Back to GetFilings.com

Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

          (Mark One)

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

                   For the fiscal year ended September 30, 2003

	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

Registrant’s telephone number, including area code:

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

      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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     o

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

      As of March 31, 2003, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $1,672,822,642 based on the last transaction price as reported on the New York Stock Exchange on such date. This calculation does not reflect a determination that certain persons are affiliates of the registrant for any other purposes.

      The number of shares of common stock outstanding on November 26, 2003 was 46,702,037 (excluding 11,673,402 shares held by the Company as treasury stock).

      Items 10, 11, 12, 13 and 14 of Part III incorporate information by reference from the definitive proxy statement for the Annual Meeting of Stockholders to be held on February 2, 2004.

Table of Contents

TABLE OF CONTENTS

i

Table of Contents

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. 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 7, 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-Q and 8-K to be filed by the Company in fiscal year 2004.

PART I

Item 1.     Business

GENERAL

      Fair Isaac Corporation (NYSE: FIC) (together with its consolidated subsidiaries, the “Company”, which may also be referred to in this report as “we,” “us,” “our,” and “Fair Isaac”) provides analytic, software and data management products and services that enable businesses to automate and improve decisions. Our predictive modeling, decision analytics, business intelligence management, decision management systems and consulting services power billions of customer decisions each year.

      We were founded in 1956 on the premise that data, used intelligently, can improve business decisions. Today, we help thousands of companies in over 60 countries target and 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 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, empowering them to manage their financial health.

      More information about us can be found on our principal Web site, www.fairisaac.com. We make our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K, as well as amendments to those reports, available free of charge through our Web site as soon as reasonably practicable after we electronically file them with the SEC. Information on our Web site is not part of this report.

1

Table of Contents

PRODUCTS AND SERVICES

      We help businesses make better decisions in the areas of customer targeting and acquisition, customer origination and customer management. Our solutions enable users to make decisions that are more accurate, objective and consistent, and that systematically advance a business’ goals. Our products and services are designed to reduce the cost of doing business, increase revenues and profitability, reduce losses from risks and fraud, and increase customer loyalty.

Our Segments

      We categorize our products and services into the following four segments:

	•	Scoring Solutions. These include our scoring services distributed through major credit reporting agencies, as well as services through which we provide our credit bureau scores to lenders directly.
	•	Strategy Machine Solutions. Our Strategy Machine Solutions are industry-tailored applications designed for specific processes such as marketing, account origination, customer management, fraud and medical bill review, as well as consumer solutions through our myFICO service.
	•	Professional Services. This segment includes revenues from consulting services and custom engagements, as well as services associated with implementing and delivering our products.
	•	Analytic Software Tools. This segment is composed of our analytic software tools sold to businesses for their use in building their own decisioning applications. These tools comprise a suite known as Fair Isaac Business Science™.

      Comparative segment revenues, operating income and related financial information for fiscal years 2003, 2002 and 2001 are set forth in Note 18 to the accompanying consolidated financial statements.

2

Table of Contents

Our Solutions

      Our solutions involve three fundamental disciplines:

	•	Analytics to identify the risks and opportunities associated with individual clients and prospects, as well as to improve the design of decision logic or “strategies”;

3

Table of Contents

	•	Data management, profiling and text recognition that bring extensive customer information to every decision; and
	•	Software such as decision engines and rules engines that implement decision strategies, often in a real-time environment.

      All of our solutions are designed to help businesses make decisions that are faster, more successful, more consistent and more objective, throughout the enterprise.

     Scoring Solutions

      We develop the world’s leading scores based on credit bureau data. Our FICO scores are used in most U.S. credit decisions, by most of the major credit card organizations as well as by mortgage and auto loan originators. These scores provide a consistent and objective measure of an individual’s credit risk. Credit grantors use the FICO scores to prescreen solicitation candidates, to evaluate applicants for new credit and to review existing accounts. The FICO scores are calculated based on proprietary scoring models. The scores produced by these models are available through each of the three major credit reporting agencies in the United States: TransUnion Corporation (“TransUnion”), Experian Information Solutions, Inc. (“Experian”), and Equifax Inc (“Equifax”). Users generally pay the credit reporting agencies scoring fees based on usage, and the credit reporting agencies share these fees with us.

      Our new U.S. credit bureau products, NextGen FICO risk scores, are also now available at all three major credit-reporting agencies. NextGen FICO risk scores provide a more refined risk assessment than the classic FICO risk scores.

      In addition to our U.S. credit risk scores, we have developed marketing and bankruptcy scores offered through the U.S. credit reporting agencies; an application fraud and a bankruptcy score available in Canada; consumer risk scores offered through credit reporting agencies in Canada, South Africa and the U.K.; commercial credit scores delivered by both U.S. and U.K. credit reporting agencies; and a bankruptcy scoring service offered through Visa USA.

      We have also developed scoring systems for insurance underwriters and marketers. Such systems use the same underlying statistical technology as our FICO risk scores, but are designed to predict applicant or policyholder insurance loss risk for automobile or homeowners’ coverage. Our insurance scores are available in the U.S. from TransUnion, Experian, Equifax and Choicepoint, Inc., and in Canada from Equifax.

      We also provide credit bureau scoring services and related consulting directly to users in financial services through two U.S.-based services: PreScore Service for prescreening solicitation candidates, and ScoreNet Service for customer account management.

     Strategy Machine Solutions

      We develop Strategy Machine solutions that apply analytics, data management and software to specific business challenges and processes. These include credit offer prescreening, medical bill review, telecommunications fraud prevention and others. Our Strategy Machine solutions serve clients in the financial services, insurance, healthcare, retail, telecommunications and government sectors.

     Marketing Strategy Machine Solutions

      The chief Strategy Machine offering for marketing is our Fair Isaac MarketSmart Decision System (“MarketSmart”). MarketSmart is a multi-channel, Web-enabled marketing solution with campaign management, data warehousing, analytic and other capabilities. MarketSmart helps financial institutions, retailers and telecommunications companies determine where, when and how to interact with their prospects and customers to build stronger relationships. MarketSmart now includes customer data integration (CDI) services, including the Fair Isaac SmartLink service. CDI services enable users to quickly and accurately link data from multiple external databases to build a fuller picture of every customer and his or her

4

Table of Contents

      We provide solutions that enable companies, typically financial services institutions such as banks, credit unions, finance companies and installment lenders, to automate and improve the processing of requests for credit from applicants. These solutions increase the speed and efficiency with which requests are handled, reduce losses and increase approval rates through analytics that assess applicant risk, and reduce the need for manual review by loan officers. This fiscal year, we launched similar solutions enabling companies to extend and manage trade credit to small businesses.

      Our solutions include LiquidCredit, a Web-based service primarily focused on the credit decision and offered largely to mid-tier financial services institutions and e-commerce providers; Capstone, a complete solution for application decisioning and processing, which is offered in both end-user software and application service provider (ASP) mode to high-volume operations; StrategyWare, an end-user software product used to design and automate more complex credit decision strategies; and CreditDesk, an end-user software product that performs credit decisioning and application processing for the mid-tier financial services market. We also offer custom and consortium-based credit risk and application fraud models.

      Our account management products and services enable businesses to automate and improve decisions on their existing customers. These solutions help businesses decide which customers to cross-sell, what additional products and services to offer, when and how much to change a customer’s credit line, what total amount of credit to extend to a customer, and how to prioritize and handle the collection of delinquent accounts.

      We provide account management solutions for:

	•	Financial Services. In financial services, our leading account management product is the TRIAD adaptive control system. TRIAD technology is known as adaptive control because it enables businesses to rapidly adapt to changing business and internal conditions by designing and testing new strategies in a “champion/challenger” environment. TRIAD — the world’s leading credit account management system — has more than 250 users worldwide and is used to manage approximately 65% of the world’s credit card accounts. TRIAD is made available to our client base in many different ways, including Customer Management TRIAD, which enables lenders to manage customer relationships and credit exposure across multiple credit products. Netsourced TRIAD is a Web-delivered service that we offer directly to users, which enables users to access TRIAD account management capabilities in ASP mode, where we host the software. We also offer transaction-based neural network (the term neural network is defined under “Technology” later in this section) models for TRIAD that help payment card issuers manage their credit card accounts more profitably. We market and sell TRIAD multi-year software licenses, maintenance, consulting services, and strategy design and evaluation. Additionally, we provide TRIAD and similar credit account management services through large third-party credit card processors worldwide, including the two largest processors in the U.S.: First Data Resources, Inc. and Total System Services, Inc.

		As a result of our acquisition of NAREX Inc. in July 2003, we now offer collections and recovery solutions to financial institutions, collections agencies and debt buyers. These solutions include UniScore, a Web-based recovery score package; PlacementsPlus, an account placement optimization and management system; and custom collection and recovery models implemented in an ASP environment.

	•	Telecommunications. Our principal solution is RoamEx Roamer Data Exchanger, which helps wireless telecommunications carriers reduce fraud. RoamEx delivers near real-time exchange of roamer call records that occur when subscribers roam outside a carrier’s home network. RoamEx is used to exchange more than 90% of North American wireless carriers’ roamer call detail records,

5

Table of Contents

		helping carriers combat fraud. We also offer the TelAdaptive account management system, which provides functionality similar to TRIAD as a Web-delivered service.
	•	Insurance. We provide insurers with decisioning solutions that enable them to create, test and implement decision strategies for areas such as cross-selling, pricing, claims handling, retention, prospecting and underwriting.

      Our fraud products improve our clients’ profitability by predicting the likelihood that a customer account is experiencing fraud. Our fraud products analyze customer transactions in real time and generate recommendations for immediate action, which is critical to stopping fraud and abuse. These applications can also detect some organized fraud schemes that are too complex and well-hidden to be identified by other methods.

      Our solutions are designed to detect and prevent a wide variety of fraud and risk types across multiple industries, including credit and debit payment card fraud; identity fraud; telecommunications subscription fraud, technical fraud and bad debt; merchant acquiring fraud; healthcare fraud; Medicaid and Medicare fraud; and property and casualty insurance fraud, including workers’ compensation fraud. Fair Isaac fraud solutions protect merchants, financial institutions, insurance companies, telecommunications carriers, government agencies and employers from losses and damaged customer relationships caused by fraud.

      Our leading fraud detection solution is Falcon Fraud Manager, recognized as the leader in global payment card fraud detection. Falcon uses neural network predictive models and patented profiling technology, both further described below, to examine transaction, cardholder and merchant data to detect a wide range of payment card fraud quickly and accurately. Falcon analyzes payment card transactions in real-time, assesses the risk of fraud, and takes the user-defined steps to prevent fraud while expediting legitimate transactions. Falcon protects hundreds of millions of active accounts, and is used in approximately 65% of all credit card transactions worldwide.

      Fraud Predictor with Merchant Profiles is used in conjunction with Falcon to improve fraud detection rates by analyzing merchant profile data. The merchant profiles include characteristics that reveal, for example, merchants that have a history of higher fraud volumes, and which purchase types and ticket sizes have most often been fraudulent at a particular merchant.

      We also market fraud and fraud-related solutions for:

	•	Financial Services: We complement our Falcon product with fraud consulting services, and with fraud and risk management solutions for merchants and others. CardAlert Fraud Manager helps card issuers and Electronic Funds Transfer (EFT) network providers effectively combat large-scale counterfeit ATM and debit card fraud. Our Risk Manager for Acquirers products helps merchant acquirers assess the bankruptcy and fraud risk of merchant relationships, as well as the likelihood of merchant attrition.
	•	Insurance: Our Claims Advisor products use neural networks and data analysis to forecast appropriate claims reserves based on individual claim data, to identify opportunities for subrogation, to identify fraud, and to manage claims workflow.
	•	Healthcare: Our Payment Optimizer product detects fraud and abuse of healthcare claims before claims are paid.
	•	Telecommunications: Our Risk Manager and Fraud Manager solutions help telecommunications carriers stop complex types of fraud such as subscription fraud, internal fraud, dealer/agent fraud, calling card fraud, cloning, clip-on fraud and PBX fraud, as well as to mitigate early-life and ongoing bad debt.

6

Table of Contents

      We provide software solutions and services that automate the review and repricing of medical bills for workers’ compensation and automobile medical injuries. Using these solutions, property and casualty insurers can automatically review and process up to 80 percent of medical bills without human intervention.

      Our principal solutions in this area are:

	•	Medical Bill Review: Our principal solutions are CompAdvisor, the leading medical bill review and repricing solution for workers’ compensation, and AutoAdvisor, our medical bill repricing solution for automobile medical injury claims. These solutions check each bill against an extensive database of state fee schedules, automated contracts and user-defined policies to help insurers and others get the maximum savings on every bill reviewed. Both solutions optionally include Capstone for Medical Bills, a module that uses rules management technology to increase the speed, accuracy and consistency of decisions and reduce labor costs. These products are available in both licensed client/server and ASP versions.
	•	Outsourced Cost Containment Services: We provide turnkey insurance bill review administration services at selected locations across the country. These branch operations offer expert medical bill and preferred provider review for workers’ compensation and auto medical insurance bills, including the additional review of complex medical, hospital and surgical bills.

      In September 2003, Fair Isaac expanded its medical bill review capabilities through the acquisition of Diversified HealthCare Services, Inc., a provider of medical bill review products and services for the workers’ compensation insurance industry.

      Through our myFICO service, we provide solutions based on our analytics to consumers, sold directly by us or through distribution partners. U.S. consumers can use the myFICO services to purchase their FICO scores, the credit reports underlying the scores, explanations of the factors affecting their scores, and customized advice on how to improve their scores. Customers of myFICO can also simulate how taking specific actions would affect their FICO score. In 2003, myFICO became the first and only source for consumers to obtain their FICO scores and credit reports from all three of the major US credit reporting agencies. The myFICO services are available online at www.myfico.com as well as through two of the credit reporting agencies involved — Equifax and TransUnion — as well as through lenders and financial portals.

      We provide a variety of custom offerings, business and technical consulting services, and technical system integration services to markets worldwide. The focus is on leveraging our industry experience and technical expertise, typically on a custom basis, to help clients address unique business challenges, to support the usage of our Strategy Machine Solutions and our analytic software tools, and to create new sales opportunities for our other offerings. This group also performs consultative selling, developing customized solution sets combining various products and capabilities to meet unique client or industry opportunities. These services are generally offered on an hourly or fixed fee basis.

      Our services include:

	•	Technology Integration Services. We provide business consulting and technology integration services that support, complement and enhance the value of our software products. These services include installation and strategy development associated with our Strategy Machine solutions and analytic software tools.
	•	Business Integration Services. We help formulate, align, and deploy business and operational strategies across the enterprise to drive profitability, expand top-line growth, and deliver real competitive advantage. We holistically assess the business, prioritize high-impact areas for improve-

7

Table of Contents

		ment, and provide creative solutions to complex business issues through operational strategy, business process alignment, and enabling technology services.
	•	Strategy Science. Using our Strategy Science technology and related advanced analytic methodologies, we perform decision modeling and strategy science projects for customer acquisition and customer management.
	•	Global Analytics. We perform custom analytic projects, primarily predictive model development and analytic consulting for the credit and insurance industries. This work leverages our analytic methodologies and expertise to solve risk management and marketing challenges for a single business, using that business’ data and industry best practices to develop a highly customized solution.
	•	Customer Relationship Management Consulting. We provide strategy development, analytics and systems planning for customer management and marketing.

      We provide end-user software products that businesses use to build their own tailored decisioning applications. In contrast to our packaged Strategy Machine applications developed for specific industry applications, we design our analytic software tools to perform a single function — such as management of the rules and policies an enterprise uses to make decisions — that can be easily integrated within a variety of specialized industry applications. The combination of these tools supports enterprise-wide decision management leveraging data analytics.

      Our suite of tools, known as Fair Isaac Business Science, enables businesses to automate and improve their business decision processes and strategies, creating their own customized decision applications. We use these tools as common software components for our own Strategy Machine offerings. We also partner with third-party providers within given industry markets and with major software companies to imbed our tools within existing applications.

      The principal products offered in fiscal 2003 were software products that enable:

	•	Decision Design and Management. Fair Isaac Blaze Advisor and Fair Isaac Blaze Decision System are software tools supporting enterprise-wide decision management. Fair Isaac Blaze Advisor is a rules management tool used to design, develop, execute and maintain rules-based business applications. Fair Isaac Blaze Decision System provides a mechanism for deploying decision strategies and associated predictive analytics into an enterprise’s IT architecture. These tools enable businesses to more quickly develop complex decisioning applications, respond to changing customer needs, implement regulatory compliance and reduce the total cost of day-to-day operations. Among the users of these tools are 7 of the 10 top companies on the 2003 Fortune 500 list. In September 2003, we released Fair Isaac Blaze Advisor 5.1, which allows clients to use Blaze Advisor, Blaze Decision System and Model Builder for Decision Trees in combination to automate complex decisions.
	•	Analytic Model Development. Model Builder for Decision Trees enables the user to create empirical strategies, augmenting the user’s expert judgment by applying data-driven analytics to discover patterns empirically. In designing the steps and criteria of a decision strategy, the user can segment the customer base for targeted action based on the results of different performance measures, and can simulate the performance of the designed strategy. Model Builder for Predictive Analytics takes this data analysis further, enabling the user to develop and deploy sophisticated predictive models for use in automated decisions. Decision Optimizer, a key component in our Strategy Science offering, creates decision models for making optimal decisions across a customer portfolio where business constraints mean that each decision cannot be considered in isolation. The data-driven strategies, predictive models, and decision models produced by these tools can be executed in either Blaze Advisor or Blaze Decision System, or deployed within our Strategy Machines.

8

Table of Contents

COMPETITION

      The market for our advanced solutions is intensely competitive and is constantly changing. Our competitors vary in size and in the scope of the products and services they offer. We encounter competition from a number of sources, including:

	•	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;
	•	network and telecommunications switch manufacturers, and service providers that seek to enhance their value-added services;
	•	managed care organizations; and
	•	software tools companies supplying modeling, rules, or analytic development tools.

      We believe that none of our competitors offers the same mix of products as we do, or has the same expertise in predictive analytics. However, certain competitors may have larger shares of particular geographic or product markets.

Scoring Solutions

      In this segment we compete with both outside suppliers and in-house analytics and computer systems departments for scoring business. Major competitors among outside suppliers of scoring models include the three major credit-reporting agencies, which are also our partners in offering our scoring solutions, and also include credit reporting agencies outside the United States. Our FICO scores are used as a part of the credit decision process by the overwhelming majority of U.S. financial institutions to make the credit decisions that impact consumers, and we believe that this provides us an advantage over our competition in this market.

Strategy Machine Solutions

      Products in our Strategy Machine solutions segment help our clients with customer acquisition, origination and management, including fraud management.

      In the customer acquisition market, we compete with our customers’ internal IT departments, Acxiom Corporation, Experian, Harte-Hanks Inc., PeopleSoft and Siebel, among others.

      In the origination market, we compete with American Management Systems Inc., Experian, Automatic Data Processing, Inc., Lightbridge, Inc., Appro Systems, Inc. and First American Credit Management Solutions, Inc. (CMSI), among others.

      In the account management market, we compete with American Management Systems, Inc., Experian, Insurance Services Organization, Inc., Choicepoint, Inc., Lightbridge, Inc., PeopleSoft and Siebel, among others.

      In the fraud solutions market, we mainly compete with Retail Decisions and ACI Worldwide, a division of Transaction Systems Architects, Inc., in the financial services market; ECTel Ltd., Hewlett Packard

9

Table of Contents

      In the medical bill review market, we mainly compete with Medata and First Health.

      For our direct-to-consumer services that deliver credit scores, credit reports and consumer credit education services, we compete with our credit reporting agency partners and their affiliated companies, as well as from Trilegiant, InterSections and others.

Professional Services

      We compete with a variety of organizations that offer services similar to the consulting services that we offer. In addition, a client may use its own resources rather than engage an outside firm for these services. Our competitors include information technology product and services vendors, management and strategy consulting firms, smaller specialized information technology consulting firms and analytical services firms.

Analytic Software Tools

      Our primary competitors in this segment include SAS Institute, SPSS Inc., Angoss Software Corporation, iLog S.A., Computer Associates International, Inc., and Pegasystems Inc.

Competitive Factors

      We believe the principal competitive factors affecting our markets include: technical performance; access to unique proprietary databases; availability in ASP format; product attributes like adaptability, scalability, interoperability, functionality and ease-of-use; product price; customer service and support; the effectiveness of sales and marketing efforts; existing market penetration; and our reputation. Although we believe our products and services compete favorably with respect to these factors, we may not be able to maintain our competitive position against current and future competitors.

MARKETS AND CUSTOMERS

      Our products and services serve clients in multiple industries, including financial services, insurance, retail, telecommunications, healthcare and governmental agencies. During fiscal 2003, end users of our products included more than 90 of the 100 largest banks in the United States, and more than half of the largest 50 banks in the world; more than 70 of the 100 largest credit card issuers in the world, and all 50 of the largest U.S. issuers; more than 400 insurers; more than 150 retailers; more than 80 government or public agencies; and more than 100 telecommunications carriers.

      In addition, our consumer services are marketed to an estimated 190 million U.S. consumers whose credit relationships are reported to the three major credit reporting agencies.

      In the United States, we market our products and services primarily through our own direct sales organization. Sales groups are based in our headquarters and in field offices strategically located both in and outside the United States. We also market our products through indirect channels, including alliance partners and other resellers.

      During fiscal 2003, 2002 and 2001, revenues generated from our agreements with Equifax, TransUnion and Experian collectively accounted for 19%, 27% and 27%, respectively.

      Outside the United States, we market our products and services primarily through our subsidiary sales organizations. Our subsidiaries license and support our products in their local countries as well as within other foreign countries where we do not operate through a direct sales subsidiary. We also market our products through resellers and independent distributors in international territories not covered by our subsidiaries’ direct sales organizations.

      Our largest market segments outside the United States are the United Kingdom and Canada. Mexico, South Africa, a number of countries in South America and almost all of the Western European countries are represented in our user base. We have delivered products to users in over 60 countries.

10

Table of Contents

      Revenues from international customers, including end users and resellers, amounted to 21%, 19% and 18% of our total revenues in fiscal 2003, 2002 and 2001, respectively. See Note 18 to the accompanying consolidated financial statements for a summary of our operating segments and geographic information.

TECHNOLOGY

      We specialize in analytics, software and data management technologies that analyze data and drive business processes and decision strategies. We maintain active research in a number of fields for the purposes of deriving greater insight and predictive value from data, making various forms of data more usable and valuable to the model-building process, and automating and applying analytics to the various processes involved in making high-volume decisions in real time.

      Because of our pioneering work in credit scoring and fraud detection, we are widely recognized as the leader in predictive technology. In all our work, we believe that our tools and processes are among the very best commercially available, and that we are uniquely able to integrate advanced analytic, software and data technologies into mission-critical business solutions that offer superior returns on investment.

Principal Areas of Expertise

      Predictive Modeling. Predictive modeling identifies and mathematically represents underlying relationships in historical data in order to explain the data and make predictions or classifications about future events. Our models summarize large quantities of data to amplify its value. Predictive models typically analyze current and historical data on individuals to produce easily understood metrics such as scores. These scores rank-order individuals by likely future performance, e.g., their likelihood of making credit payments on time, or of responding to a particular offer for services. We also include in this category models that detect the likelihood of a transaction being fraudulent. Our predictive models are frequently operationalized in mission-critical transactional systems and drive decisions and actions in near real time. A number of analytic methodologies underlie our products in this area. These include proprietary applications of both linear and non-linear mathematical programming algorithms, in which one objective is optimized within a set of constraints, and advanced “neural” systems, which learn complex patterns from large data sets to predict the probability that a new individual will exhibit certain behaviors of business interest.

      Decision Analysis and Optimization. Decision analysis refers to the broad quantitative field that deals with modeling, analyzing and optimizing decisions made by individuals, groups and organizations. Whereas predictive models analyze multiple aspects of individual behavior to forecast future behavior, decision analysis analyzes multiple aspects of a given decision to identify the most effective action to take to reach a desired result. We have developed an integrated approach to decision analysis that incorporates the development of a decision model that mathematically maps the entire decision structure; proprietary optimization technology that identifies the most effective strategies, given both the performance objective and constraints; the development of designed testing required for active, continuous learning; and the robust extrapolation of an optimized strategy to a wider set of scenarios than historically encountered. This technology is behind our Strategy Science solutions.

      Transaction Profiling. Transaction profiling is a patent-protected technique used to extract meaningful information and reduce the complexity of transaction data used in modeling. Many of our products operate using transactional data, such as credit card purchase transactions, or other types of data that change over time. In its raw form, this data is very difficult to use in predictive models for several reasons: First, an isolated transaction contains very little information about the behavior of the individual that generated the transaction. In addition, transaction patterns change rapidly over time. Finally, this type of data can often be highly complex. To overcome these issues, we have developed a set of proprietary techniques that transform raw transactional data into a mathematical representation that reveals latent information, and which make the data more usable by predictive models. This profiling technology accumulates data across multiple transactions of many types to create and update profiles of transaction patterns. These profiles enable our neural network models to efficiently and effectively make accurate assessments of, for example, fraud risk and credit risk within real-time transaction streams.

11

Table of Contents

      Customer Data Integration. Decisions made on customers or prospects can benefit from data stored in multiple sources, both inside and outside the enterprise. We have focused on developing data integration processes that are able to assemble and integrate those disparate data sources into a unified view of the customer or household, through the application of persistent keying technology.

      Decision Management Software. In order to make a decision strategy operational, the various steps and rules need to be programmed or exported into the business’ software infrastructure, where it can communicate with front-end, customer-facing systems and back-end systems such as billing systems. We have developed software systems, sometimes known as decision engines and rules management systems, that perform the necessary functions to execute a decision strategy. Our software includes very efficient programs for these functions, facilitating, for example, user definition of extremely complex decision strategies using GUI interfaces; simultaneous testing of hundreds of decision strategies in test/control mode; high-volume processing and analysis of transactions in real time; and integration of multiple data sources and predictive metrics for improved behavior forecasts and finer segmentation.

Research and Development Activities

      Our research and development expenses were $67.6 million in fiscal 2003, $33.8 million in fiscal 2002, and $28.3 million in fiscal 2001. We believe that our future success depends on our ability to continually maintain and improve our core technologies, enhance our existing products, and develop new products and technologies that meet an expanding range of markets and customer requirements. In the development of new products and enhancements to existing products, we use our own development tools extensively.

      We have traditionally relied primarily on the internal development of our products. Based on timing and cost considerations, however, we have acquired, and in the future may consider acquiring, technology or products from third parties.

      In some cases, external funding (e.g., government grants) is used to develop initial concepts. For example, we work with the Defense Advanced Research Projects Agency, or DARPA, to develop advanced computational intelligence algorithms to detect patterns in genomic and medical literature data. Another long-term research project is aimed at developing computer models of brain functions in order to develop more intelligent, interactive computing systems and new types of analytic algorithms.

PRODUCT PROTECTION AND TRADEMARKS

      We rely on a combination of patent, copyright, trademark and trade secret laws and confidentiality procedures to protect our proprietary rights.

      We retain the title to and protect the suite of models and software used to develop scoring models as a trade secret. We also restrict access to our source code and limit access to and distribution of our software, documentation and other proprietary information. We have generally relied upon the laws protecting trade secrets and upon contractual non-disclosure safeguards and restrictions on transferability to protect our software and proprietary interests in our product and service methodology and know-how. Our confidentiality procedures include invention assignment and proprietary information agreements with our employees and independent contractors, and nondisclosure agreements with our distributors, strategic partners and customers. We also claim copyright protection for certain proprietary software and documentation.

      We have patents on many of our technologies and have patent applications pending on other technologies. The patents we hold may not be upheld as valid and may not prevent the development of competitive products. In addition, patents may never be issued on our pending patent applications or on any future applications that we may submit.

      Despite our precautions, it may be possible for competitors or users to copy or reproduce aspects of our software or to obtain information that we regard as trade secrets. In addition, the laws of some foreign countries do not protect proprietary rights to the same extent as do the laws of the United States. Patents and other protections for our intellectual property are important, but we believe our success and growth will depend principally on such factors as the knowledge, ability, experience and creative skills of our personnel, new products, frequent product enhancements, and name recognition.

12

Table of Contents

      We have developed technologies for research projects conducted under agreements with various United States government agencies or their subcontractors. Although we have acquired commercial rights to these technologies, the United States government typically retains ownership of intellectual property rights and licenses in the technologies that we develop under these contracts. In some cases, the United States government can terminate our rights to these technologies if we fail to commercialize them on a timely basis. In addition, under United States government contracts, the government may make the results of our research public, which could limit our competitive advantage with respect to future products based on funded research.

      We have used, registered and/or applied to register certain trademarks and service marks for our technologies, products and services.

PERSONNEL

      As of September 30, 2003, we employed 2,355 persons worldwide. Of these, 465 full-time employees were located in our San Rafael, California office, 472 full-time employees were located in our Minneapolis and Arden Hills, Minnesota offices, and 410 full-time employees were located in our San Diego, California offices. None of our employees is covered by a collective bargaining agreement and no work stoppages have been experienced.

      Information regarding our officers is included in “Executive Officers of the Registrant” at the end of Part I of this report.

      Fair Isaac, FICO, ScoreNet, PreScore, Fair Isaac MarketSmart Decision System, Fair Isaac SmartLink, LiquidCredit, StrategyWare, Capstone, CreditDesk, TRIAD, RoamEx, TelAdaptive, PlacementsPlus, Falcon, MIRA, CompAdvisor, AutoAdvisor, myFICO, Strategy Machine and “It’s just a smarter way to do business” are trademarks or registered trademarks of Fair Isaac Corporation, in the United States and/or in other countries.

Item 2.     Properties

      Our properties consist primarily of leased office facilities for sales, data processing, research and development, consulting and administrative personnel. Our principal office is located in San Rafael, California, approximately 15 miles north of San Francisco.

      Our leased properties include:

	•	approximately 225,500 square feet of office space in San Rafael, California in three buildings under leases expiring in 2006 or later;
	•	approximately 238,000 square feet of office and data processing space in Arden Hills and Minneapolis, Minnesota in five buildings under leases expiring in 2012 or later;
	•	approximately 178,500 square feet of office space in San Diego, California in two buildings under leases expiring in 2004 or later; and
	•	an aggregate of approximately 395,000 square feet of office and data center space in Alpharetta, GA; Arlington, VA; Atlanta, GA; Baltimore, MD; Birmingham, UK; Brentford, UK; Brookings, SD; Chestnut Hill, MA; Chicago, IL; Coppell, TX; Cranbury, NJ; Emeryville, CA; Englewood, CO; Exton, PA; Golden CO; Irvine, CA; Madrid, Spain; Mooresville, NC; Nanuet, NY; New Castle, DE; New York, NY; Norwalk, CT; Oakbrook Terrace, IL; Paris, France; Petaluma, CA; Reston, VA; San Jose, CA; San Mateo, CA; San Ramon, CA; Sao Paulo, Brazil; Sarasota, FL; Singapore, Singapore; St. Louis, MO; Tokyo, Japan; Toronto, Canada; Walpole, MA; and Warrenville, IL.

      See Note 20 to the accompanying consolidated financial statements for information regarding our obligations under leases. We believe that suitable additional space will be available to accommodate future needs.

Item 3.     Legal Proceedings

      We are subject to various legal proceedings in the ordinary course of business, none of which is required to be disclosed under this Item 3.

Item 4.     Submission of Matters to a Vote of Security Holders

      Not applicable.

13

Table of Contents

EXECUTIVE OFFICERS OF THE REGISTRANT

      Our executive officers as of September 30, 2003 were as follows:

14

Table of Contents

15

Table of Contents

PART II

      Our common stock trades on the New York Stock Exchange under the symbol: FIC. According to records of our transfer agent, at September 30, 2003, we had 481 shareholders of record of our common stock.

      The following table shows the high and low closing prices for our stock, as listed on the New York Stock Exchange and adjusted to give retroactive effect to the three-for-two stock split effected in June 2002, for each quarter in the last two fiscal years:

Dividends

      We paid quarterly dividends of 2 cents per share, or 8 cents per year, during the 2003, 2002 and 2001 fiscal 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. On June 5, 2002 and June 4, 2001, we effected three-for-two common stock splits, each in the form of a stock dividend. All share and per share amounts within this report have been restated to reflect these stock splits.

16

Table of Contents

      On August 5, 2002, we completed our acquisition of HNC Software Inc. (“HNC”), a provider of analytic and decision management software. Results of operations of HNC are included prospectively from the date of acquisition. As a result of this acquisition, and to lesser degrees the Nykamp Consulting Group, Inc. (“Nykamp”) acquisition consummated in December 2001, the Spectrum Managed Care, Inc. (“Spectrum”) acquisition consummated in December 2002, the NAREX Inc. (“NAREX”) acquisition consummated in July 2003, and the Diversified HealthCare Services, Inc. (“Diversified HealthCare Services”) acquisition consummated in September 2003, the comparability of the data below is impacted.

(1)	Results of operations for fiscal 2002 include a $40.2 million charge associated with the write-off of in-process research and development in connection with the HNC acquisition and $7.2 million in restructuring and other acquisition-related charges.
(2)	Includes amortization of goodwill prior to our adoption of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, on October 1, 2002.

      In April 2002 and May 2001, our Board of Directors authorized three-for-two stock splits, each effected in the form of a stock dividend, with cash paid in lieu of fractional shares. As a result of the two stock splits, stockholders of record at the close of business on May 15, 2002 and May 14, 2001, respectively, received an additional share of Fair Isaac stock for every two shares owned, which was distributed on June 5, 2002 and June 4, 2001, respectively. All share and earnings per share amounts have been restated to reflect these two stock splits.

17

Table of Contents

RESULTS OF OPERATIONS

Overview

      We are a leader in enterprise decision management, providing analytic, software and data management products and services 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 year ended September 30, 2003, 82% 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 are derived from transactional-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 account management activity; workers’ compensation and automobile medical injury insurance claims; and wireless and wireline calls and subscriber levels. 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.

      On August 5, 2002, we completed our acquisition of HNC, a provider of analytic and decision management software. Results of operations of HNC are included prospectively from the date of acquisition. As a result of this acquisition, and to lesser degrees the Nykamp acquisition consummated in December 2001, the Spectrum acquisition consummated in December 2002, the NAREX acquisition consummated in July 2003, and the Diversified HealthCare Services acquisition consummated in September 2003, our financial results during the year ended September 30, 2003, are not directly comparable to those during the years ended September 30, 2002 and 2001.

      Our reportable segments are: Scoring Solutions, Strategy Machine Solutions, Professional Services and Analytic Software Tools. 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 years ended September 30, 2003, 2002 and 2001 are set forth in Note 18 to the accompanying consolidated financial statements.

18

Table of Contents

Revenues

      The following table displays (a) the percentage of revenues by segment and (b) the percentage change in segment revenues from the prior fiscal year for the fiscal periods indicated. Segment information for fiscal 2002 and 2001 has been restated to conform to fiscal 2003 presentation.

      Total revenues increased by $236.9 million from $392.4 million during fiscal 2002 to $629.3 million during fiscal 2003, which included a $4.8 million increase in revenues that resulted from our three fiscal 2003 acquisitions as well as increases attributable to products and services previously offered by HNC as discussed below. Scoring Solutions segment revenues increased by $8.0 million from $128.0 million during fiscal 2002 to $136.0 million during fiscal 2003, primarily due to a $6.0 million increase in PreScore service revenues and a $4.7 million increase in revenues derived from risk scoring services at the credit reporting agencies, partially offset by a $2.7 million net decrease in various other product revenues. The increase in PreScore revenues was attributable primarily to a higher level of marketing efforts by credit card issuers. The growth in risk scoring services resulted primarily from increased sales of scores for account review as well as mortgage origination and refinancing. During fiscal 2003 and 2002, revenues generated from our agreements with Equifax, TransUnion and Experian collectively accounted for 19% and 27%, respectively, of our total revenues, including revenues from these customers that are recorded in our other segments. Strategy Machine Solutions segment revenues increased by $190.4 million from $190.2 million during fiscal 2002 to $380.6 million during fiscal 2003, primarily due to a $159.9 million increase in revenues derived from products and services previously offered by HNC, a $11.2 million increase in revenues derived from consumer score services through myFICO.com and strategic alliance partners’ web sites, a $9.2 million increase in Strategy Science revenues, a $6.9 million increase in TRIAD revenues and a $3.2 million net increase in various other product revenues. The increase in consumer score services revenue was attributable primarily to an increase in customer volume. The increase in Strategy Science revenues was principally due to increases in transactional-based revenues resulting from the growth of our Strategy Science customer base as well as increases in gain-share revenues from this customer base. The increase in Strategy Science revenues also included $4.5 million in fees associated with perpetual licensing of preconfigured strategies to customers who had previously licensed the strategies on a transactional, service basis. The increase in TRIAD revenues was attributable primarily to an increase in perpetual license sales and an increase in transactional volume associated with our processor account management services period over period. Fiscal 2003 revenues also include $2.6 million of Falcon perpetual license fees related to the integration of licensing rights in connection with client acquisition activity and superseding transactional license fee arrangements. Professional Services segment revenues increased by $21.4 million from $62.6 million during fiscal 2002 to $84.0 million during fiscal 2003, primarily due to increased revenues of $23.2 million resulting from the acquisition of HNC, partially offset by a $1.8 million net decrease associated with various other professional service offerings. Analytic Software Tools segment revenues increased by $17.2 million from $11.6 million during fiscal 2002 to $28.8 million during fiscal 2003, primarily due to a $15.7 million increase in revenues derived from products previously offered by HNC and a $3.3 million increase from Strategy Science software products in connection with the perpetual licensing of preconfigured strategies to customers who had previously licensed the strategies on a transactional, service basis, partially offset by a $1.8 million net decrease in revenues associated with various other products.

19

Table of Contents

      Total revenues increased by $63.3 million from $329.1 million during fiscal 2001 to $392.4 million during fiscal 2002. Scoring Solutions segment revenues increased by $4.0 million from $124.0 million during fiscal 2001 to $128.0 million during fiscal 2002, primarily due to a $6.4 million increase in revenues derived from risk and insurance scoring services at the credit reporting agencies and a $0.6 million net increase in other product revenues, partially offset by a $3.0 million decrease in PreScore and ScoreNet services. The growth in risk scoring services resulted primarily from increased sales of scores for account review and increased online scores for auto financing, as well as for mortgage originations and refinancing. During both fiscal 2002 and 2001, revenues generated from our agreements with Equifax, TransUnion and Experian collectively accounted for 27% of our total revenues, including revenues from these customers that are recorded in our other segments. Strategy Machine Solutions segment revenues increased by $28.4 million from $161.8 million during fiscal 2001 to $190.2 million during fiscal 2002, primarily due to the addition of $28.2 million of revenues derived from products and services previously offered by HNC, an $8.0 million increase in revenues derived from consumer score services through myFICO.com and strategic alliance partners’ web sites, partially offset by a $4.8 million decrease in MarketSmart Decision System revenues and a $3.0 million net decrease in various other product revenues. The increase in consumer score services revenue was attributable primarily to an increase in customer volume. The decrease in MarketSmart Decision System revenues was attributable primarily to a decline in customer transaction volumes. Professional Services segment revenues increased by $25.6 million from $37.0 million during fiscal 2001 to $62.6 million during fiscal 2002, primarily due to a $6.0 million increase in revenues resulting from the acquisition of HNC, a $5.4 million increase in Strategy Science development revenues, a $3.4 million increase in TRIAD implementation revenues and a $10.8 million net increase associated with various other professional service offerings. Analytic Software Tools segment revenues increased by $5.3 million from $6.3 million during fiscal 2001 to $11.6 million during fiscal 2002, primarily due to the addition of $3.1 million in Blaze Advisor revenues previously offered by HNC, a $2.5 million increase in Blaze Decision System revenues, offset by a $0.3 million net decrease in revenues associated with various other products. The increase in Blaze Decision System revenues was attributable to an increase in perpetual license sales.

      Revenues derived from clients outside the United States totaled $133.6 million, $76.2 million and $60.0 million in fiscal 2003, 2002 and 2001, respectively, representing 21%, 19% and 18% of total consolidated revenues in each of these years.

20

Table of Contents

Operating Expenses and Other Income (Expense)

      The following table sets forth for the fiscal periods indicated (a) the percentage of revenues represented by certain line items in our accompanying consolidated statements of income and (b) the percentage change in the amount of each such line item from the prior fiscal year.

     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; amounts payable to credit reporting agencies for scores; software costs; and expenses related to our consumer score services through myFICO.com.

      The fiscal 2003 over fiscal 2002 increase in cost of revenues was principally due to the HNC acquisition. Cost of revenues, as a percentage of revenues, decreased during fiscal 2003 as compared to 2002. This percentage decrease was attributable primarily to the addition of higher margin product offerings from the HNC acquisition, including Falcon Fraud Manager, Capstone Decision Manager, RoamEx and Blaze Advisor, an increase in higher margin Strategy Science and Decision Optimizer revenues, an increase in high margin TRIAD perpetual license sales and higher margins achieved by our consumer score services through myFICO.com due to increased revenues and related cost efficiencies.

      The fiscal 2002 over 2001 increase in cost of revenues was principally due to the acquisition of the Nykamp and HNC businesses and to an increase in direct materials expenses associated with our consumer score services through myFICO.com, offset by a reduction in the use of outside consultants and contractors that are relatively more expensive than internal resources. Cost of revenues, as a percentage of revenues, was consistent between fiscal 2002 and 2001.

21

Table of Contents

     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 other Strategy Machine Solutions and Analytic Software tools.

      The fiscal 2003 over fiscal 2002 increase in research and development expenses was principally due to the HNC acquisition. Research and development expenses, as a percentage of revenues, increased in fiscal 2003 as compared to fiscal 2002. This percentage increase was attributable primarily to a higher level of research and development efforts associated with product lines acquired from HNC. Research and development expenses as a percentage of revenues were consistent between fiscal 2002 and fiscal 2001. We anticipate that research and development expenditures in future periods, as a percentage of revenue, will be consistent with fiscal 2003 levels.

     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 fiscal 2003 over fiscal 2002 increase in selling, general and administrative expenses was principally due to the HNC acquisition. Selling, general and administrative expenses, as a percentage of revenues, decreased in fiscal 2003 as compared to fiscal 2002. This percentage decrease was attributable primarily to personnel and other general and administrative cost efficiencies achieved by the HNC acquisition, offset partially by a $2.5 million increase in our provision for doubtful accounts and a $2.3 million increase in media expenditures.

      Selling, general and administrative expenses, as a percentage of revenues, decreased in fiscal 2002 as compared to fiscal 2001. This percentage decrease was attributable primarily to a reduction in personnel, consulting, sales commission, conference and trade show expenses, offset in part by increased personnel and other expenses resulting from the HNC acquisition during fiscal 2002.

     Amortization of Intangible Assets

      Amortization of intangible assets consists of amortization expense that we have recorded on intangible assets recorded in connection with acquisitions accounted for by the purchase method of accounting. Effective October 1, 2002, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, and accordingly, ceased the amortization of goodwill and indefinite-lived intangible assets. Amortization expense in fiscal 2003 totaled $13.8 million as compared to amortization expense of $4.4 million in fiscal 2002. The increase is attributable primarily to the incremental amortization of intangible assets recorded in connection with the HNC acquisition in August 2002, and to a lesser degree the full year of amortization of intangible assets resulting from our acquisition of assets from Nykamp in December 2001, the nine months of amortization of intangible assets resulting from our acquisition of assets from Spectrum in December 2002, the two months of amortization of intangible assets resulting from our acquisition of assets from NAREX in July 2003, and the partial month of amortization of intangible assets resulting from our acquisition of assets from Diversified HealthCare Services in September 2003.

      Amortization expense in fiscal 2002 totaled $4.4 million as compared to amortization expense of $2.1 million in fiscal 2001. The increase in fiscal 2002 is attributable primarily to the incremental amortization of intangible assets recorded in connection with the HNC acquisition on August 5, 2002, and to a lesser degree the amortization of intangible assets resulting from our acquisition of assets from Nykamp in December 2001.

      Our definite-lived intangible assets 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.

22

Table of Contents

     In-process Research and Development

      During fiscal 2002, we recorded in-process research and development (IPR&D) expense of $40.2 million in connection with our acquisition of HNC. No IPR&D was recorded in connection with our fiscal 2003 acquisitions as we did not acquire any in-process technology. IPR&D represents the present value of the estimated after-tax cash flows expected to be generated by purchased technologies that, as of the acquisition dates, had not yet reached technological feasibility. The classification of the technology as complete or under development was made in accordance with the guidelines of SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed, and Financial Accounting Standards Board Interpretation No. 4, Applicability of SFAS No. 2 to Business Combinations Accounted for by the Purchase Method. In addition, the Fair Value, as defined below, of the IPR&D projects was determined in accordance with SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets.

      We used an independent appraisal firm to assist us with our valuation of the fair value of the assets purchased from HNC. Fair value is defined as the price at which property would expect to be exchanged between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.

      HNC’s IPR&D projects consisted of projects within HNC’s three legacy suites of software, consisting of the Efficiency, Risk and Opportunity suites, as well as its development of a new software platform technology. The current Efficiency Suite products under development as of the acquisition date were Roamex 5.0, which replaces 60% of the existing Roamex code and adds additional capabilities, and Blaze Advisor 4.5, a business rules product that adds additional rules management features to this product line. The current Risk Suite products under development were Falcon 5.0, which will be the first project in a series to replace the legacy Falcon product code base with new Java and platform technology, and Payment Optimizer, a payment optimizer tool that incorporates new platform modeling and profiling components. The current Opportunity Suite product under development was Opportunity Suite Development (“OSD”). OSD was the core engine for this suite, and was a build out of the Optimization and Simulation Environment (“OSE”) application version 2.0 UNIX based running on a web browser. At the time of acquisition, HNC was also in the process of developing a new software platform technology that enables efficient deployment and installation of multiple products while significantly reducing implementation and development costs.

      The IPR&D projects were valued through the application of discounted cash flow analyses, taking into account many key characteristics of HNC as well as its future prospects, the rate of technological change in the industry, product life cycles, risks specific to each project, and various projects’ stage of completion. Stage of completion was estimated by considering the time, cost, and complexity of tasks completed prior to the acquisition, verses the project’s overall expected cost, effort and risks required for achieving technological feasibility. In the application of the discounted cash flow analyses, HNC’s management provided distinct revenue forecasts for each IPR&D project. The projections were based on the expected date of market introduction, an assessment of customer needs, the expected pricing and cost structure of the related product(s), product life cycles, and the importance of the existing technology relative to the in-process technology. In addition, the costs expected to complete each project were added to the operating expenses to calculate the operating income for each IPR&D project. As certain other assets contribute to the cash flow attributable to the assets being valued, returns to these other assets were calculated and deducted from the pre-tax operating income to isolate the economic benefit solely attributable to each of the in-process technologies. The present value of IPR&D was calculated based on discount rates recommended by the American Institute of Certified Public Accountants IPR&D Practice Aid, which depend on the stage of completion and the additional risk associated with the completion of each of the IPR&D projects. As a recommended basis for the valuation of technology under development, we considered venture capital rates of return as an appropriate measure of the discount rates associated with each IPR&D project. As a result, the earnings associated with the incomplete technology were discounted at a rate ranging from 25% to 60%.

23

Table of Contents

     Restructuring and Merger-related

      During fiscal 2002, in connection with our acquisition of HNC, we incurred charges totaling $7.2 million, consisting of the following: (i) $5.0 million in restructuring charges, including $3.2 million in charges associated with our abandonment of a Fair Isaac facility lease concurrent with the acquisition, representing future cash obligations under the lease net of estimated sublease income, and $1.8 million in severance costs associated with a reduction in Fair Isaac staff in connection with the acquisition, and (ii) $2.2 million in other non-recurring acquisition related costs, consisting primarily of retention bonuses earned through September 30, 2002 by employees with future severance dates and employee outplacement costs.

      During fiscal 2003, we incurred HNC-related merger expenses totaling $2.5 million, consisting primarily of retention bonuses. No such amounts were recorded in fiscal 2001.

     Interest Income

      Interest income is derived primarily from the investment of funds in excess of our immediate operating requirements. Interest income increased to $7.5 million in fiscal 2003, as compared to $6.4 million for fiscal 2002 and $5.8 million in fiscal 2001. The increases were attributable primarily to higher average cash and investment balances, principally resulting from our acquisition of HNC on August 5, 2002, an increase in cash proceeds from stock option exercises, and $391.5 million in net proceeds from the issuance of our 1.5% Senior Convertible Notes in August 2003, partially offset by increases in our repurchases of common stock and lower interest and investment income yields due to market conditions.

     Interest Expense

      On August 6, 2003, we issued $400.0 million of 1.5% Senior Convertible Notes (the “Senior Notes”) that mature in August 2023. Interest expense on the Senior Notes recorded by us, including amortization of debt issuance costs, totaled $1.3 million during fiscal 2003.

      As a result of the HNC acquisition and subsequent merger of the HNC entity into Fair Isaac, we became the issuer of $150.0 million in 5.25% Convertible Subordinated Notes (the “Subordinated Notes”) due in September 2008. The Subordinated Notes were recorded at their fair value of $139.7 million on the acquisition date, as determined based on their quoted market price, which resulted in our recognition of a $10.3 million note discount. The carrying amount of the Subordinated Notes is being accreted to $150.0 million over their remaining term using the effective interest method, resulting in an effective interest rate of approximately 6.64% per annum. Interest expense on the Subordinated Notes recorded by us totaled $9.3 million and $1.5 million during fiscal 2003 and 2002, respectively.

     Other Income (Expense), Net

      Other income (expense), 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. Other income, net totaled $1.0 million in fiscal 2003 as compared to $1.1 million in fiscal 2002. The decrease in other income, net is attributable primarily to a $1.9 million decrease in gains recorded from the sale of marketable securities during fiscal 2003 as compared to fiscal 2002, partially offset by the non-recurrence of a $1.1 million loss associated with the impairment and write-off of an equity investment recorded during fiscal 2002 and to a $0.7 million increase in foreign exchange rate gains recorded during fiscal 2003 as compared to fiscal 2002.

      Other income, net totaled $1.1 million in fiscal 2002 as compared to other expense, net of $1.0 million in fiscal 2001. Other income, net in fiscal 2002 includes $2.7 million in realized gains on the sale of investments, whereas investment gains/losses were insignificant in fiscal 2001.

24

Table of Contents

     Provision for Income Taxes

      Our effective tax rate was 37.75%, 66.3% and 40.0% in fiscal 2003, 2002 and 2001, respectively. The fiscal 2003 over 2002 decrease was principally due to the non-recurrence of a $40.2 million non-deductible IPR&D charge. The fiscal 2002 over 2001 increase was principally due to the $40.2 million non-deductible IPR&D charge, offset by the reduction of the valuation allowance on capital loss carryovers and to the increased availability of research and development tax credits. The fiscal 2002 effective tax rate, excluding the IPR&D adjustment, would have been 37.7%.

     Operating Income

      Operating income increased from $47.1 million in fiscal 2002 to $174.2 million in fiscal 2003. This increase was attributable primarily to the HNC acquisition, including the non-recurrence of the $40.2 million IPR&D charge, a $4.7 million decrease in 2003 related to merger-related expenses, and to a lesser degree, increased revenues and operating income associated with legacy Fair Isaac product offerings. At the segment level, the increase in operating income was attributable primarily to a $63.5 million increase in segment operating income within our Strategy Machine Solutions segment, and to a lesser degree increased segment operating income within our Professional Services, Scoring Solutions and Analytic Software Tools segments of $11.1 million, $4.2 million, and $3.4 million, respectively. The increase in Strategy Machine Solutions segment operating income was driven primarily by the growth of segment revenues and operating margins, principally as a result of additional revenues derived from products and services previously offered by HNC, but also by the increase in revenues derived from consumer score services through myFICO.com and strategic alliance partners’ web sites, an increase in Strategy Science revenues and an increase in TRIAD revenues. HNC merger-related cost efficiencies also contributed to the increase in Strategy Machine Solutions segment operating income. The increase in Professional Services segment operating income was driven primarily by the increase in segment revenues, including those derived from legacy HNC services as well as an increase in higher margin professional service revenues associated with legacy Fair Isaac product offerings. The increase in Scoring Solutions segment operating income was driven primarily by an increase in PreScore revenues and by an increase in revenues derived from risk scoring services at the credit reporting agencies. The increase in Analytic Software Tools segment operating income was driven primarily by the addition of higher margin Blaze Advisor revenues previously offered by HNC and by the increase in higher margin Decision Optimizer software license revenues.

      Operating income decreased from $72.1 million for fiscal 2001 to $47.1 million for fiscal 2002. This decrease was attributable primarily to the $40.2 million IPR&D charge and $7.2 million in other merger-related costs recorded in connection with the HNC acquisition. Excluding these charges, operating income in fiscal 2002 increased by $22.4 million. At the segment level, the increase in operating income was attributable to increased segment operating income within our Strategy Machine Solutions, Scoring Solutions, and Analytical Software Tools segments of $11.9 million, $11.6 million and $2.6 million, respectively, partially offset by a $3.7 million decrease in segment operating income within our Professional Services segment. The increase in Strategy Machine Solutions segment operating income was driven primarily by the increase in revenues from consumer score services through myFICO.com and strategic alliance partners’ web sites, as well as additional revenues derived from products and services previously offered by HNC. The increase in Scoring Solutions segment operating income was driven primarily by an increase in revenues derived from risk scoring services at the credit reporting agencies. The increase in Analytic Software Tools segment operating income was due primarily to an increase in higher margin Blaze Decision System and Blaze Advisor revenues in fiscal 2002, the latter of which resulted from the HNC acquisition. The decrease in the Professional Services segment operating income resulted primarily from the acquisitions of Nykamp and HNC, which contributed to lower professional services margins in fiscal 2002, offset by the increase in professional service revenue contributions from these acquisitions.

     Stock-based Compensation

      We have stock-based employee compensation plans, which are described more fully in Notes 1 and 17 to the accompanying consolidated financial statements. We measure compensation expense for our employee

25

Table of Contents

      We recorded stock-based compensation expense of $3.0 million, $1.4 million and $1.0 million during fiscal 2003, 2002 and 2001, respectively. This expense is recorded in cost of revenues, research and development, and selling, general and administrative expense. The fiscal 2003 over fiscal 2002 increase is primarily due to a $1.0 million incremental increase related to a full year of amortization of deferred compensation related to 156,700 shares of restricted common stock granted during fiscal 2002, which vest in 25% increments at each annual anniversary from the grant date. We are amortizing this deferred compensation on a straight-line basis over the total four-year vesting period. The additional $0.6 million increase is due a full year of amortization of deferred compensation related to the intrinsic value of HNC’s unvested options to purchase Fair Isaac common stock assumed at the time of the HNC acquisition. This deferred compensation is being amortized on a straight-line basis over the vesting period of the options.

      The fiscal 2002 over fiscal 2001 increase is primarily due to amortization of $0.2 million of deferred compensation on the intrinsic value of HNC’s unvested options to purchase Fair Isaac common stock assumed at the time of the HNC acquisition. The additional $0.2 million increase is due to amortization of deferred compensation on the shares of restricted common stock granted during fiscal 2002.

Capital Resources and Liquidity

      Our working capital at September 30, 2003 and 2002 totaled $569.5 million and $338.0 million, respectively. The increase in working capital year over year is attributable primarily to a $224.1 million increase in cash and cash equivalents and short-term marketable securities, and an aggregate $7.4 million increase in other net working capital accounts. The increase in cash and cash equivalents and short-term marketable securities is principally due to the $391.5 million in net proceeds from issuance of the Senior Notes in August 2003, net cash provided by operating and other financing activities during fiscal 2003, as described below, partially offset by the use of $331.6 million for stock repurchases.

      The increase in other net working capital balances consisted primarily of a $12.0 million increase in net receivables, a $10.9 million decrease in other accrued liabilities, a $2.3 million decrease in accrued compensation and employee benefits, offset by a $8.4 million increase in deferred revenue, a $7.7 million increase in accounts payable, a $1.2 million decrease in deferred income taxes, and a $0.5 million decrease in prepaid expenses and other current assets. The increase in net receivables was attributable primarily to an increase in revenues during the quarter ended September 30, 2003, as compared to the quarter preceding September 30, 2002, partially offset by an increase in our allowance for doubtful accounts. The decrease in other accrued liabilities was attributable primarily to a reduction in HNC merger-related accruals, partially offset by an increase in income taxes payable. The decrease in accrued compensation and employee benefits was attributable primarily to a decrease in accrued incentive compensation. The increase in deferred revenue was attributable primarily to an increase in customer prepayments. The increase in accounts payable was attributable primarily to the timing of vendor disbursements and to a lesser degree the acquisitions of NAREX and Diversified HealthCare Services.

      Our primary method for funding operations and growth has been through cash flows generated from operations. Net cash provided by operating activities increased from $103.1 million in fiscal 2002 to $174.6 million in fiscal 2003, reflecting an increase in net earnings before non-cash charges and the effect of other net working capital changes, as discussed herein. Net cash provided by operating activities increased from $70.5 million in fiscal 2001 to $103.1 million in fiscal 2002, reflecting primarily an increase in net earnings before merger-related IPR&D and other non-cash charges, partially offset by the effect of net working capital changes excluding the impact of the HNC and Nykamp acquisitions.

26

Table of Contents

      Net cash used in investing activities totaled $153.9 million in fiscal 2003, compared to net cash provided by investing activities of $92.5 million in fiscal 2002, and net cash used in investing activities of $98.1 million in fiscal 2001. The increase in net cash used in investing activities during fiscal 2003 as compared to fiscal 2002 is attributable primarily to a $189.1 million decrease in net cash and cash equivalents acquired in acquisitions, net of cash paid, period over period, a $65.5 million increase in purchases of marketable securities, net of sales and maturities, and $0.5 million in cash paid for a cost-method investment in the current year period only, offset by a $5.1 million reduction in property and equipment purchases and the receipt of $3.6 million in cash proceeds from the sale of a product line in the current period. The increase in cash flows provided by investing activities in fiscal 2002 as compared to fiscal 2001 is attributable primarily to the $143.1 million of cash and cash equivalents acquired in the HNC acquisition, a $49.5 million reduction in purchases of marketable securities, net of proceeds from sales and maturities, a $0.6 million reduction in property and equipment purchases, partially offset by $2.6 million of cash paid to effect the Nykamp acquisition in fiscal 2002.

      Net cash provided by financing activities totaled $132.0 million in fiscal 2003, compared to net cash used in financing activities of $123.4 million in fiscal 2002 and net cash provided by financing activities of $12.7 million in fiscal 2001. The increase in net cash provided by financing activities during fiscal 2003 as compared to fiscal 2002 is attributable primarily to the $391.5 million in net proceeds from issuance of the Senior Notes, a $52.3 million increase in proceeds from issuances of common stock year over year, partially offset by the use of $331.6 million in cash to repurchase common stock in fiscal 2003, as compared to the use of $144.4 million to repurchase common stock in fiscal 2002, and a $1.3 million increase in dividends paid year over year. The increase in net cash used in financing activities in fiscal 2002, as compared to fiscal 2001, is attributable primarily to the $144.4 million in cash to repurchase common stock in fiscal 2002, as compared to the use of $19.9 million to repurchase common stock in fiscal 2001, a $10.6 million decrease in proceeds from issuances of common stock, and to a $1.3 million increase in dividends paid year over year.

      From time to time, we repurchase our common stock in the open market pursuant to programs approved by our Board of Directors. During fiscal 2003, 2002 and 2001, we expended $331.6 million, $144.4 million and $19.9 million, respectively, in connection with our repurchase of common stock under such programs. In November 2003, our Board of Directors approved a new common stock repurchase program allowing us to purchase up to 1.5 million shares of our common stock from time to time in the open market and in negotiated transactions. No shares have been repurchased under this new program.

      We paid quarterly dividends of two cents per share, or eight cents per year, during each of fiscal 2003, 2002 and 2001. 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.

      On August 6, 2003, we issued $400.0 million of the Senior Notes. The Senior Notes become convertible into shares of Fair Isaac common stock, subject to the conditions described below, at an initial conversion price of $65.9288 per share, subject to adjustments for certain events. The initial conversion price is equivalent to a conversion rate of approximately 15.1679 shares of Fair Isaac common stock per $1,000 principal amount of the Senior Notes. Holders may surrender their Senior Notes for conversion, if any of the following conditions is satisfied: (i) prior to August 15, 2021, during any fiscal quarter, if the closing price of our common stock for at least 20 trading days in the 30 consecutive trading day period ending on the last day of the immediately preceding fiscal quarter is more than 120% of the conversion price per share of our common stock on the corresponding trading day; (ii) at any time after the closing sale price of our common stock on any date after August 15, 2021 is more than 120% of the then current conversion price; (iii) during the 5 consecutive business day period following any 10 consecutive trading day period in which the average trading price of a Senior Note was less than 98% of the average sale price of our common stock during such 10 trading day period multiplied by the applicable conversion rate, subject to certain limitations; (iv) if we have called the Senior Notes for redemption; or (v) if we make certain distributions to holders of our common stock or we enter into specified corporate transactions.

27

Table of Contents

      The Senior Notes are senior unsecured obligations of Fair Isaac and rank equal in right of payment with all of our unsecured and unsubordinated indebtedness. The Senior Notes are effectively subordinated to all of our existing and future secured indebtedness and existing and future indebtedness and other liabilities of our subsidiaries. The Senior Notes bear regular interest at an annual rate of 1.5%, payable on August 15 and February 15 of each year, beginning February 15, 2004 through August 15, 2008. Beginning August 15, 2008, regular interest will accrue at the rate of 1.5%, and be due and payable upon the earlier to occur of redemption, repurchase, or final maturity. In addition, the Senior Notes bear contingent interest during any six-month period from August 15 to February 14 and from February 15 to August 14, commencing with the six-month period beginning August 15, 2008, if the average trading price of the Senior Notes for the five trading day period immediately preceding the first day of the applicable six-month period equals 120% or more of the sum of the principal amount of, plus accrued and unpaid regular interest on, the Senior Notes. The amount of contingent interest payable on the Senior Notes in respect of any six-month period will equal 0.25% per annum of the average trading price of the Senior Notes for the five trading day period immediately preceding such six-month period.

      We may redeem for cash all or part of the Senior Notes on and after August 15, 2008, at a price equal to 100% of the principal amount of the Senior Notes, plus accrued and unpaid interest. Holders may require us to repurchase for cash all or part of their Senior Notes on August 15, 2007, August 15, 2008, August 15, 2013 and August 15, 2018, or upon a change in control, at a price equal to 100% of the principal amount of the Senior Notes being repurchased, plus accrued and unpaid interest.

      We are the issuer of $150.0 million of the Subordinated Notes. The Subordinated Notes are convertible into shares of Fair Isaac common stock at a conversion rate of approximately 18.02 shares of Fair Isaac common stock per $1,000 principal amount of the Subordinated Notes, subject to anti-dilution adjustment. The Subordinated Notes are general unsecured obligations of Fair Isaac and are subordinated in right of payment to all existing and future senior indebtedness of Fair Isaac. Interest on the Subordinated Notes is payable on March 1 and September 1 of each year until maturity. We may redeem the Subordinated Notes on or after September 5, 2004, or earlier if the price of Fair Isaac common stock reaches certain levels. If we redeem the Subordinated Notes prior to September 1, 2007, we will also be required to pay a redemption premium as prescribed by the indenture.

      We are party to a credit agreement with a financial institution that provides for a $15.0 million revolving line of credit through February 2004. Under the agreement 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, dividend payments, 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 and a foreign exchange facility that allows us to enter contracts with the financial institution to purchase and sell certain currencies, subject to a maximum aggregate amount of $20.0 million and other specified limits. As of September 30, 2003, no borrowings were outstanding under this agreement and we were in compliance with all related covenants. As of September 30, 2003, this credit facility also served to collateralize certain letters of credit aggregating $0.7 million, issued by us in the normal course of business. As of September 30, 2003, this credit facility also served to collateralize contracts to sell certain currencies aggregating $7.6 million, entered into by us pursuant to our hedging program to manage our foreign currency exchange rate risk on existing foreign currency receivable and bank balances. Available borrowings under this credit agreement are reduced by the principal amount of letters of credit and by 20% of the aggregate amount of contracts to purchase and sell certain foreign currencies outstanding under the facility.

      As of September 30, 2003, we had $660.7 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

28

Table of Contents

      We are a limited partner in Azure Venture Partners I, L.P. (“Azure”), a venture capital investment management fund, and are committed to invest an additional $1.4 million into this fund. The ultimate timing of this additional investment will be dependent on when the fund managers make additional capital calls. The most recent capital call required us to invest an additional $0.5 million into this fund in May 2003. It is possible that additional capital calls may require us to invest some or all of our remaining commitment during fiscal 2004.

      The following is a summary of our contractual obligations as of September 30, 2003:

(1)	$400.0 million represents the aggregate principal amount of the Senior Notes. Refer to Note 9 to our accompanying consolidated financial statements for more detailed information regarding the Senior Notes.
(2)	$150.0 million represents the aggregate principal amount of the Subordinated Notes. Refer to Note 10 to our accompanying consolidated financial statements for more detailed information regarding the Subordinated Notes.
(3)	We are committed to invest an additional $1.4 million into the Azure fund. The ultimate timing of this additional investment will be dependent on when the fund managers make additional capital calls. It is possible that additional capital calls may require us to invest some or all of our remaining commitment during fiscal 2004.

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 effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that are material to investors.

Critical Accounting Policies and Estimates

      We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. 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, capitalized software development costs, 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

29

Table of Contents

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

      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.

      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 allows 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.

      Transactional-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 reasonably assured.

      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. 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

30

Table of Contents

      Revenue determined by 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.

      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.

      We make estimates regarding the collectibility of our accounts receivable. When we evaluate the adequacy of our allowance for doubtful accounts, we closely 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.

      Our business acquisitions typically result in the recognition of goodwill and other intangible assets, and in certain cases one-time charges associated with the write-off of in-process research and development, which affect the amount of current and future period charges and amortization expense. 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. Estimates using different, but each reasonable, assumptions could 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 goodwill. We adopted the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, on October 1, 2002, and as a result have ceased amortization of goodwill. As required by SFAS No. 142, we have determined that our reporting units are the same as our reportable segments. In addition, we were required to assess whether goodwill within our reporting units was impaired at the date of the adoption of this statement using a two-step transitional impairment test. We completed the first step during fiscal 2003, and determined that goodwill was not impaired on October 1, 2002. Accordingly, we were not required to complete the second step of the impairment test. We selected the fourth quarter to perform our annual goodwill impairment test, and determined that goodwill was not impaired as of July 1, 2003. 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.

31

Table of Contents

      We capitalize certain software development costs after establishment of a product’s technological feasibility. Such costs are then amortized over the estimated life of the related product. Periodically, we compare a product’s unamortized capitalized cost to the product’s estimated net realizable value. To the extent unamortized capitalized costs exceed net realizable value based on the product’s estimated future gross revenues, reduced by the estimated future costs of completing and disposing of the product, the excess is written off. This analysis requires us to estimate future gross revenues associated with certain products, and the future costs of completing and disposing of certain products. If these estimates change, write-offs of capitalized software costs could result.

      Costs incurred to develop internal-use software during the application development stage are capitalized and reported at the lower of cost or fair value. 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 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.

      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. 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. 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. 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.

      We are subject to various proceedings, lawsuits and claims relating to product, 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. The amount of loss accrual, if any, is determined after analysis of each matter, and is subject to adjustment if warranted by new developments or revised strategies.

RISK FACTORS

Risks Related to Our Business

      We expect that revenues from some or all of our Falcon Fraud Manager, Decision Manager for Medical Bill Review, Outsourced Bill Review and account management products and services, and our agreements with TransUnion, Equifax and Experian, will account for a substantial portion of our total revenues for the

32

Table of Contents

	•	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;
	•	inability to successfully sell our products in new vertical markets; and
	•	events that reduce the effectiveness of or need for fraud detection capabilities.

      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 contracts with the three major credit reporting agencies, TransUnion, Equifax and Experian. These contracts accounted for 19% of our revenues in fiscal 2003. The loss of any major customer, the loss of a relationship with one of the major credit reporting agencies or the delay of significant revenue from these customers or credit reporting agencies, could have a material adverse effect on our revenues and results of operations.

      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 the rejection of our products, damage to our reputation, lost revenues, diverted development resources, potential product liability claims and increased service and support costs and warranty claims.

      Our Scoring Solutions segment and Strategy Machine Solutions segment rely on distributors, including with respect to our Scoring Solutions segment, TransUnion, Equifax and Experian, and we intend to continue to market and distribute our products through existing and future distributor relationships. Failure by our existing and future distributors to generate significant revenues 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 become our competitors with respect to the products they distribute either by developing a competitive product themselves or by distributing a competitive

33

Table of Contents

      The market price of our common shares may be volatile and could be subject to wide fluctuations due to a number of factors, including variations in our revenues and operating results. With respect to 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. Most of our operating expenses will not be affected by short-term fluctuations in revenues; thus, short-term fluctuations in revenues may significantly impact operating results. Additional factors that will cause our share 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 market prices of equity securities 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 shares.

      We cannot forecast our revenues accurately because the length of our sales cycles makes it difficult for us to predict the quarter in which sales to expected customers will occur. The long sales cycle for our products may cause license revenue and operating results to vary significantly from period to period. The sales cycle to license our products can typically range 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. This has contributed, and we expect it to continue to contribute, to fluctuations in our operating results.

34

Table of Contents

      Significant portions of our quarterly software licensing agreements are concluded in the last month of the fiscal quarter, generally with a concentration of such revenues earned in the final week of that month. Prior to the very end of any quarter, we must rely on our forecasts of revenue for planning, modeling and other purposes. However, forecasts are only estimates and may not correlate to revenues in a particular quarter or over a longer period of time. Consequently, a significant discrepancy between actual results and sales forecasts could cause us to improperly plan or budget and thereby adversely affect our business, financial condition or results of operations. Any publicly-stated revenue or earnings projections by us are especially subject to this risk.

      Our future success will likely depend in large part on our ability to attract and retain experienced sales, 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 persons is very competitive due to the limited number of people available with the necessary technical skills and understanding. We have experienced difficulty in recruiting qualified personnel, especially technical and sales personnel, and we may need additional staff to support new customers and/or increased customer needs. We may also recruit and employ 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.

      We must develop or obtain a reliable source of sufficient amounts of current and statistically relevant data to analyze transactions and update our products, including our consumer credit, financial services, predictive modeling, decision analysis, intelligence management, credit card fraud control and profitability management, loan underwriting and insurance 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 agree to provide us the data we require to analyze transactions, report results and build new models. If we fail to maintain good 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, our Decision Manager for Medical Bill Review products uses data from state workers’ compensation fee schedules adopted by state regulatory agencies. Third parties have previously 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 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:

	•	the possibility that we will pay more than the acquired companies or assets are worth;
	•	the difficulty of assimilating the operations and personnel of the acquired businesses;
	•	the potential product liability associated with the sale of the acquired companies’ products;

35

Table of Contents

	•	the potential disruption of our ongoing business;
	•	the potential dilution of our existing stockholders and earnings per share;
	•	unanticipated liabilities, legal risks and costs;
	•	the distraction of management from our ongoing business; and
	•	the impairment of relationships with employees and customers as a result of any integration of new management personnel.

      These factors could harm our business, financial condition or results of operations, particularly in the event of a significant acquisition.

      Our success will depend, 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. We cannot assure you that our means of protecting 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, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources and could harm our business, financial condition or results of operations.

      In addition, some of our technologies were developed under research projects conducted under agreements with various United States government agencies or subcontractors. Although we have commercial rights to these technologies, the United States 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 United States 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.

      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 and the functionality of products overlaps. We may need to defend claims that our products infringe patent, copyright or other rights, and as a result 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.

36

Table of Contents

      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 affecting the Internet in general, could significantly harm our business, financial condition or results of operations. We cannot be certain that advances in computer capabilities, new discoveries in the field of cryptography, or other developments will not compromise or breach the technology protecting the networks that access our netsourced products, consumer services and proprietary database information.

      System interruptions could delay and disrupt our products and services, cause harm to our business and reputation and result in loss of customers. These interruptions include fires, floods, earthquakes, power losses, telecommunication failures and other events beyond our control. It is particularly important for us to protect our data centers against damage from these events. The on-line services we provide are dependent on links to telecommunication providers, and we believe we have taken reasonable precautions to protect our data centers or any failure of our telecommunications links from events that could interrupt our operations. Any sustained system interruption could materially adversely affect our ability to meet our customers’ requirements, which could harm our business, financial condition or results of operations.

Risks Related to Our Industry

      We have a significant share of the available market in our Scoring 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, 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.

      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

37

Table of Contents

	•	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.

      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 analytics departments;
	•	credit reporting agencies;
	•	computer service providers;
	•	regional risk management, marketing, systems integration and data warehousing competitors;
	•	application software companies, including enterprise software vendors;
	•	management information system departments of our customers and potential customers, including financial institutions, insurance companies and telecommunications carriers;
	•	third-party professional services and consulting organizations;
	•	Internet companies;
	•	hardware suppliers that bundle or develop complementary software;
	•	network and telecommunications switch manufacturers, and service providers that seek to enhance their value-added services;
	•	neural network tool suppliers; and
	•	managed care organizations.

      We expect to experience additional competition from other established and emerging companies, as well as from other technologies. For example, our Falcon Fraud Manager and Falcon Fraud Manager for Merchants 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.

38

Table of Contents

      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 of our competitors that directly compete with our products. 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.

      Legislation and governmental regulation affects 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, or FCRA;
	•	regulation designed to insure that lending practices are fair and non-discriminatory, such as the Equal Credit Opportunity Act, or ECOA;
	•	privacy law, including but not limited to the provisions of the Financial Services Modernization Act of 1999, or FSMA, the Health Insurance Portability and Accountability Act of 1996;
	•	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;
	•	consumer protection laws, such as federal and state statutes governing the use of the Internet and telemarketing; and
	•	regulations of foreign jurisdictions on our international operations, including the European Union’s Privacy Directive.

      In making credit evaluations of consumers, performing fraud screening or user authentication, our customers are subject to requirements of federal law, including the FCRA and the ECOA, and regulations thereunder, as well as state laws which impose a variety of additional requirements. Privacy legislation such as the FSMA 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 national uniformity provisions of the FCRA are set to expire in 2004 which could lead to greater state regulation and additional costs to our business. 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, our Decision Manager for Medical Bill Review products and Outsourced Bill Review services.

      During fiscal 2003, 82% 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,

39

Table of Contents

Risk Related to External Conditions

      Due to the economic slowdown in the United States and in Europe in recent years, companies in many industries are delaying or reducing technology purchases. This softening of demand for our decisioning solutions or other products and services results in reductions in capital expenditures by our customers, longer sales cycles, deferral or delay of purchase commitments for our products and increased price competition. As a result, if the current economic conditions in the U.S. and Europe continue or worsen, if a wider or global economic slowdown occurs, or if there is an escalation in regional or continued global conflicts, we may fall short of our revenue expectations for the first quarter of fiscal 2004 or for the entire year.

      A growing portion of our revenues is derived from international sales. During fiscal 2003, 21% 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:

	•	the general economic and political conditions in countries where we sell our products and services;
	•	difficulty in staffing our operations in various countries;
	•	the effects of a variety of foreign laws and regulations, including restrictions on access to personal information;
	•	import and export licensing requirements;
	•	longer payment cycles;
	•	potentially 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.

      We cannot assure you 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.

40

Table of Contents

      Certain provisions of our Amended and 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 adoption of 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 of 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.

      We have not decided to expense stock options despite the recent debate regarding the accounting treatment of stock options. If we elected or were required to record an expense for our stock-based compensation plans using the fair value method under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation instead of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, we could have significant accounting charges. If future laws or regulations require us to treat all stock-based compensation as an expense using the fair value method, we may avoid any accounting charges by reducing the number of stock options granted to employees or by granting options to fewer employees. This could affect our ability to retain existing employees and attract qualified candidates, and increase the cash compensation we would have to pay to them. Alternatively, if we continue to issue stock options at the same level, operating expenses could rise, negatively affecting 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 the valuation of our deferred tax assets and liabilities, or by changes in tax laws. 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 these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these examinations will not have an adverse effect on our operating results and financial condition.

Market Risk Disclosures

      The following discussion about our market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We believe that our equity risks are not material. 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

41

Table of Contents

      We are also subject to interest rate risk related to our 1.5% Senior Notes and our 5.25% Subordinated Notes. To the extent that general market interest rates fluctuate, the fair value of the notes may increase or decrease.

Forward Foreign Currency Contracts

      We maintain a hedging 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, with contract amounts representing the expected payments to be made under these instruments at September 30, 2003: