FAIR ISAAC CORP - 10-Q Quarterly Report

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

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

The number of shares of common stock outstanding on December 31, 2003 was 47,003,604 (excluding 11,590,525 shares held by the Company as treasury stock).


PART I — FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements					1
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations					11
Item 3. Quantitative and Qualitative Disclosures About Market Risk					31
Item 4. Controls and Procedures					32
PART II — OTHER INFORMATION
Item 1. Legal Proceedings					32
Item 4. Submission of Matters to a Vote of Security Holders					32
Item 6. Exhibits and Reports on Form 8-K					33
Signatures					34

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


			December 31,			September 30,
			2003			2003

Assets
Current assets:
	Cash and cash equivalents		$	197,526		$	249,458
	Marketable securities available for sale, current portion			318,363			255,893
	Receivables, net			132,158			138,712
	Prepaid expenses and other current assets			16,263			16,981
	Deferred income taxes, current portion			5,255			6,828

		Total current assets		669,565			667,872
Marketable securities available for sale, less current portion				227,983			155,312
Other investments				1,528			8,942
Property and equipment, net				49,676			50,706
Goodwill				458,141			457,842
Intangible assets, net				91,243			93,930
Deferred income taxes, less current portion				40,738			40,738
Other assets				17,841			19,831

			$	1,556,715		$	1,495,173


Liabilities and Stockholders’ Equity
Current liabilities:
	Accounts payable		$	13,078		$	15,267
	Accrued compensation and employee benefits			22,045			25,839
	Other accrued liabilities			40,933			25,672
	Deferred revenue			37,642			31,584

		Total current liabilities		113,698			98,362
Senior convertible notes				400,000			400,000
Convertible subordinated notes, net of discount				141,740			141,364
Other liabilities				5,982			5,905

		Total liabilities		661,420			645,631

Stockholders’ equity:
	Preferred stock ($0.01 par value; 1,000 shares authorized; none issued and outstanding)			—			—
	Common stock ($0.01 par value; 200,000 shares authorized, 58,594 and 58,251 shares issued and 47,004 and 46,578 shares outstanding at December 31, 2003 and September 30, 2003, respectively)			470			466
	Paid-in-capital			1,030,529			1,019,847
	Treasury stock, at cost (11,590 and 11,673 shares at December 31, 2003 and September 30, 2003, respectively)			(483,016	)		(486,477	)
	Unearned compensation			(3,120	)		(3,710	)
	Retained earnings			347,167			319,341
	Accumulated other comprehensive income			3,265			75

		Total stockholders’ equity		895,295			849,542

			$	1,556,715		$	1,495,173

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


			Quarter Ended
			December 31,

			2003			2002

Revenues			$	169,341		$	146,732

Operating expenses:
	Cost of revenues (1)			59,535			60,654
	Research and development			16,401			17,247
	Selling, general and administrative (1)			41,760			32,183
	Amortization of intangible assets (1)			4,067			3,262
	Restructuring and merger-related			—			2,010

		Total operating expenses		121,763			115,356

Operating income				47,578			31,376
Interest income				2,445			2,596
Interest expense				(4,378	)		(2,322	)
Other income, net				558			528

Income before income taxes				46,203			32,178
Provision for income taxes				17,442			12,389

Net income			$	28,761		$	19,789

Earnings per share:
	Basic		$	0.62		$	0.39

	Diluted		$	0.59		$	0.38

Shares used in computing earnings per share:
	Basic			46,549			50,162

	Diluted			49,158			52,173

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


	Common Stock																Accumulated
																	Other		Total
			Par		Paid-In-			Treasury			Unearned			Retained			Comprehensive		Stockholders’			Comprehensive
	Shares		Value		Capital			Stock			Compensation			Earnings			Income		Equity			Income

Balance at September 30, 2003		46,578	$	466	$	1,019,847		$	(486,477	)	$	(3,710	)	$	319,341		$	75	$	849,542
Exercise of stock options		343		3		8,206			—			—			—			—		8,209
Tax benefit from exercised stock options		—		—		2,487			—			—			—			—		2,487
Amortization of unearned compensation		—		—		—			—			568			—			—		568
Forfeitures of stock options assumed in HNC acquisition		—		—		(22	)		—			22			—			—		—
Issuance of ESPP shares from treasury		83		1		11			3,461			—			—			—		3,473
Dividends paid		—		—		—			—			—			(935	)		—		(935	)
Net income		—		—		—			—			—			28,761			—		28,761		$	28,761
Unrealized gains on investments		—		—		—			—			—			—			2,789		2,789			2,789
Cumulative translation adjustments		—		—		—			—			—			—			401		401			401

Balance at December 31, 2003		47,004	$	470	$	1,030,529		$	(483,016	)	$	(3,120	)	$	347,167		$	3,265	$	895,295		$	31,951

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


				Quarter Ended
				December 31,

				2003			2002

Cash flows from operating activities:
Net income				$	28,761		$	19,789
Adjustments to reconcile net income to net cash provided by operating activities:
	Depreciation and amortization				11,307			11,645
	Share of equity in earnings of investment				(17	)		(32	)
	Gain on sales of marketable securities				(125	)		(626	)
	Amortization of unearned compensation				568			810
	Tax benefit from exercised stock options				2,487			4,399
	Net amortization of premium (discount) on marketable securities				86			(149	)
	Provision for doubtful accounts				241			975
	Amortization of discount on convertible subordinated notes				376			352
	Net loss on sales of property and equipment				58			—
	Changes in operating assets and liabilities, net of acquisition effects:
		Receivables			8,995			9,379
		Prepaid expenses and other assets			570			361
		Accounts payable			(2,551	)		2,583
		Accrued compensation and employee benefits			(3,766	)		(3,180	)
		Accrued and other liabilities			14,736			3,238
		Deferred revenue			6,001			3,106

			Net cash provided by operating activities		67,727			52,650

Cash flows from investing activities:
Purchases of property and equipment					(4,320	)		(2,691	)
Cash proceeds from sale of product line					—			3,000
Collections of notes receivable from sale of product lines					1,700			—
Cash paid in acquisitions					(5,000	)		(2,250	)
Purchases of marketable securities					(266,416	)		(108,995	)
Proceeds from sales of marketable securities					69,611			64,566
Proceeds from maturities of marketable securities					74,019			18,545

			Net cash used in investing activities		(130,406	)		(27,825	)

Cash flows from financing activities:
Proceeds from issuances of common stock under employee stock option and purchase plans					11,682			15,197
Dividends paid					(935	)		(1,011	)
Repurchases of common stock					—			(76,036	)

			Net cash provided by (used in) financing activities		10,747			(61,850	)

Decrease in cash and cash equivalents					(51,932	)		(37,025	)
Cash and cash equivalents, beginning of period					249,458			96,834

Cash and cash equivalents, end of period				$	197,526		$	59,809

Supplemental disclosures of cash flow information:
Cash paid for income taxes, net of refunds				$	3,412		$	364

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

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

In these condensed consolidated financial statements, Fair Isaac Corporation is referred to as “we,” “us,” “our,” and “Fair Isaac.” HNC Software Inc., which we acquired in August 2002, is referred to as “HNC.”

We have prepared the accompanying unaudited interim condensed consolidated financial statements in accordance with the instructions to Form 10-Q. Consequently, we have not necessarily included in this Form 10-Q all information and footnotes required for audited financial statements. In our opinion, the accompanying unaudited interim condensed consolidated financial statements in this Form 10-Q reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of our financial position and results of operations. These unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with our audited consolidated financial statements and notes thereto presented in our Annual Report on Form 10-K for the fiscal year ended September 30, 2003. The interim financial information contained in this report is not necessarily indicative of the results to be expected for any other interim period or for the entire fiscal year.

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

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

We measure compensation expense for our employee stock-based compensation awards using the intrinsic value method and provide pro forma disclosures of net income and earnings per share as if a fair value method had been applied. Therefore, compensation cost for fixed employee stock awards is measured as the excess, if any, of the fair value of our common stock at the grant date over the amount an employee must pay to acquire the stock and is amortized over the related service periods using the straight-line method. Compensation cost for variable employee stock awards is measured as the excess, if any, of the fair value of our common stock at the end of the reporting period over the amount an employee must pay to acquire the stock, and the compensation cost is amortized over the related service periods for each vesting date using the straight-line method. Compensation expense previously recorded for vested variable awards is reversed when the measurement of compensation cost decreases from prior measurements. Compensation expense previously recorded for unvested employee stock-based compensation awards that are forfeited upon employee termination is reversed in the period of forfeiture.

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

The following table compares net income and earnings per share as reported to the pro forma amounts that would be reported had compensation expense been recognized for our stock-based compensation plans on a fair value basis for the quarters ended December 31, 2003 and 2002:


		Quarter Ended
		December 31,

		2003			2002

		(In thousands, except per
		share data)
Net income, as reported		$	28,761		$	19,789
Add: Stock-based employee compensation expense included in reported net income, net of tax			353			498
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax			(5,319	)		(4,154	)

Pro forma net income		$	23,795		$	16,133

Earnings per share, as reported:
	Basic	$	0.62		$	0.39

	Diluted	$	0.59		$	0.38

Pro forma earnings per share:
	Basic	$	0.51		$	0.32

	Diluted	$	0.49		$	0.31

On October 1, 2003, we acquired substantially all of the assets of Seurat Company (“Seurat”) for cash consideration of $5.0 million. Seurat is a provider of solutions and services that help companies target, acquire and retain customers through creative marketing strategies. We accounted for this transaction using the purchase method of accounting. The results of operations of Seurat have been included in the accompanying condensed consolidated statements of income beginning on October 1, 2003. Our allocation of the purchase price, including $0.1 million in acquisition costs, was as follows: (i) $3.6 million was allocated to net tangible assets, consisting principally of receivables and property and equipment, (ii) $1.4 million was allocated to intangible assets, consisting of acquired customer contracts and relationships, and (iii) $0.1 million was allocated to goodwill. The acquired intangible assets have an estimated useful life of five years and are being amortized over this period using the straight-line method. The goodwill was allocated entirely to our Strategy Machine Solutions operating segment, all of which is deductible for tax purposes.

As of September 30, 2003, we held an approximate 6.0% ownership interest in Open Solutions, Inc. (“OSI”), a developer of client/server core data processing solutions for community banks and credit unions, that was accounted for using the cost method. The OSI investment was recorded by us at its estimated fair value of $7.5 million in connection with the HNC acquisition, and was included in other investments as of September 30, 2003. In November 2003, OSI completed an initial public offering of its stock. In connection therewith, we reclassified our investment in OSI to marketable securities available for sale, current portion, based on our holding intent. As of December 31, 2003, our investment in OSI was recorded at its fair value of $12.2 million, which includes an unrealized gain of $4.7 million ($2.9 million net of tax) that is included in accumulated other comprehensive income within stockholders’ equity.

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

Amortization expense associated with our intangible assets, which has been reflected as a separate operating expense caption within the accompanying condensed consolidated statements of income, consisted of the following during the quarters ended December 31, 2003 and 2002:

Cost of revenues reflects our amortization of completed technology, and selling, general and administrative expenses reflect our amortization of other intangible assets. Intangible assets were $91.2 million and $93.9 million, net of accumulated amortization of $20.1 million and $16.1 million, as of December 31, 2003 and September 30, 2003, respectively.

The following table summarizes activity for the quarter ended December 31, 2003, related to restructuring accruals previously recorded in connection with the HNC acquisition, of which $0.9 million and $0.9 million is recorded in other accrued current liabilities as of December 31, 2003 and September 30, 2003, respectively, and $1.1 million and $1.3 million is recorded in other long-term liabilities as of December 31, 2003 and September 30, 2003, respectively, within the accompanying condensed consolidated balance sheets:

During the quarter ended December 31, 2002, we incurred merger-related expenses totaling $2.0 million, consisting primarily of retention bonuses.

The following reconciles the numerators and denominators of basic and diluted earnings per share (“EPS”) for the quarters ended December 31, 2003 and 2002:

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

The computation of diluted EPS for the quarters ended December 31, 2003 and 2002 excludes options to purchase approximately 405,000 and 2,733,000 shares of common stock, respectively, because the options’ exercise prices exceeded the average market price of our common stock in these periods and their inclusion would be antidilutive. The computation of diluted EPS for the quarters ended December 31, 2003 and 2002 also exclude approximately 2,703,000 shares of common stock issuable upon conversion of our 5.25% Convertible Subordinated Notes (the “Subordinated Notes”), as the inclusion of such shares would have been antidilutive for this period. The computation of diluted EPS for the quarter ended December 31, 2003 also excludes approximately 6,067,000 shares of common stock issuable upon conversion of our 1.5% Senior Convertible Notes (the “Senior Notes”), as the conditions for conversion had not been satisfied as of December 31, 2003. 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 five 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.

In November 2003, our Board of Directors approved the adoption of the 2003 Employment Inducement Award Plan (the “Plan”). The Plan reserves 1,500,000 shares of common stock solely for the granting of inducement stock options and other awards, as defined, and meets the “employment inducement award” provisions of the New York Stock Exchange’s recently adopted listing standards regarding shareholder approval of equity-based inducement incentive plans. Except for the employment inducement award criteria, awards under this plan will be generally consistent with those made under our other existing stock option plan.

In connection with our acquisition of Seurat during the quarter ended December 31, 2003, variable awards for 169,500 shares with a modified exercise price of $53.25 (original exercise price of $59.20) were granted to Seurat employees under the Plan. No compensation cost was recognized during the quarter as the quarter end stock price did not exceed this exercise price.

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

•

Strategy Machine Solutions. These solutions are industry-tailored applications designed for specific processes such as marketing, account origination, customer account management, fraud and medical bill review, as well as consumer solutions through our myFICO service.

•

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.

•

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.

Our Chief Executive Officer evaluates segment financial performance based on segment revenues and operating income. Segment operating expenses consist of direct and indirect costs principally related to personnel, facilities, consulting, travel, depreciation and amortization. Indirect costs are allocated to the segments generally based on relative segment revenues, fixed rates established by management based upon estimated expense contribution levels and other assumptions that management considers reasonable. Our

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

Chief Executive Officer does not evaluate the financial performance of each segment based on its respective assets or capital expenditures; rather, depreciation and amortization amounts are allocated to the segments from their internal cost centers as described above.

The following tables summarize segment information for the quarters ended December 31, 2003 and 2002:


		Quarter Ended December 31, 2003

		Strategy									Analytic
		Machine			Scoring			Professional			Software
		Solutions			Solutions			Services			Tools			Total

								(In thousands)
Revenues		$	103,261		$	35,307		$	22,492		$	8,281		$	169,341
Operating expenses			(78,990	)		(16,073	)		(20,119	)		(6,581	)		(121,763	)

	Segment operating income	$	24,271		$	19,234		$	2,373		$	1,700			47,578

Unallocated interest expense															(4,378	)
Unallocated interest and other income, net															3,003

Income before income taxes														$	46,203

Depreciation and amortization		$	6,453		$	2,880		$	1,623		$	351		$	11,307


		Quarter Ended December 31, 2002

		Strategy									Analytic
		Machine			Scoring			Professional			Software
		Solutions			Solutions			Services			Tools			Total

								(In thousands)
Revenues		$	85,367		$	34,168		$	20,265		$	6,932		$	146,732
Operating expenses			(71,910	)		(15,440	)		(19,785	)		(6,211	)		(113,346	)

	Segment operating income	$	13,457		$	18,728		$	480		$	721			33,386

Unallocated restructuring and merger-related															(2,010	)

Operating income															31,376
Unallocated interest expense															(2,322	)
Unallocated interest and other income, net															3,124

Income before income taxes														$	32,178

Depreciation and amortization		$	6,640		$	3,102		$	1,522		$	381		$	11,645

During the quarters ended December 31, 2003 and 2002, we recorded revenues in the amount of $1.1 million and $0.2 million, respectively, related to sales of products through Informa GmbH (“Informa”), an equity method investee in which we own a 33.3% interest, and had receivables from Informa in the amount of $1.1 million and $0.1 million as of December 31, 2003 and September 30, 2003, respectively.

We are in a dispute with a customer regarding the amount owed in connection with the sale of several of our products. We also have had claims asserted by former employees relating to compensation and other employment matters. As to these matters, the amount or range of any potential liability cannot be determined with certainty.

We are involved in various other claims and legal actions arising in the ordinary course of business. We believe that these claims and actions will not result in a material adverse impact to our results of operations, liquidity or financial condition. However, the amount of the liabilities associated with these claims and actions, if any, cannot be determined with certainty.

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

On February 2, 2004, our Board of Directors declared a three-for-two stock split in the form of a 50% stock dividend on our common stock, payable on March 10, 2004 to shareholders of record on February 18, 2004. We will pay cash in lieu of fractional shares. The share and per share amounts within the accompanying condensed consolidated financial statements and notes have not been adjusted to reflect this pending stock split.

On February 2, 2004, our Board of Directors declared a two cents per share quarterly cash dividend, payable on March 10, 2004 to shareholders of record on a pre-split basis on February 18, 2004.

On February 2, 2004, our shareholders ratified an amendment to our Restated Certificate of Incorporation to increase the total authorized shares of common stock from 100,000,000 to 200,000,000, which has been reflected in the accompanying condensed consolidated balance sheets.

During the period January 1, 2004 through February 12, 2004, we repurchased 375,000 shares of our common stock for an aggregate cost of $23.1 million. The shares were repurchased pursuant to a program approved by our Board of Directors in the prior fiscal year that allowed us to repurchase up to 1,500,000 shares of our common stock.

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

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 Management’s Discussion and Analysis of Financial Condition and Results of Operations-Risk Factors, below. The performance of our business and our securities may be adversely affected by these factors and by other factors common to other businesses and investments, or to the general economy. Forward-looking statements are qualified by some or all of these risk factors. Therefore, you should consider these risk factors with caution and form your own critical and independent conclusions about the likely effect of these risk factors on our future performance. Such forward-looking statements speak only as of the date on which statements are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events or circumstances. Readers should carefully review the disclosures and the risk factors described in this and other documents we file from time to time with the SEC, including our reports on Forms 10-K, 10-Q and 8-K to be filed by Fair Isaac in fiscal year 2004.

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”) is 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 quarter ended December 31, 2003, 79% 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 or unit based software license fees, annual license fees under long-term software license arrangements, transactional fees derived under scoring, network service or internal hosted software arrangements, and annual software maintenance fees. The recurrence of these revenues is, to a significant degree, dependent upon our clients’ continued usage of our products and services in their business activities. The more significant activities underlying the use of our products in these areas include: credit and debit card usage or active account levels; lending acquisition, origination and account management activity; workers’ compensation and automobile medical injury insurance claims; and wireless and wireline calls and subscriber levels. Approximately 82% and 83% of our revenues during the quarters ended December 31, 2003 and 2002, respectively, were derived from arrangements with transactional or unit based pricing. We also derive revenues from other sources which generally do not recur and include, but are not limited to, perpetual or time-based licenses with upfront payment terms, non-recurring professional service arrangements and gain-share arrangements where revenue is derived based

on percentages of client revenue growth or cost reductions attributable to our products.

Within the consumer credit and financial services sectors there has recently been a sizable amount of industry consolidation, some of which remains pending. Several of our customers have announced consolidation plans in recent months. Consolidation among our customers can create opportunities for us to broaden our existing relationships with these customers. In addition, due to the long-term obligations we typically have with our customers, we do not expect significant near term effects on our revenues from consolidation. While consolidation events could cause future revenues to decline, on balance we view current consolidation in our customer base as unlikely to have a material effect on our near term future results.

One measure used by management as an indicator of our business performance is the volume of new bookings achieved. We define a “new booking” as estimated future contractual revenues, including agreements with perpetual, multi-year and annual terms. New bookings values may include: (i) estimates of variable fee components such as hours to be incurred under new professional services arrangements and customer account or transaction activity for agreements with transactional-based fee arrangements, (ii) additional or expanded business from renewals of contracts, and (iii) to a lesser extent, previous customers that have attrited and been re-sold only as a result of a significant sales effort. In the quarter ended December 31, 2003 we achieved new bookings of $135.1 million, including 25 deals with bookings values over $1.0 million and eight deals with bookings values over $3.0 million, compared to new bookings in the quarter ended December 31, 2002 of $102.8 million, including 15 deals with bookings values over $1.0 million and nine deals with bookings values over $3.0 million.

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

Our revenues derived from clients outside the United States have been growing more rapidly than our revenues from domestic clients. International revenues totaled $37.4 million and $24.9 million during the quarters ended December 31, 2003 and 2002, respectively, representing 22% and 17% of total consolidated revenues in each of these periods. We believe this international growth is a product of successful relationships with third parties that assist in international sales efforts and our own increased sales focus internationally, and we expect that the percentage of our revenues from international clients will continue to increase.

We acquired Spectrum Managed Care, Inc. (“Spectrum”) in December 2002, NAREX Inc. (“NAREX”) in July 2003, Diversified HealthCare Services, Inc. (“Diversified HealthCare Services”) in September 2003, and Seurat Company (“Seurat”) in October 2003. Results of operations from these acquisitions are included prospectively from the date of acquisition. As a result of these acquisitions, our financial results during the quarter ended December 31, 2003, are not directly comparable to those during the quarter ended December 31, 2002 or other quarters prior to any of these acquisitions.

Our reportable segments are: Strategy Machine Solutions, Scoring Solutions, Professional Services and Analytic Software Tools. Although we sell solutions and services into a larger number of end user product and industry markets, our reportable business segments reflect the primary method in which management organizes and evaluates internal financial information to make operating decisions and assess performance. Comparative segment revenues, operating income, and related financial information for the quarters ended December 31, 2003 and 2002 are set forth in Note 8 to the accompanying condensed consolidated financial statements.

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





	Quarter Ended December 31,				Percentage of Revenues Quarter Ended December 31,								Period-to-Period
Segment	2003		2002		2003			2002			Period-to-Period Change		Percentage Change

Strategy Machine Solutions	$	103,261	$	85,367		61	%		58	%	$	17,894		21	%
Scoring Solutions		35,307		34,168		21	%		23	%		1,139		3	%
Professional Services		22,492		20,265		13	%		14	%		2,227		11	%
Analytic Software Tools		8,281		6,932		5	%		5	%		1,349		19	%

Total revenues	$	169,341	$	146,732		100	%		100	%		22,609		15	%

The increase in total revenues from the quarter ended December 31, 2002 to the quarter ended December 31, 2003 included a $10.2 million increase in revenues that resulted from our four acquisitions in fiscal 2003 and 2004.

Strategy Machine Solutions segment revenues increased primarily due to a $6.3 million increase in revenues from our account management solutions, a $4.1 million increase in revenues from our insurance and healthcare solutions, a $2.4 million increase in

revenues from our fraud solutions, a $1.9 million increase in revenues from our marketing solutions, a $1.4 million increase in revenues from our strategy science solutions and a $1.8 million increase in revenues from our other strategy machine solutions. The increase in account management solutions revenues was attributable primarily to increases in both international perpetual license sales and transactional volumes under transactional-based agreements, including transactional-based revenues derived from our Narex acquisition in July 2003. The increase in insurance and healthcare solutions revenues was attributable primarily to an increase in customer medical bill review volumes resulting from our Diversified and Spectrum acquisitions in September 2003 and December 2002, respectively, partially offset by a decline in bill review volumes associated with our existing customer base, including that related to the loss of a significant customer, as well as lower claims volumes at some of our key customers. The increase in fraud solutions revenues was attributable primarily to an increase in active accounts and merchant transaction volumes, principally due to growth in our customer base, and to the cross-selling of additional fraud products to our existing customer base. The increase in marketing solutions revenues was attributable primarily to an increase in customer transaction volumes resulting from our Seurat acquisition in October 2003, partially offset by a decrease in service revenues from our existing customer base. The increase in strategy science solutions revenues was attributable primarily 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.

Scoring Solutions segment revenues increased primarily due to an increase in revenues derived from risk scoring services at the credit reporting agencies, resulting principally from increased sales of scores for account review and prescreening activities. During the quarters ended December 31, 2003 and 2002, revenues generated from our agreements with Equifax, TransUnion and Experian, collectively accounted for approximately 19% and 20%, respectively, of our total company revenues, including revenues from these customers that are recorded in our other segments.

Professional Services segment revenues increased primarily due to an increase in model development and business consulting revenues, including revenues derived from our Seurat acquisition in October 2003, partially offset by a decline in software implementation revenues due to a lower number of implementation projects in the current quarter.

Analytic Software Tools segment revenues increased primarily due to an increase in sales of perpetual licenses for our analytic model development software products.

The following table sets forth certain summary information related to our operating expenses and other income (expense) for the fiscal periods indicated.


			Quarter Ended December 31,						Percentage of Revenues Quarter Ended December 31,									Period-to-Period
			2003			2002			2003			2002			Period-to-Period Change			Percentage Change

Revenues			$	169,341		$	146,732			100	%		100	%	$	22,609			15	%

Operating expenses:
	Cost of revenues			59,535			60,654			35	%		41	%		(1,119	)		(2	)%
	Research and development			16,401			17,247			10	%		12	%		(846	)		(5	)%
	Selling, general and administrative			41,760			32,183			25	%		22	%		9,577			30	%
	Amortization of intangible assets			4,067			3,262			2	%		2	%		805			25	%
	Restructuring and merger-related			—			2,010			—			2	%		(2,010	)		(100	)%

		Total operating expenses		121,763			115,356			72	%		79	%		6,407			6	%

Operating income				47,578			31,376			28	%		21	%		16,202			52	%
Interest income				2,445			2,596			2	%		2	%		(151	)		(6	)%
Interest expense				(4,378	)		(2,322	)		(3	)%		(1	)%		2,056			89	%
Other income, net				558			528			—			—			—			—

Income before income taxes				46,203			32,178			27	%		22	%		14,025			44	%
Provision for income taxes				17,442			12,389			10	%		8	%		5,053			41	%

Net income			$	28,761		$	19,789			17	%		14	%		8,972			45	%


Number of employees				2,371			2,288									83			4	%

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

The decrease in cost of revenues was attributable primarily to a $2.6 million reduction in personnel costs, partially offset by a $1.4 million increase in third-party software and data costs and a $0.1 million net increase in various other expenditures. The reduction in personnel costs resulted primarily from our transfer of key management personnel into sales strategy and execution roles from their previous operational roles at the beginning of the first quarter of fiscal 2004, partially offset by an increase in personnel costs resulting from our fiscal 2003 and 2004 acquisitions. The increase in third-party software and data costs was attributable primarily to an increase in revenues, including those resulting from our fiscal 2003 and 2004 acquisitions. In future periods, we expect that cost of revenues as a percentage of revenues will be consistent with the first quarter of fiscal 2004 to slightly lower.

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 decrease in research and development expenses was attributable primarily to a reduction in research and development personnel and related costs, primarily related to Strategy Machine Solutions development projects. We anticipate that research and development expenditures in future periods, as a percentage of revenue, will be consistent with the first quarter of fiscal 2004 to slightly lower.

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 increase in selling, general and administrative expenses was attributably primarily to a $6.6 million increase in personnel costs, a $2.2 million increase in legal and accounting professional fees and a $1.3 million increase in advertising expenditures, partially offset by a $0.5 million net decrease in various other expenditures. The increase in personnel costs resulted primarily from our transfer of key management personnel into sales strategy and execution roles from their previous operational roles at the beginning of the first fiscal quarter of 2004, and to a lesser degree an increase in personnel resulting from our fiscal 2003 and 2004 acquisitions. In future periods, we expect that selling, general and administrative expenses as a percentage of revenues will decrease slightly from the first quarter of fiscal 2004.

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. The increase in amortization expense is attributable primarily to the full quarter of amortization of intangible assets recorded in connection with our acquisition of Spectrum in December 2002, NAREX in July 2003, Diversified HealthCare Services in September 2003, and Seurat in October 2003.

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.

Related to our acquisition of HNC Software Inc. (“HNC”) in fiscal 2002, we incurred merger-related expenses totaling $2.0 million during the quarter ended December 31, 2002, consisting primarily of retention bonuses.

Interest income is derived primarily from the investment of funds in excess of our immediate operating requirements. The decrease in interest income was attributable primarily to lower interest and investment income yields due to market conditions.

In August 2003, we issued $400.0 million of 1.5% Senior Notes that mature in August 2023. Interest expense on the Senior Notes recorded by us, including amortization of debt issuance costs, totaled $2.0 million during the quarter ended December 31, 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% 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 $2.4 million and $2.3 million during the quarters ended December 31, 2003 and 2002, respectively.

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

Our effective tax rate was 37.75% and 38.5% during the quarters ended December 31, 2003 and 2002, respectively. The current

quarter decrease was principally due to the increased availability of research and development tax credits. The provision for income taxes during interim quarterly reporting periods is based on our estimates of the effective tax rates for the respective full fiscal year.

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


		Quarter Ended December 31,					Period-to-Period			Period-to-Period Percentage
Segment		2003		2002			Change			Change

Strategy Machine Solutions		$	24,271	$	13,457		$	10,814			80	%
Scoring Solutions			19,234		18,728			506			3	%
Professional Services			2,373		480			1,893			394	%
Analytic Software Tools			1,700		721			979			136	%

	Segment operating income		47,578		33,386			14,192			43	%
Unallocated restructuring and merger-related			—		(2,010	)		(2,010	)		(100	)%

Operating income		$	47,578	$	31,376			16,202			52	%

The increase in operating income was attributable primarily to an increase in segment revenues, which included a $10.2 million increase in revenues that resulted from our four acquisitions in fiscal 2003 and 2004, and a $2.0 million decrease in merger-related expenses that did not recur in the current year. At the segment level, the increase in operating income was attributable primarily to $10.8 million, $1.9 million and $1.0 million increases in segment operating income within our Strategy Machine Solutions, Professional Services and Analytic Software Tools segments, 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 management’s cost control efforts, acquisition-related efficiencies resulting from the integration of the four acquisitions consummated in fiscal 2003 and the first quarter of fiscal 2004 and a mix of relatively higher margin product revenues. The increase in Professional Services segment operating income was primarily due to an increase in higher margin model development and business consulting revenues, including revenues derived from our Seurat acquisition in October 2003, partially offset by a decline in software implementation revenues due to a lower number of implementation projects in the first quarter of fiscal 2004. The increase in Analytic Software Tools segment operating income was driven primarily by an increase in the sale of higher margin perpetual licenses related to our analytic model development software products.

We recorded stock-based compensation expense of $0.6 million and $0.8 million during the quarters ended December 31, 2003 and 2002, respectively. This expense is recorded in cost of revenues, research and development, and selling, general and administrative expense. The quarter over quarter decrease is primarily due to a decrease in 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 resulting from forfeitures. This deferred compensation is being amortized on a straight-line basis over the vesting period of the options.

Our working capital at December 31, 2003 and September 30, 2003 totaled $555.9 million and $569.5 million, respectively. The decrease in working capital during the quarter ended December 31, 2003 is attributable to a $15.3 million increase in other accrued liabilities, a $6.1 million increase in deferred revenue, a $6.6 million decrease in net receivables, a $1.6 million decrease in deferred income taxes, and a $0.7 million decrease in prepaid expenses and other current assets, offset by a $10.5 million increase in cash and cash equivalents and short-term marketable securities, a $3.8 million decrease in accrued compensation and employee benefits, and a $2.2 million decrease in accounts payable.

The increase in other accrued liabilities was attributable primarily to an increase in income taxes payable and an increase in accrued interest payable on our Senior and Subordinated Notes due to timing of interest payments, partially offset by a reduction in HNC merger-related accruals. The increase in deferred revenue was attributable primarily to an increase in customer prepayments. The decrease in net receivables was attributable primarily to increased customer collections, partially offset by an increase resulting

from the increase in revenues during the quarter ended December 31, 2003 as compared to the preceding quarter ended September 30, 2003. The increase in cash and cash equivalents and short-term marketable securities was attributable primarily to net cash provided by operations and other financing activities, partially offset by the use of cash for investing activities, as described below. The decrease in accrued compensation and employee benefits was attributable primarily to a decrease in accrued salaries due to the timing of payroll disbursements and a decrease in accrued employee stock purchase plan withholdings, partially offset by an increase in accrued incentive compensation. The decrease in accounts payable was attributable primarily to the timing of vendor disbursements.

Our primary method for funding operations and growth has been through cash flows generated from operations. Net cash provided by operating activities increased from $52.7 million during the quarter ended December 31, 2002 to $67.7 million during the quarter ended December 31, 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 used in investing activities totaled $130.4 million for the quarter ended December 31, 2003, compared to net cash used in investing activities of $27.8 million for the quarter ended December 31, 2002. The increase in net cash used in investing activities during the quarter ended December 31, 2003 as compared to the quarter ended December 31, 2002 is attributable primarily to a $96.9 million increase in purchases of marketable securities, net of sales and maturities, a $2.8 million increase in cash and cash equivalents paid in acquisitions due to the current quarter acquisition of Seurat, a $3.0 million decrease in cash proceeds from the sale of a product line as no product line sales occurred during the quarter ended December 31, 2003 as compared to the quarter ended December 31, 2002, a $1.6 million increase in property and equipment purchases, partially offset by repayments of $1.7 million on notes receivable resulting from fiscal 2003 product line sales.

Net cash provided by financing activities totaled $10.7 million during the quarter ended December 31, 2003, compared to net cash used in financing activities of $61.9 million during the quarter ended December 31, 2002. The increase in net cash provided by financing activities during the quarter ended December 31, 2003 as compared to the quarter ended December 31, 2002 is attributable primarily to Fair Isaac not repurchasing any of its common stock during the quarter ended December 31, 2003 as compared to $76.0 million expended for repurchases of common stock during the quarter ended December 31, 2002, a $0.1 million decrease in dividends paid due to a lower amount of common shares outstanding quarter over quarter, partially offset by a $3.5 million decrease in proceeds from issuances of common stock quarter over quarter.

From time to time, we repurchase our common stock in the open market pursuant to programs approved by our Board of Directors. During the quarter ended December 31, 2002, we expended $76.0 million 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. During the period January 1, 2004 through February 12, 2004, we repurchased 375,000 shares of our common stock for an aggregate cost of $23.1 million under this program.

We paid quarterly dividends of two cents per share during the quarters ended December 31, 2003 and 2002. 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.

We are the issuer of $400.0 million of the Senior Notes that mature on August 15, 2023. 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 five 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.

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 that mature on September 1, 2008. The Subordinated Notes are convertible into shares of Fair Isaac common stock at a conversion price of $55.49 per share, subject to anti-dilution adjustment. The conversion price is equivalent to a conversion rate of approximately 18.02 shares of Fair Isaac common stock per $1,000 principal amount of the Subordinated Notes. 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. Holders may require us to repurchase for cash all or part of their Subordinated Notes upon a change in control at a price equal to 100% of the principal amount of the Subordinated Notes being repurchased, plus accrued and unpaid interest up to the purchase date.

We may redeem for cash all or part of the Subordinated Notes at any time before September 5, 2004, at a redemption price equal to the principal amount of each Subordinated Note, only if: (i) the closing price of Fair Isaac common stock has exceeded 150% of the conversion price then in effect for at least 20 trading days within a period of any 30 consecutive trading days ending on the trading day before we mail a provisional redemption notice, and (ii) the shelf registration statement covering resales of the Subordinated Notes and the Fair Isaac common stock issuable upon conversion of the Subordinated Notes is effective, available for use, and expected to remain so for 30 days, unless registration is no longer required. Upon such provisional redemption, we will pay, in cash or Fair Isaac common stock or both, the aggregate interest payable on the Subordinated Notes through September 1, 2004. We may redeem for cash all or part of the Subordinated Notes on or after September 5, 2004, at the following redemption prices expressed as percentages of the principal amount, plus accrued and unpaid interest up to the redemption date:

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 December 31, 2003, no borrowings were outstanding under this agreement and we were in compliance with all related covenants. As of December 31, 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 December 31, 2003, this credit facility also served to collateralize contracts to sell certain currencies aggregating $11.2 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. We do not believe that the covenants of this credit facility materially restrict our future liquidity or operations.

As of December 31, 2003, we had $743.9 million in cash, cash equivalents and marketable security investments. We believe that these balances, including interest to be earned thereon, and anticipated cash flows from operating activities will be sufficient to fund our working and other capital requirements over the course of the next twelve months and for the foreseeable future. In the normal course of business, we evaluate the merits of acquiring technology or businesses, or establishing strategic relationships with or investing in these businesses. We may elect to use available cash and cash equivalents and marketable security investments to fund such activities in the future. In the event additional needs for cash arise, we may raise additional funds from a combination of sources including the potential issuance of debt or equity securities. Additional financing might not be available on terms favorable to us, or at all, particularly in light of the current decline in the capital markets. If adequate funds were not available or were not available on acceptable terms, our ability to take advantage of unanticipated opportunities or respond to competitive pressures could be limited.

We 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. It is possible that additional capital calls may require us to invest some or all of our remaining commitment during fiscal 2004.

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.

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 the basis for making judgments about the carrying value of certain assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

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

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

When software licenses are sold together with implementation or consulting services, license fees are recognized upon delivery

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

If at the outset of an arrangement we determine that the arrangement fee is not fixed or determinable, revenue is deferred until the arrangement fee becomes due. If at the outset of an arrangement we determine that collectibility is not probable, revenue is deferred until the earlier of when collectibility becomes probable or the receipt of payment. If an arrangement provides 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. The determination of certain of our credit scoring and data processing revenues requires the use of estimates, principally related to transaction volumes in instances where these volumes are reported to us by our clients on a monthly or quarterly basis in arrears. In these instances, we estimate transaction volumes based on preliminary customer transaction information, if available, or based on average actual reported volumes for an immediate trailing period. Differences between our estimates and actual final volumes reported are recorded in the period in which actual volumes are reported. We have not experienced significant variances between our estimates and actual reported volumes in the past and anticipate that we will be able to continue to make reasonable estimates in the future. If for some reason we were unable to reasonably estimate transaction volumes in the future, revenue may be deferred until actual customer data was received, and this could have a material impact on our results of operations during the period of time that we changed accounting methods.

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

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

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

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

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

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

We test goodwill for impairment at the reporting unit level at least annually during the fourth quarter of each fiscal year and more frequently if impairment indicators are identified. We have determined that our reporting units are the same as our reportable segments. The first step of the goodwill impairment test is a comparison of the fair value of a reporting unit to its carrying value. We estimate the fair values of our reporting units using discounted cash flow valuation models and by comparing our reporting units to guideline publicly-traded companies. These methods require estimates of our future revenues, profits, capital expenditures, working capital, and other relevant factors, as well as selecting appropriate guideline publicly-traded companies for each reporting unit. We estimate these amounts by evaluating historical trends, current budgets, operating plans, industry data, and other relevant factors. The

estimated fair value of each of our reporting units exceeded its respective carrying value in fiscal 2003, indicating the underlying goodwill of each reporting unit was not impaired as of our most recent testing date. Accordingly, we were not required to complete the second step of the goodwill impairment test. The timing and frequency of our goodwill impairment test is based on an ongoing assessment of events and circumstances that would more than likely reduce the fair value of a reporting unit below its carrying value. We will continue to monitor our goodwill balance and conduct formal tests on at least an annual basis or earlier when impairment indicators are present. There are various assumptions and estimates underlying the determination of an impairment loss, and estimates using different, but each reasonable, assumptions could produce significantly different results. Therefore, the timing and recognition of impairment losses by us in the future, if any, may be highly dependent upon our estimates and assumptions. We believe that the assumptions and estimates utilized were appropriate based on the information available to management.

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, reductions or write-offs of capitalized software development 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. This analysis requires us to estimate future net cash flows associated with the assets, as well as the future costs of selling such assets. If these estimates change, reductions or write-offs of internal-use software costs could result.

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, which requires the use of estimates. If we determine during any period that we could realize a larger net deferred tax asset than the recorded amount, we would adjust the deferred tax asset to increase income for the period. 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. Although we believe that our estimates are reasonable, there is no assurance that our the valuation allowance will not need to be increased to cover additional deferred tax assets that may not be realizable, and such an increase could have a material adverse impact on our income tax provision and results of operations in the period in which such determination is made. In addition, the calculation of tax liabilities also involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with management’s expectations could also have a material impact on our income tax provision and results of operations in the period in which such determination is made.

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. If the potential loss is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. If the potential loss is considered less than probable or the amount cannot be reasonably estimated, disclosure of the matter is considered.

The amount of loss accrual or disclosure, if any, is determined after analysis of each matter, and is subject to adjustment if warranted by new developments or revised strategies. Due to uncertainties related to these matters, accruals or disclosures are based on the best information available at the time. Significant judgment is required in both the assessment of likelihood and in the determination of a range of potential losses. Revisions in the estimates of the potential liabilities could have a material impact on our financial position or results of operations.

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

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

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

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events that reduce the effectiveness of or need for fraud detection capabilities.

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

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 and other parties that distribute our products to certain markets. The loss of any major customer, the loss of a relationship with one of the major credit reporting agencies, the loss of another significant third-party distributor or the delay of significant revenue from these sources, could have a material adverse effect on our revenues and results of operations.

Defects, failures and delays associated with our introduction of new products could seriously harm our business.

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 future revenues may be uncertain because of reliance on third parties for marketing and distribution.

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 offering. For example, credit reporting agencies may evaluate and seek to distribute or acquire alternative vendors’ prepaid products that compete with our products. Competition from existing and future distributors or other sales and marketing partners could significantly harm sales of our products.

Our share price will fluctuate as a result of several factors, including changes in our revenues and operating results.

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:

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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;

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

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

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

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 may not be able to forecast our revenues accurately because our products have a long and variable sales cycle.

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.

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.

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

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 and may become more competitive with general market and economic improvement. 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.

Failure or inability to obtain data from our customers or others could harm our business.

We must develop or obtain a reliable source of sufficient amounts of current and statistically relevant data to analyze transactions and update our products, 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, certain of our insurance solutions products use 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 may incur risks related to acquisitions or significant investment in businesses.

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:

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the possibility that we will pay more than the acquired companies or assets are worth;

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

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the potential product liability associated with the sale of the acquired companies’ products;

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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.

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

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.

We may be subject to possible infringement claims that could harm our business.

With recent developments in the law that permit patenting of business methods, we expect that products in the industry segments in which we compete, including software products, will increasingly be subject to claims of patent infringement as the number of products and competitors in our industry segments grow 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:

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

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

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

Our business requires the appropriate and secure utilization of consumer and other sensitive information. Internet-based, electronic commerce requires the secure transmission of confidential information over public networks and several of our products are accessed through the Internet, including our consumer services accessible through the www.myFICO.com website. Security breaches in connection with the delivery of our products and services, including products and services utilizing the Internet, or well-publicized security breaches 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.

Protection from system interruptions is important to our business, and a sustained interruption of our telecommunication systems could harm our business.

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.

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

We have a significant share of the available market in 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.

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

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

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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

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

New product introductions and pricing strategies by our competitors could decrease our product sales and market share, or could pressure us to reduce our product prices in a manner that reduces our margins.

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

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regional risk management, marketing, systems integration and data warehousing competitors;

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management information system departments of our customers and potential customers, including financial institutions, insurance companies and telecommunications carriers;

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network and telecommunications switch manufacturers, and service providers that seek to enhance their value-added services;

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

Our competitors may be able to sell products competitive to ours at lower prices individually or as part of integrated suites of several related products. This ability may cause our customers to purchase products 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.

Government regulations that apply to us or to our customers may expose us to liability, or render our products obsolete.

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:

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federal and state regulation of consumer report data and consumer reporting agencies, such as the Fair Credit Reporting Act, or FCRA;

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regulation designed to insure that lending practices are fair and non-discriminatory, such as the Equal Credit Opportunity Act, or ECOA;

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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;

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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;

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

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consumer protection laws, such as federal and state statutes governing the use of the Internet and telemarketing; and

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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, recent amendments to the FCRA will result in new regulation. These regulations or the interpretation of these amendments could affect the demand for or profitability of some of our products, including scoring and consumer products. State regulation could cause financial institutions to pursue new strategies, reducing the demand for our products. In addition, legislative reforms of workers’ compensation laws that aim to simplify this area of regulation and curb abuses could diminish the need for, and the benefits provided by, certain of our insurance solutions products and services.

Since our revenues depend, to a great extent, upon conditions in the consumer credit, financial services and insurance industries, an industry specific downturn may harm our business, financial condition or results of operations.

During the quarter ended December 31, 2003, 79% of our revenues were derived from sales of products and services to the consumer credit, financial services and insurance industries. A downturn in the consumer credit, the financial services or the insurance industry, including a downturn caused by increases in interest rates or a tightening of credit, among other factors, could harm our business, financial condition or results of operations. Since 1990, while the rate of account growth in the U.S. bankcard industry has been slowing and many of our large institutional customers have merged and consolidated, we have generated most of our revenue growth from our bankcard-related scoring and account management businesses by selling and cross-selling our products and services to large banks and other credit issuers. As this industry continues to consolidate, we may have fewer opportunities for revenue growth due to changing demand for our products and services that support customer acquisition programs of our customers. In addition, industry consolidation could affect the base of recurring revenues derived from contracts in which we are paid on a per-transaction basis if consolidated customers combine their operations under one contract. We cannot assure you that we will be able effectively to promote future revenue growth in our businesses.

General economic conditions and world events may affect demand for our products and services.

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

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

A growing portion of our revenues is derived from international sales. During the quarter ended December 31, 2003, 22% 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;

•

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

•

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.

We have adopted anti-takeover defenses that could make it difficult for another company to acquire control of Fair Isaac or limit the price investors might be willing to pay for our stock.

Certain provisions of our Restated Certificate of Incorporation, as amended, could make a merger, tender offer or proxy contest involving us difficult, even if such events would be beneficial to the interests of our stockholders. These provisions include 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 may incur significant stock-based compensation charges related to certain employee stock options in future periods, particularly if requirements relating to accounting for employee stock options are changed.

We have certain employee stock options that are subject to variable accounting treatment that require us to remeasure

compensation costs for the options each reporting period based on changes in the market value of our stock. Depending on the movements in the market value of our stock, the variable accounting of those stock options may result in additional non-cash compensation costs in future periods.

In addition, we have not decided to expense stock options generally despite the recent debate regarding the accounting treatment of stock options. If we elected or were required to record an expense for all of 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 determine to avoid a portion of these 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.

Changes in tax laws or adverse outcomes resulting from examination of our income tax returns could adversely affect our results.

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.

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.

We maintain an investment portfolio consisting mainly of income securities with an average maturity of three years or less. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. We have the ability to hold our fixed income investments until maturity, and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio. The following table presents the principal amounts and related weighted-average yields for our investments with interest rate risk at December 31, 2003 and September 30, 2003:


	December 31, 2003							September 30, 2003

	Cost		Carrying		Average			Cost		Carrying		Average
	Basis		Amounts		Yield			Basis		Amounts		Yield

	(In thousands)
Cash and cash equivalents	$	194,246	$	194,245		1.15	%	$	243,368	$	243,358		1.05	%
Short-term investments		305,930		306,200		1.24	%		255,423		255,893		1.50	%
Long-term investments		223,617		223,955		1.81	%		151,201		151,610		1.94	%

	$	723,793	$	724,400		1.39	%	$	649,992	$	650,861		1.43	%

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.

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 December 31, 2003:

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

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

We are subject to various legal proceedings in the ordinary course of business, none of which is required to be disclosed under this Item 1.

Set forth below is information concerning each matter submitted to a vote at the Annual Meeting of Stockholders held on February 2, 2004.

Stockholders elected eight incumbent directors for one-year terms. The vote tabulation for individual directors was:


NOMINEE	FOR		WITHHELD

Mr. A. George Battle		35,704,004		5,117,767
Mr. Tony J. Christianson		35,659,491		5,162,280
Mr. Thomas G. Grudnowski		36,200,244		4,621,527
Mr. Alex W. Hart		24,241,680		16,580,091
Mr. Philip G. Heasley		24,228,899		16,592,872
Mr. Guy R. Henshaw		35,779,628		5,042,143
Mr. David S. P. Hopkins		35,763,481		5,058,290
Ms. Margaret L. Taylor		24,242,958		16,578,813

The stockholders approved the amendment of the Company’s Restated Certificate of Incorporation to increase the number of authorized shares of common stock from 100 million to 200 million (with 34,929,694 votes for, 5,867,159 votes against and 24,918 abstentions). The amendment became effective upon its filing with the state of Delaware, which was accomplished February 4, 2004.

The stockholders ratified the appointment of KPMG LLP as the Company’s independent auditors for the fiscal year ending September 30, 2004 (with 40,056,924 votes for, 746,596 votes against and 18,251 abstentions).


Exhibit
Number		Description

10.1		The Company’s 2003 Employment Inducement Award Plan as adopted on November 16, 2003.
10.2		Employment Agreement entered into effective January 30, 2004, by and between Fair Isaac Corporation and Thomas G. Grudnowski.
31.1		Rule 13a-14(a)/15d-14(a) Certifications of CEO.
31.2		Rule 13a-14(a)/15d-14(a) Certifications of CFO.
32.1		Section 1350 Certification of CEO.
32.2		Section 1350 Certification of CFO.

i. On November 3, 2003, we furnished a Current Report on Form 8-K to the SEC, including the Company’s press release announcing financial results for the quarter and year ended September 30, 2003.

ii. On January 26, 2004, we furnished a Current Report on Form 8-K to the SEC, including the Company’s press release announcing financial results for the quarter ended December 31, 2003.

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

To Fair Isaac Corporation Report On Form 10-Q
For The Quarterly Period Ended December 31, 2003


Exhibit
Number	Description

10.1	The Company’s 2003 Employment Inducement Award Plan as adopted on November 16, 2003.	Filed Electronically
10.2	Employment Agreement entered into effective January 30, 2004, by and between Fair Isaac Corporation and Thomas G. Grudnowski.	Filed Electronically
31.1	Rule 13a-14(a)/15d-14(a) Certifications of CEO	Filed Electronically
31.2	Rule 13a-14(a)/15d-14(a) Certifications of CFO	Filed Electronically
32.1	Section 1350 Certification of CEO	Filed Electronically
32.2	Section 1350 Certification of CFO	Filed Electronically


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


200 Smith Ranch Road		94903
San Rafael, California		(Zip Code)
(Address of principal executive offices)


PART 1 — FINANCIAL INFORMATION
	Item 1. Condensed Consolidated Financial Statements
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
PART II — OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
EXHIBIT INDEX
EXHIBIT 10.1
EXHIBIT 10.2
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2


	Accrual at					Accrual at
	September 30,		Cash			December 31,
	2003		Payments			2003

	(In thousands)
Facilities charges	$	2,208	$	(219	)	$	1,989
Employee separation		5		(5	)		—

	$	2,213	$	(224	)	$	1,989


	Redemption
Period	Price

Beginning on September 5, 2004 through August 31, 2005		102.625	%
Beginning on September 1, 2005 through August 31, 2006		101.750	%
Beginning on September 1, 2006 through August 31, 2007		100.875	%
Beginning on September 1, 2007 and thereafter		100.000	%

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


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]


Fair Isaac Corporation
(Exact name of registrant as specified in its charter)


		Contract Amount

		Foreign				Fair Value
		Currency		US$		US$

		(In thousands)
Sell foreign currency:
	British Pound (GBP)	GBP	4,250	$	7,511	$	7,576
	EURO (EUR)	EUR	1,500		1,872		1,885
	Japanese Yen (YEN)	YEN	195,000		1,819		1,812

				$	11,202	$	11,273


	FAIR ISAAC CORPORATION

DATE: February 6, 2004
	By	/s/ KENNETH J. SAUNDERS

		Kenneth J. Saunders
		Vice President and Chief Financial Officer
		(for Registrant as duly authorized officer and as Principal Financial Officer)

DATE: February 6, 2004
	By	/s/ RUSSELL C. CLARK

		Russell C. Clark
		Vice President, Finance and Corporate Controller
		(Principal Accounting Officer)