this change in the selling approach. Further, to the extent that revenue increases as a result of this change, there is no assurance that any such increase will occur as quickly as we might anticipate.

We rely on relatively few customers, as well as our contracts with the three major credit reporting agencies, for a significant portion of our revenues. If the terms of these relationships change, our revenues and operating results could decline.

Most of our customers are relatively large enterprises, such as banks, insurance companies, healthcare firms, retailers and telecommunications carriers. As a result, many of our customers and potential customers are significantly larger than we are and may have sufficient bargaining power to demand reduced prices and favorable nonstandard terms. We also derive a substantial portion of our revenues and operating income from our contracts with the three major credit reporting agencies, TransUnion, Equifax and Experian, and other parties that distribute our products to certain markets. The loss of any major customer, the loss of a relationship with one of the major credit reporting agencies, the loss of a significant third-party distributor or the delay of significant revenue from these sources, could have a material adverse effect on our revenues and results of operations.

If we experience defects, failures and delays associated with the introduction of new products, our business could suffer serious harm.

Significant undetected errors or delays in new products or new versions of products may affect market acceptance of our products and could harm our business, financial condition or results of operations. In the past, we have experienced delays while developing and introducing new products and product enhancements, primarily due to difficulties developing models, acquiring data and adapting to particular operating environments. We have also experienced errors or “bugs” in our software products, despite testing prior to release of the products. Software errors in our products could affect the ability of our products to work with other hardware or software products, could delay the development or release of new products or new versions of products and could adversely affect market acceptance of our products. Errors or defects in our products that are significant, or are perceived to be significant, could result in: rejection of our products, damage to our reputation, loss of revenue, diversion of development resources, increase in product liability claims, and increases in service and support costs and warranty claims.

We rely on relationships with third parties for marketing and distribution. If we experience difficulties in these relationships, our future revenues may be adversely affected.

Our Scoring Solutions segment and Strategy Machine Solutions segment rely on distributors, and we intend to continue to market and distribute our products through existing and future distributor relationships. Our Scoring Solutions segment relies on, among others, TransUnion, Equifax and Experian. Failure of our existing and future distributors to generate significant revenues, demands by such distributors to change the terms on which they offer our products, or our failure to establish additional distribution or sales and marketing alliances could have a material adverse effect on our business, operating results and financial condition. In addition, distributors may compete with us either by developing competitive products themselves or by distributing competitive offerings. For example, credit reporting agencies may evaluate and seek to distribute or acquire alternative vendors’ prepaid products that compete with our products. Competition from distributors or other sales and marketing partners could significantly harm sales of our products.

The occurrence of certain negative events may cause fluctuations in our stock price.

The market price of our common stock may be volatile and could be subject to wide fluctuations due to a number of factors, including variations in our revenues and operating results. We believe that you should not rely on period-to-period comparisons of financial results as an indication of future performance. Because many of our operating expenses will not be affected by short-term fluctuations in revenue, short-term fluctuations in revenues may significantly impact operating results. Additional factors that may cause our stock price to fluctuate include the following:

	•		variability in demand from our existing customers;

	•		failure to meet the expectations of market analysts;

	•		changes in recommendations by market analysts;

	•		the lengthy and variable sales cycle of many products, combined with the relatively large size of orders for our products, increase the likelihood of short-term fluctuation in revenues;

	•		consumer dissatisfaction with, or problems caused by, the performance of our products;

	•		the timing of new product announcements and introductions in comparison with our competitors;

	•		the level of our operating expenses;

	•		changes in competitive conditions in the consumer credit, financial services and insurance industries;

	•		fluctuations in domestic and international economic conditions;

	•		our ability to complete large installations on schedule and within budget;

	•		acquisition-related expenses and charges; and

	•		timing of orders for and deliveries of software systems.

In addition, the financial markets have experienced significant price and volume fluctuations that have particularly affected the stock prices of many technology companies, and these fluctuations sometimes have been unrelated to the operating performance of these companies. Broad market fluctuations, as well as industry-specific and general economic conditions may adversely affect the market price of our common stock.

Our products have long and variable sales cycles. If we do not accurately predict these cycles, we may not forecast our financial results accurately and our stock price could be adversely affected.

We experience difficulty in forecasting our revenues accurately because the length of our sales cycles makes it difficult for us to predict the quarter in which sales will occur. As a result of our sales cycle, license revenue and operating results may vary significantly from period to period. The sales cycle for licensing our products typically ranges from 60 days to 18 months. Customers are often cautious in making decisions to acquire our products, because purchasing our products typically involves a significant commitment of capital, and may involve shifts by the customer to a new software and/or hardware platform or changes in the customer’s operational procedures. Delays in completing sales can arise while customers complete their internal procedures to approve large capital expenditures and test and accept our applications. Consequently, we face difficulty predicting the quarter in which sales to expected customers will occur and experience fluctuations in our revenues and operating results. If we are unable to accurately forecast our revenues, our stock price could be adversely affected.

We typically have revenue transactions concentrated in the final weeks of a quarter which may prevent accurate forecasting of our financial results and cause our stock price to decline.

Large portions of our software license agreements are consummated in the weeks immediately preceding quarter end. Before these agreements are consummated, however, we create and rely on forecasted revenues for planning, modeling and earnings guidance. Forecasts, however, are only estimates and actual results may vary for a particular quarter or longer periods of time. Consequently, significant discrepancies between actual and forecasted results could limit our ability to plan, budget or provide accurate guidance, which could adversely affect our stock price. Any publicly-stated revenue or earnings projections are subject to this risk.

The failure to recruit and retain additional qualified personnel could hinder our ability to successfully manage our business.

Our future success will depend in large part on our ability to attract and retain experienced sales, consulting, research and development, marketing, technical support and management personnel. The complexity of our products requires highly trained customer service and technical support personnel to assist customers with product installation and deployment. The labor market for these individuals is very competitive due to the limited number of people available with the necessary technical skills and

understanding and may become more competitive with general market and economic improvement. We have experienced difficulty in recruiting qualified personnel, especially technical, sales and consulting personnel, and we may need additional staff to support new customers and/or increased customer needs. We may also recruit skilled technical professionals from other countries to work in the United States. Limitations imposed by federal immigration laws and the availability of visas could hinder our ability to attract necessary qualified personnel and harm our business and future operating results. There is a risk that even if we invest significant resources in attempting to attract, train and retain qualified personnel, we will not succeed in our efforts, and our business could be harmed. Non-appreciation in the value of our stock may adversely affect our ability to use equity and equity based incentive plans to attract and retain personnel, and may require us to use alternative and more expensive forms of compensation for this purpose.

The failure to obtain certain forms of model construction data from our customers or others could harm our business.

We must develop or obtain a reliable source of sufficient amounts of current and statistically relevant data to analyze transactions and update our products. In most cases, these data must be periodically updated and refreshed to enable our products to continue to work effectively in a changing environment. We do not own or control much of the data that we require, most of which is collected privately and maintained in proprietary databases. Customers and key business alliances provide us the data we require to analyze transactions, report results and build new models. If we fail to maintain sufficient sourcing relationships with our customers and business alliances, or if they decline to provide such data due to legal privacy concerns, competition concerns, prohibitions or a lack of permission from their customers, we could lose access to required data and our products might become less effective. In addition, certain of our insurance solutions products use data from state workers’ compensation fee schedules adopted by state regulatory agencies. Third parties have asserted copyright interests in these data, and these assertions, if successful, could prevent us from using these data. Any interruption of our supply of data could seriously harm our business, financial condition or results of operations.

We will continue to rely upon proprietary technology rights, and if we are unable to protect them, our business could be harmed.

Our success depends, in part, upon our proprietary technology and other intellectual property rights. To date, we have relied primarily on a combination of copyright, patent, trade secret, and trademark laws, and nondisclosure and other contractual restrictions on copying and distribution to protect our proprietary technology. This protection of our proprietary technology is limited, and our proprietary technology could be used by others without our consent. In addition, patents may not be issued with respect to our pending or future patent applications, and our patents may not be upheld as valid or may not prevent the development of competitive products. Any disclosure, loss, invalidity of, or failure to protect our intellectual property could negatively impact our competitive position, and ultimately, our business. There can be no assurance that our protection of our intellectual property rights in the United States or abroad will be adequate or that others, including our competitors, will not use our proprietary technology without our consent. Furthermore, litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets, or to determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of resources and could harm our business, financial condition or results of operations.

Some of our technologies were developed under research projects conducted under agreements with various U.S. government agencies or subcontractors. Although we have commercial rights to these technologies, the U.S. government typically retains ownership of intellectual property rights and licenses in the technologies developed by us under these contracts, and in some cases can terminate our rights in these technologies if we fail to commercialize them on a timely basis. Under these contracts with the U.S. government, the results of research may be made public by the government, limiting our competitive advantage with respect to future products based on our research.

If we are subject to infringement claims, it could harm our business.

With recent developments in the law that permit patenting of business methods, we expect that products in the industry segments in which we compete, including software products, will increasingly be subject to claims of patent infringement as the number of products and competitors in our industry segments grow. We may need to defend claims that our products infringe patent, copyright or other rights, and as a result we may:

	•		incur significant defense costs or substantial damages;

	•		be required to cease the use or sale of infringing products;

	•		expend significant resources to develop or license a substitute non-infringing technology;

	•		discontinue the use of some technology; or

	•		be required to obtain a license under the intellectual property rights of the third party claiming infringement, which license may not be available or might require substantial royalties or license fees that would reduce our margins.

Security is important to our business. Breaches of security, or the perception that e-commerce is not secure, could harm our business.

Our business requires the appropriate and secure utilization of consumer and other sensitive information. Internet-based, electronic commerce requires the secure transmission of confidential information over public networks, and several of our products are accessed through the Internet, including our consumer services accessible through the www.myFICO.com website. Security breaches in connection with the delivery of our products and services, including products and services utilizing the Internet, or well-publicized security breaches, and the trend toward broad consumer and general public notification of such incidents, could significantly harm our business, financial condition or results of operations. We cannot be certain that advances in criminal capabilities, discovery of new vulnerabilities, attempts to exploit vulnerabilities in our systems, data thefts, physical system or network break-ins or inappropriate access, or other developments will not compromise or breach the technology protecting the networks that access our net-sourced products, consumer services and proprietary database information.

Protection from system interruptions is important to our business. If we experience a sustained interruption of our telecommunication systems it could harm our business.

Systems or network interruptions could delay and disrupt our ability to develop, deliver or maintain our products and services, causing harm to our business and reputation and resulting in loss of customers or revenue. These interruptions can include fires, floods, earthquakes, power losses, equipment failures and other events beyond our control.

Risks Related to Our Industry

Our ability to increase our revenues will depend to some extent upon introducing new products and services. If the marketplace does not accept these new products and services, our revenues may decline.

We have a significant share of the available market in portions of our Scoring Solutions segment and for certain services in our Strategy Machine Solutions segment (specifically, the markets for account management services at credit card processors and credit card fraud detection software). To increase our revenues, we must enhance and improve existing products and continue to introduce new products and new versions of existing products that keep pace with technological developments, satisfy increasingly sophisticated customer requirements and achieve market acceptance. We believe much of our future growth prospects will rest on our ability to continue to expand into newer markets for our products and services, such as direct marketing, healthcare, insurance, small business lending, retail, telecommunications, personal credit management, the design of business strategies using Strategy Science technology and Internet services. These areas are relatively new to our product development and sales and marketing personnel. Products that we plan to market in the future are in various stages of development. We cannot assure you that the marketplace will accept these products. If our current or potential customers are not willing to switch to or adopt our new products and services, our revenues will decrease.

If we fail to keep up with rapidly changing technologies, our products could become less competitive or obsolete.

In our markets, technology changes rapidly, and there are continuous improvements in computer hardware, network operating systems, programming tools, programming languages, operating systems, database technology and the use of the Internet. If we fail to enhance our current products and develop new products in response to changes in technology or industry standards, our products could rapidly become less competitive or obsolete. For example, the rapid growth of the Internet environment creates new opportunities, risks and uncertainties for businesses, such as ours, which develop software that must also be designed to operate in Internet, intranet and other online environments. Our future success will depend, in part, upon our ability to:

	•		internally develop new and competitive technologies;

	•		use leading third-party technologies effectively;

	•		continue to develop our technical expertise;

	•		anticipate and effectively respond to changing customer needs;

	•		initiate new product introductions in a way that minimizes the impact of customers delaying purchases of existing products in anticipation of new product releases; and

	•		influence and respond to emerging industry standards and other technological changes.

If our competitors introduce new products and pricing strategies, it could decrease our product sales and market share, or could pressure us to reduce our product prices in a manner that reduces our margins.

We may not be able to compete successfully against our competitors, and this inability could impair our capacity to sell our products. The market for business analytics is new, rapidly evolving and highly competitive, and we expect competition in this market to persist and intensify. Our competitors vary in size and in the scope of the products and services they offer, and include:

	•		in-house analytic and systems developers;

	•		scoring model builders;

	•		enterprise resource planning (ERP) and customer relationship management (CRM) packaged solutions providers;

	•		business intelligence solutions providers;

	•		providers of credit reports and credit scores;

	•		providers of automated application processing services;

	•		data vendors;

	•		neural network developers and artificial intelligence system builders;

	•		third-party professional services and consulting organizations;

	•		providers of account/workflow management software;

	•		managed care organizations; and

	•		software tools companies supplying modeling, rules, or analytic development tools.

We expect to experience additional competition from other established and emerging companies, as well as from other technologies. For example, certain of our fraud solutions products compete against other methods of preventing credit card fraud, such as credit cards that contain the cardholder’s photograph, smart cards, cardholder verification and authentication solutions and other card authorization techniques. Many of our anticipated competitors have greater financial, technical, marketing, professional services and other resources than we do. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements. They may also be able to devote greater resources than we can to develop, promote and sell their products. Many of these companies have extensive customer relationships, including relationships with many of our current and potential customers. Furthermore, new competitors or alliances among competitors may emerge and rapidly gain significant market share. If we are unable to respond as quickly or effectively to changes in customer requirements as our competition, our ability to expand our business and sell our products will be negatively affected.

Our competitors may be able to sell products competitive to ours at lower prices individually or as part of integrated suites of several related products. This ability may cause our customers to purchase products that directly compete with our products from our competitors. Price reductions by our competitors could negatively impact our margins, and could also harm our ability to obtain new long-term contracts and renewals of existing long-term contracts on favorable terms.

Government regulations that apply to us or to our customers may expose us to liability, affect our ability to compete in certain markets, limit the profitability of or demand for our products, or render our products obsolete. If these regulations are applied or are further developed in ways adverse to us, it could adversely affect our business and results of operations.

Legislation and governmental regulation affect how our business is conducted and, in some cases, subject us to the possibility of future lawsuits arising from our products and services. Legislation and governmental regulation also influence our current and prospective customers’ activities, as well as their expectations and needs in relation to our products and services. Both our core businesses and our newer consumer initiatives are affected by regulation, including the following significant regulatory areas:

	•		federal and state regulation of consumer report data and consumer reporting agencies, such as the Fair Credit Reporting Act (“FCRA”), the Fair and Accurate Credit Transactions Act (“FACTA”), which amends FCRA, and certain proposed regulations under FACTA, presently under consideration;

	•		regulations designed to combat identity theft and loss of data, such as FACTA and other regulations modeled after the current California Security Breach Notification Act, that require consumer notification of security breach incidents and additional federal and state legislative enactments in this area;

	•		regulations designed to insure that lending practices are fair and non-discriminatory, such as the Equal Credit Opportunity Act (“ECOA”);

	•		privacy-related laws, including but not limited to the provisions of the Financial Services Modernization Act of 1999, also known as the Gramm Leach Bliley Act (“GLBA”), the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”), the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”) and similar state privacy laws;

	•		regulations governing the extension of credit to consumers and by Regulation E under the Electronic Fund Transfers Act, as well as non-governmental VISA and MasterCard electronic payment standards;

	•		Fannie Mae and Freddie Mac regulations, among others, for our mortgage services products;

	•		insurance regulations related to our insurance products;

	•		a broad array of consumer protection laws, for example, federal and state statutes governing the use of the Internet and telemarketing;

	•		regulations of foreign jurisdictions on our international operations, including the European Union’s Privacy Directive; and

	•		Sarbanes-Oxley Act (“SOX”) regulations to verify internal process controls and require material event awareness and notification.

In making credit evaluations of consumers, performing fraud screening or user authentication, our customers are subject to requirements of federal law, including FCRA, FACTA and ECOA, and regulations thereunder, as well as state laws which impose a variety of additional requirements. Privacy legislation such as GLBA or consumer data security standards, may also affect the nature and extent of the products or services that we can provide to customers, as well as our ability to collect, monitor and disseminate information subject to privacy protection. In addition to existing regulation, changes in legislative, judicial, regulatory or consumer environments could harm our business, financial condition or results of operations. For example, the FACTA amendments to FCRA will result in new regulation. These regulations or the interpretation of these amendments could affect the demand for or profitability of some of our products, including scoring and consumer products. State regulation could cause financial institutions to pursue new strategies, reducing the demand for our products. In addition, legislative reforms of workers’ compensation laws that aim to simplify this area of regulation and curb abuses could diminish the need for, and the benefits provided by, certain of our insurance solutions products and services.

Our revenues depend, to a great extent, upon conditions in the consumer credit, financial services and insurance industries. If any of our clients’ industries experiences a downturn, it could harm our business, financial condition or results of operations.

During fiscal 2005, 75% of our revenues were derived from sales of products and services to the consumer credit, financial services and insurance industries. A downturn in the consumer credit, the financial services or the insurance industry, including a downturn caused by increases in interest rates or a tightening of credit, among other factors, could harm our business, financial condition or results of operations. While the rate of account growth in the U.S. bankcard industry has been slowing and many of our large institutional customers have merged and consolidated in recent years, we have generated most of our revenue growth from our bankcard-related scoring and account management businesses by selling and cross-selling our products and services to large banks and other credit issuers. As this industry continues to consolidate, we may have fewer opportunities for revenue growth due to changing demand for our products and services that support customer acquisition programs of our customers. In addition, industry consolidation could affect the base of recurring revenues derived from contracts in which we are paid on a per-transaction basis if consolidated customers combine their operations under one contract. There can be no assurance that we will be able effectively to promote future revenue growth in our businesses.

Risk Related to External Conditions

If any of a number of material adverse developments occur in general economic conditions and world events, such developments could affect demand for our products and services and harm our business.

During the economic slowdown in the United States and Europe in recent years, companies in many industries delayed or reduced technology purchases, and we experienced softened demand for our decisioning solutions and other products and services. If the current improvement in economic conditions in the U.S. and Europe slows or reverses, or if there is an escalation in regional or continued global conflicts or terrorism, we may experience reductions in capital expenditures by our customers, longer sales cycles, deferral or delay of purchase commitments for our products and increased price competition, which may adversely affect our business and results of operations.

In operations outside the United States, we are subject to unique risks that may harm our business, financial condition or results of operations.

A growing portion of our revenues is derived from international sales. During fiscal 2005, 25% of our revenues were derived from business outside the United States. As part of our growth strategy, we plan to continue to pursue opportunities outside the United States. Accordingly, our future operating results could be negatively affected by a variety of factors arising out of international commerce, some of which are beyond our control. These factors include:

	•		general economic and political conditions in countries where we sell our products and services;

	•		difficulty in staffing and efficiently managing our operations in multiple geographic locations and in various countries;

	•		effects of a variety of foreign laws and regulations, including restrictions on access to personal information;

	•		import and export licensing requirements;

	•		longer payment cycles;

	•		reduced protection for intellectual property rights;

	•		currency fluctuations;

	•		changes in tariffs and other trade barriers; and

	•		difficulties and delays in translating products and related documentation into foreign languages.

There can be no assurance that we will be able to successfully address each of these challenges in the near term. Additionally, some of our business will be conducted in currencies other than the U.S. dollar. Foreign currency transaction gains and losses are not currently material to our cash flows, financial position or results of operations. However, an increase in our foreign revenues could subject us to increased foreign currency transaction risks in the future.

Our anti-takeover defenses could make it difficult for another company to acquire control of Fair Isaac, thereby limiting the demand for our securities by certain types of purchasers or the price investors are willing to pay for our stock.

Certain provisions of our Restated Certificate of Incorporation, as amended, could make a merger, tender offer or proxy contest involving us difficult, even if such events would be beneficial to the interests of our stockholders. These provisions include adopting a Rights Agreement, commonly known as a “poison pill,” and giving our board the ability to issue preferred stock and determine the rights and designations of the preferred stock at any time without stockholder approval. The rights of the holders of our common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock, while providing flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire, or discouraging a third party from acquiring, a majority of our outstanding voting stock. These factors and certain provisions of the Delaware General Corporation Law may have the effect of deterring hostile takeovers or otherwise delaying or preventing changes in control or changes in our management, including transactions in which our stockholders might otherwise receive a premium over the fair market value of our common stock.

Due to changes in accounting rules, we are now incurring significant compensation charges related to share-based payment awards.

In December 2004, the Financial Accounting Standards Board published Statement of Financial Accounting Standards No. 123(R), which requires us to measure all share-based payment awards, including stock options, using a fair-value method and record such expense. The adoption of this standard has had, and will continue to have, a significant negative impact on our consolidated net income and earnings per share and may inhibit our use of stock option-based compensation in the future. There is uncertainty as to the ability of other forms of compensation to attract and retain employees, as well as the financial and other consequences of such forms of compensation.

If we experience changes in tax laws or adverse outcomes resulting from examination of our income tax returns, it could adversely affect our results of operations.

We are subject to income taxes in the United States and in certain foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. Our future effective tax rates could be adversely affected by changes in tax laws, by our ability to generate taxable income in foreign jurisdictions in order to utilize foreign tax losses, and by the valuation of our deferred tax assets. In addition, we are subject to the examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from such examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from such examinations will not have an adverse effect on our operating results and financial condition.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market Risk Disclosures

We are exposed to market risk related to changes in interest rates, equity market prices, and foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes.

Interest Rate Risk

We maintain an investment portfolio consisting mainly of income securities with an average maturity of three years or less. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. We have the ability to hold our fixed income investments until maturity, and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio. The following table presents the principal amounts and related weighted-average yields for our investments with interest rate risk at June 30, 2006 and September 30, 2005:


	June 30, 2006							September 30, 2005
	Cost		Carrying		Average			Cost		Carrying		Average
	Basis		Amount		Yield			Basis		Amount		Yield
	(In thousands)
Cash and cash equivalents	$	133,990	$	133,964		4.43	%	$	82,883	$	82,880		3.23	%
Short-term investments		182,765		182,170		4.63	%		146,543		146,088		3.26	%
Long-term investments		30,274		29,973		4.78	%		53,002		52,503		3.73	%

	$	347,029	$	346,107		4.56	%	$	282,428	$	281,471		3.34	%

We are the issuer of 1.5% Senior Convertible Notes (“Senior Notes”) that mature in August 2023. The fair value of our Senior Notes, including the new notes issued in the exchange offer completed on March 31, 2005, as determined based on quoted market prices, may increase or decrease due to various factors, including fluctuations in the market price of our common stock, fluctuations in market interest rates and fluctuations in general economic conditions. The following table presents the principal amounts, carrying amounts, and fair values for our Senior Notes at June 30, 2006 and September 30, 2005:


	June 30, 2006						September 30, 2005
			Carrying		Fair				Carrying		Fair
	Principal		Amount		Value		Principal		Amount		Value
	(In thousands)
Senior Notes	$	400,000	$	400,000	$	403,000	$	400,000	$	400,000	$	446,497

Forward Foreign Currency Contracts

We maintain a program to manage our foreign currency exchange rate risk on existing foreign currency receivable and bank balances by entering into forward contracts to sell or buy foreign currency. At period end, foreign-denominated receivables and cash balances held by our U.S. reporting entities are remeasured into the U.S. dollar functional currency at current market rates. The change in value from this remeasurement is then reported as a foreign exchange gain or loss for that period in our accompanying consolidated statements of income and the resulting gain or loss on the forward contract mitigates the exchange rate risk of the associated assets. All of our forward foreign currency contracts have maturity periods of less than three months. Such derivative financial instruments are subject to market risk.

The following table summarizes our outstanding forward foreign currency contracts, by currency at June 30, 2006:


	Contract Amount
	Foreign				Fair Value
	Currency		US$		US$
	(In thousands)
Sell foreign currency:
British Pound (GBP)	GBP	1,000	$	1,822	$	—
EURO (EUR)	EUR	1,000		1,254		—
Japanese Yen (YEN)	YEN	100,000		861		—

			$	3,937	$	—

The forward foreign currency contracts were all entered into on June 30, 2006, therefore, the fair value was $0 on that date.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An evaluation was carried out under the supervision and with the participation of Fair Isaac’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Fair Isaac’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that Fair Isaac’s disclosure controls and procedures are effective to ensure that information required to be disclosed by Fair Isaac in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

Changes in Internal Control over Financial Reporting

No change in Fair Isaac’s internal control over financial reporting was identified in connection with the evaluation required by Rule 13a-15(d) of the Exchange Act that occurred during the period covered by this quarterly report and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

Item 1A. Risk Factors

The information set forth under the heading “Risk Factors” in Item 2 of Part I of this Quarterly Report on Form 10-Q (Management’s Discussion and Analysis of Financial Condition and Results of Operations) is incorporated herein by reference.

Item 6. Exhibits


Exhibit
Number		Description
31.1		Rule 13a-14(a)/15d-14(a) Certifications of CEO.

31.2		Rule 13a-14(a)/15d-14(a) Certifications of CFO.

32.1		Section 1350 Certification of CEO.

32.2		Section 1350 Certification of CFO.


	FAIR ISAAC CORPORATION

DATE: August 8, 2006	By	/s/ CHARLES M. OSBORNE
		Charles M. Osborne
		Vice President and Chief Financial Officer
		(for Registrant as duly authorized officer and
		as Principal Financial Officer)

DATE: August 8, 2006	By	/s/ MICHAEL J. PUNG
		Michael J. Pung
		Vice President, Finance
		(Principal Accounting Officer)

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	PART I — FINANCIAL INFORMATION

Item 1.	Financial Statements	1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	35
Item 4.	Controls and Procedures	37

	PART II — OTHER INFORMATION

Item 1.	Legal Proceedings	37
Item 1A.	Risk Factors	37
Item 6.	Exhibits	37
Signatures		38
Rule 13a-14(a)/15d-14(a) Certifications of CEO
Rule 13a-14(a)/15d-14(a) Certifications of CFO
Section 1350 Certification of CEO
Section 1350 Certification of CFO