Research Associate: Ruchika Banka, M.Fin

December 27, 2007

Research Associate: Ruchika Banka, M.Fin. Editor: Jyoti Lakhotia, M.Fin. Zacks Research Digest Sr. Ed.: Ian Madsen, CFA: [email protected]; 1-800-767-3771 x9417

www.zackspro.com 111 N. Canal Street, Suite1101  Chicago, IL 60606 Cognos Inc. (COGN - NASDAQ) $57.57 Note: This report contains substantially new material. Subsequent reports will have changes highlighted.

Reason for Report: 3Q08 Earnings Results (Prev.: IBM to acquire COGN, November 29)

Brokers’ Recommendations: Positive: 6.7% (1); Neutral: 86.7% (13); Negative: 6.7% (1) Prev. Ed: 5, 19, 1

Brokers’ Target Price: $58.00 ( $2.65 from last edition; 13 firms) Brokers’ Avg. Expected Return: 1.0%

Recent Events – Summary

December 20: Cognos announces 3Q08 financial results ended November 30, 2007.

November 12: IBM and Cognos announce a definitive agreement for IBM to acquire Cognos.

October 25: Cognos completes the acquisition of Applix.

October 03: COGN conducts Analyst Day meeting.

Overview

Key Positive Arguments Key Negative Arguments  COGN product set has evolved into a more  Large well-capitalized competitors like integrated offering and growth in large deals infrastructure vendors MSFT, IBM, ORCL, SAP, reflects customers’ desire to standardize on and SEBL are expanding their product solution by software vendors. integrating greater business intelligence  Cognos 8 will extend business intelligence to functionality, encroaching on COGN’s sector. mobile devices boosting its long-term growth.  Currency fluctuations can have a material impact  The acquisition of Celequest has enhanced the on Cognos's top and bottom lines. position of Cognos within next generation BI  A weaker BI spending environment can lead to technologies and delivery mechanisms. revenue slowdown in the absence of a diversified revenue stream.  The new product introduction from large software vendors and ERP players could lead to pricing pressure for the company.

Headquartered in Ottawa, Canada, Cognos Inc. (COGN) is a global provider of business intelligence (BI) software. The company's solution helps improve business performance by enabling planned performance management, supported by effective decision making at all levels of the organization through consistent reporting and analysis of data derived from various sources. Its integrated solution consists of its suite of BI components, analytical applications, and performance management applications. COGN is the only company to support all of these key management activities with the

© Copyright 2007, Zacks Investment Research. All Rights Reserved. complete solution that spans all of these essential components of CPM – enterprise planning, score carding, and business intelligence. For more information, please visit www.cognos.com.

COGN’s Fiscal Year ends on February 28.

Recent Events – Details

On December 20, 2007, Cognos announced 3Q08 results. According to the company’s press release, revenue and non GAAP EPS came in at $290.0 million and $0.51, respectively. The quarter revenue and non-GAAP EPS results surpassed the Street consensus estimates of $279.1 million and $0.49.

On November 12, 2007, IBM and Cognos announced the two companies have entered into a definitive agreement for IBM to acquire Cognos in an all-cash transaction at a price of approximately $5.0 billion or $58.00 per share, with a net transaction value of $4.9 billion. The acquisition is subject to Cognos shareholder approval, regulatory approvals and other customary closing conditions. It is expected to close in the first quarter of CY08.

On October 25, 2007, Cognos announced the completion of the Applix acquisition. Applix is a publicly- held company based in Westborough, Massachusetts and an industry leader in analytics. All remaining outstanding Applix shares have been converted into the right to receive $17.87 per share in cash. Applix is now an indirect, wholly-owned subsidiary of Cognos. The acquisition of Applix builds on the proven strength of Cognos 8 Planning, Cognos 8 Controller, and Cognos 8 Business Intelligence. Applix extends the Cognos solution to address financial performance analysis and optimization, including new solution areas, such as, profitability, sales mix, and price/volume variance analysis. IDC estimates the worldwide market for packaged applications for Financial Performance and Strategy Management at almost $2.0 billion for calendar 2007.

Revenue

Revenue - FYE Feb 28 3Q08A q/q % Chge y/y % Chge 2007A 2008E 2009E 2009E Product License $108.9 25.2% 15.9% $376.2 $422.3 $475.2 $532.5 Product Support $125.7 9.1% 16.6% $422.5 $483.3 $545.3 $597.4 Services $54.9 9.4% 19.3% $180.6 $205.3 $227.2 $255.0 Total Revenue $288.3 14.2% 16.3% $979.2 $1,105.8 $1,239.5 $1,384.9

3Q08 average revenue as per Zacks Digest was $288.3 million, up 16.3% y/y and 14.2% q/q. License revenue was $108.9 million, up 15.9% y/y and 25.2% q/q. Service revenue was recorded at $54.9 million, up 19.3% y/y and 9.4% q/q while Product Support revenue was $125.7 million, up 16.6% y/y and 9.1% q/q. The results were in line with the Company press release. The results surpassed management’s guidance range of $270.0-$285.0 million and the Street estimate of $279.1 million. Analysts attribute the majority of the revenue upside to Applix.

A pie chart analysis of revenue segments is given below:

Zacks Investment Research Page 2 www.zackspro.com 3Q08A 2008E 2009E 19% 18% 18% 38% 38% 38%

43% Product License 44% Product License 44% Product License Product Support Product Support Product Support Services Services Services

COGN posted 16.0% y/y license growth versus its stated goal of 10.0%. The company is witnessing traction from Cognos 8 (both in BI and Performance Management) and the release of new products that leverage the Cognos 8 platform (including Cognos Go! Search, Cognos Go! Mobile, and Cognos Go! Office). New customer purchases accounted for 26.0% of License revenue, below the 32.0% level recorded in 2Q08.

On a regional basis, revenues overall were higher than expected. America’s revenue came in a little softer than expected, but strong results in Europe made up for the shortfall. America’s revenues of $159.4 million grew 11% y/y. European revenues of $103.3 million grew 9% y/y. Asia/Pac revenues of $25.6 million grew by 9% y/y.

Additional 3Q08 Metrics

After two quarters of declining large deal growth, deals over $1.0 million increased 64.0% over the previous year to 18 deals. Transaction volumes spiked to a five-year high for deals over $50,000. Analysts attribute part of this is probably due to the Applix acquisition with its smaller deal size but increased transaction volumes. Also, Cognos’s sales force could be trying to pull in deals ahead of IBM’s acquisition.

 There were 18 deals greater than $1.0 million versus 11 in 3Q07.  There were 196 deals greater than $200,000 versus 140 in 3Q07.  There were 983 deals greater than $50,000 versus 806 in 3Q07.  The average deal size in the quarter was $205,000 down from $222,000 in 3Q07.

Cognos indicated a continued focus on large accounts by its Global Major Accounts (GMA) team. Management plans to increase the number of GMAs to 170 accounts in FY08 from 120 at the end of FY07.

Expanding Sales Coverage

COGN continued to expand sales coverage and display sales pipeline visibility, hiring 30 quota carrying reps in 3Q08 (up to 441, above management FY08 400 goal). Sales force effectiveness is expected to improve under the current management and current sales force levels may offer 12.0-15.0% additional sales capacity. Management expects total rep count of approximately 450 after the closure of the Applix deal expected in 4Q08.

Outlook

COGN continues to forecast 10.0% growth in Product License for FY08, driven by higher sales head count, stabilization of legacy revenue, and market strength. A strong pipeline (particularly around large deals) and a robust BI demand environment gave management the confidence to increase revenue guidance for FY08 despite a continued drag from adverse currency movement.

Zacks Investment Research Page 3 www.zackspro.com One analyst (MorganStanley) believes that the combined BI/BPM platform directly targets the increasing demand for an integrated solution that is expected in the market, particularly in finance departments. Consequently, the analyst has slightly raised the License estimate by about 1.0% for FY08 from $410.0 million to $415.0 million. However, lower expectations from the professional services business more than offset this increase leading to a decline in FY08 total revenue estimate from $1,083.0 million to $1,078.0 million.

COGN is likely to continue to drive revenue growth through an expanded integrated product portfolio. The company plans on rolling out several products throughout the fiscal year. These products include the Cognos 8 maintenance release 8.3 (which includes Cognos 8 Transform), Cognos 8 Planning 8.2, the Cognos 8 Go! Mobile upgrade, and Cognos 8 BI Analysis for Microsoft Excel. The 8.3 maintenance releases is entering beta testing shortly and will include enhanced enterprise deployment and administration capabilities. This version also includes more flexible information packaging for business users and will include Cognos 8 Transform. Management believes Cognos 8 Transform will help to move the company's significant base of PowerPlay customers into the Cognos 8 environment.

Please refer to the Zacks Research Digest spreadsheet on COGN for detailed sales breakdown and estimates.

Margins

MARGINS – FYE Feb 28 3Q08A q/q Chge y/y Chge 2007A 2008E 2009E 2010E Gross 80.9% 1.7% 2.3% 78.8% 80.5% 80.6% 80.3% Operating 15.5% 1.0% -3.7% 17.9% 17.8% 20.2% 19.8% Pre-tax 16.1% -0.9% -6.0% 20.5% 19.4% 21.4% 20.7% Net 14.9% 1.2% -2.5% 16.3% 16.0% 16.8% 16.4%

Zacks Digest average gross margin in 3Q08 was 80.9%, up 230 basis points y/y and 170 basis points sequentially. Operating margin was 15.5%, down 370 basis points y/y but up 100 basis points sequentially. Net margin was 14.9%, down 250 basis points y/y but up 120 basis points sequentially.

According to the company, the upside in gross margin was driven by better-than-expected services margin, which saw meaningful productivity gains in the consulting business. Management had put a plan in place to improve service margins to the high teens in FY08, thus leading to a sequential improvement.

EBIT in the quarter was $28.5 million. SG&A in the quarter was $162.4 million. The quarter recorded a higher-than-expected operating expense due to the extra cost associated with the IBM transaction, as well as increased head count from the Applix acquisition. The increased hiring efforts likely increased the SG&A expense. R&D in the quarter was $35.3 million. The SG&A expense seemed to be swayed by currency fluctuations while R&D remained unaffected. This may be due to Cognos having more flexibility with expenses in its R&D organization as opposed to its SG&A organization. Cognos management mentioned at the quarterly conference call that longer term it plans to maneuver the cost structure via routing positions to lower-cost areas such as India.

Outlook

Analysts expect operating margin to improve quarter to quarter throughout FY08 as efficiencies are realized in the company’s European operations and investments in 4Q08 subside. Analysts also suggest that Cognos should continue to drive modest new operating leverage in the near term by scaling revenues over some recent investments in SG&A. The analysts believe that Cognos will be in a good position to raise operating margins to the low to mid-20s, up from the high-teens (FY08) level, at revenue levels approaching $1.5 billion. In the near term, SG&A spending is likely to be a key indicator of the competitive pressure faced by the company and also the success by which Cognos can attract more and more help from value-added service partners that focus on verticals and on domain expertise.

Zacks Investment Research Page 4 www.zackspro.com Please refer to the Zacks Research Digest spreadsheet on COGN for more details on margin estimates.

Earnings per Share

Pro Forma EPS – FYE Feb 28 3Q08A 4Q08E 1Q09E 2007A 2008E 2009E 2010E Zacks Consensus $0.76 $0.32 $1.79 $2.14 Company Guidance High Estimate $0.53 $0.88 $0.51 $1.79 $2.11 $2.65 $2.84 Low Estimate $0.51 $0.78 $0.35 $1.76 $2.00 $2.24 $2.84 Digest Average $0.51 $0.83 $0.41 $1.77 $2.05 $2.45 $2.84

*Zacks consensus is GAAP; all other are pro forma estimates. The Zacks Digest average non-GAAP EPS in 3Q08 was $0.51 (in line with the company’s results). The results were on the higher end of management’s guidance range of $0.45-$0.53 and surpassed the Street estimate of $0.49 due to a lower-than-expected tax rate and share count.

GAAP EPS came in at $0.37 (in line with the company’s results), modestly in line with the $0.36-$0.44 guided range and below the Street estimate of $0.41. The decline was likely due to acquisition-related expenses and higher commissions resulting from higher revenues.

The reconciliation between GAAP and non-GAAP EPS is illustrated below:

US GAAP Proforma Net Income (Loss) $31.0 $43.1 Reconciliation: (+) Total stock option expense $12.1 (+) Amortization of intangible assets $3.3 (+) Deferred support revenue written-down $1.7 (-)Tax effect, net ($5.1) $12.1 Net Income after reconciliation $43.1 $43.1 EPS before reconciliation $0.37 $0.51 Reconciliation effect =$12.1/84.692* $0.14

* Diluted shares Outstanding * Figures have been rounded off to the nearest decimal

2008 forecasts (15 analysts) range from $2.00 to $2.11; the average is $2.05. 2009 forecasts (15 analysts) range from $2.24 to $2.65; the average is $2.45. 2010 forecast (1 analyst) is $2.84.

Outlook

Looking ahead, management is expecting an unfavorable currency impact of $0.12 for FY08. The company expects Canadian dollar fluctuations to negatively impact earnings by $0.09 in the remaining two quarters. While management plans to cut costs to offset this currency impact, cutting costs might not help a company’s topline growth. The additional buyback, which was completed in the second quarter of FY07, is accretive by $0.02 to FY08 and $0.04-$0.05 to FY09. The new repurchase program will be about $0.04-$0.05 accretive to the first 12 months. Additionally, the Applix acquisition will contribute about $0.04-$0.05 per share in earnings accretion in FY09.

Although one analyst (Wedbush) believes the APLX acquisition could be accretive by up to $0.07-0.09 in FY09, it has conservatively increased its EPS estimate by only a trivial amount of $0.04 given both integration risk and a potentially deteriorating U.S. economic environment.

Zacks Investment Research Page 5 www.zackspro.com Please refer to the Zacks Research Digest spreadsheet on COGN for more extensive EPS figures.

Target Price/Valuation

The average price target for COGN is $58.00 ( by $2.65 from the previous Zacks Digest report). Most of the analysts have increased their target price to $58.00, the proposed price offered by IBM to the company.

Rating Distribution Positive 6.7% Neutral 86.7% Negative 6.7% Max. Target Price $58.00 Min. Target Price $58.00 Avg. Target Price $58.00 Analysts with Price Target/Total# 13/15

Risks to the target price achievement include volatility in global IT environment, increasing competition from other enterprises, the company’s failure to meet future capital needs in order to support operations, fluctuations in foreign exchange rate and its inability to successfully integrate any current or future acquisition.

Please refer to the Zacks Research Digest spreadsheet on COGN for further details on valuation.

Capital Structure/Cash Flow/Solvency/Governance/Other

Balance sheet

Cash - The company ended the quarter with $167.5 million in cash and equivalents, which is lower than the $439.4 million cash balance the company had at the end of the last quarter. The decline in cash levels was a result of Cognos using approximately $306.0 million of its cash to purchase Applix in 3Q08. Given the fact that the company’s cash balance has been very strong for quite some time, the company has put it to good use in the way of share repurchases as well as acquisitions. Operating cash flow in the quarter was $6.6 million versus $22.3 million in the last quarter and $23.5 million in the year-ago quarter.

Deferred Revenue – Deferred revenue ended the quarter at $1.9 million, down from $236.6 million in 2Q08. COGN’s deferred revenue typically declines for each of the first three quarters before being replenished in 4Q.

DSO - DSO (Days sales outstanding) was 70 days versus 57 days last quarter, and was in line with management’s target range of 65 to 70 days.

Employees Strength

3Q08 marked the most employees COGN has hired in the past seven quarters. The company's count of quota-carrying sales representatives increased sequentially from 411 to 441 (highest ever level), reflecting the addition of salespeople from its acquisition of Applix. Management expects to have 450 sales representatives after the close of the Applix acquisition (expected in the October to December time frame).

Other Developments

Zacks Investment Research Page 6 www.zackspro.com Share Repurchase Program Announced

After spending over $300.0 million on the Applix acquisition, the company will have about $200.0 million in cash. Management indicated securing a $200.0 million line of credit recently in order to have the opportunity to react quickly to acquisition prospects or any other spending initiatives. COGN announced an extension of its Open Market Share Repurchase Program to repurchase additional shares worth $200.0 million (expiry October 2008).

Analyst Day Highlights

COGN hosted its annual financial Analyst Day on October 03, 2007, in Boston. At the analyst day, Cognos described the returns expected from its significant investments in a services-based Cognos 8 platform, expansion of the sales force and recent acquisitions. These investments are expected to drive double-digit growth in both the license and total revenue lines through FY08 and FY09. While adverse currency moves have muted FY08 margin expansion, management looks for non-GAAP operating margins to finally exceed 20.0% in FY09.

Key highlights on the Analyst Day event can be summarized as follows:

 Management's optimism about the market opportunity and particularly its confidence in Cognos's ability to execute is very high.  Efforts over the past few years have been mainly devoted to building and hardening the Cognos 8 architecture. Now, with sales head count being aggressively added, the focus will be realizing the value of that early investment.  The emerging market opportunity is being underestimated by investors. Cognos signed its first ever multimillion dollar deal in China last quarter.

Potentially Severe Problems

There are none other than those discussed in other sections of this report.

Long-Term Growth

The long-term growth rates for COGN fall within the range of 12.0% (CIBC) and 23.0% (RBC Cap.). Digest long-term average growth rate is 16.6%.

In order to further strengthen the current product portfolio, management launched a new generation of Enterprise Business Intelligence Series, which include Cognos ReportNet, PowerPlay, and DecisionStream. This new release will continue to expand the deployment of new platform. The company also launched new releases of Cognos Metrics Manager, Cognos Controller, and Cognos Planning.

The company struck a multi-year deal with Boeing. Cognos indicated that the deal was a multi-year umbrella agreement with revenues to be recognized as and when Boeing rolls out seats. One analyst (CIBC) estimates the potential will certainly be greater than $10.0 million over the next 3 to 5 years, which is Cognos’s largest of such deals to date.

Another analyst (ThinkEquity) believes feedback from a couple of customer events suggests that Cognos 8 sales cycles are challenging to navigate, with no clear signs of easing, and indications that existing customers are taking a cautious approach to Cognos 8 migrations. Additionally, the analyst thinks that if no suggestion of macro acceleration is given, increasing competition is likely to constrain License revenue growth and valuation.

Zacks Investment Research Page 7 www.zackspro.com Upcoming Events

On March 19, 2008, the company is expected to announce its 4Q08 & FY08 results.

Individual Analyst Opinions

POSITIVE RATINGS

RBC Cap. – Outperform ($58.00 target price): 12/21/07. The firm maintained an Outperform rating with a target price of $58.00 due to the high probability of deal completion. INVESTMENT SUMMARY: The firm considers COGN to be the best strategic fit for IBM.

NEUTRAL RATINGS

BMO Capital – Market Perform ($58.00 target price): 12/21/07. INVESTMENT SUMMARY: The firm sees IBM’s proposed acquisition of Cognos at $58.00 per share as a reasonable price for the company and recommends shareholders tender to the offer, as it believes there is a low likelihood that another offer will surface.

Broadpoint Capital – Neutral (No target price): 12/20/07: The firm reiterated a Neutral rating following the announcement of COGN to be acquired by IBM.

Newcrest – Hold ($58.00 target price): 12/20/07: The firm upheld a Hold rating and maintained a target price of $58.00 following the announcement of COGN to be acquired by IBM. INVESTMENT SUMMARY: The firm believes the offer will achieve the required shareholder support and regulatory hurdles.

Wedbush – Hold ($58.00 target price): 12/21/07. The firm downgraded its rating from Buy to Hold and revised the target price from $54.00 to $58.00, given the likelihood that IBM’s acquisition of COGN and that no other vendor will make a competitive bid for the company. INVESTMENT SUMMARY: The firm believes investors should buy COGN shares as the company’s long-term growth strategy remains intact, the market for BI products remains robust and healthy, and ORCL’s proposed acquisition of HYSL could yield positive benefits to the company in the near term. Given the strong demand for financial performance products, it expects the deal to be marginally dilutive to FY08 results and slightly accretive in FY09.

CIBC – Sector Perform ($58.00 target price): 12/20/07: The firm reiterated a Sector Perform rating with a target price of $58.00 to reflect the current IBM acquisition bid. INVESTMENT SUMMARY: The firm sees little reason for the deal not to be completed shortly after the shareholder meeting. Cognos's results suggest the business model is intact, certain regulatory approvals have already been received, and shareholder approval appears likely.

Cowen – Neutral (No target price): 12/20/07. INVESTMENT SUMMARY: The firm maintained a Neutral stance on the stock, attributable to the acquisition.

Friedman, Billings – Market Perform ($58.00 target price): 12/20/07: The firm maintained a Market perform rating with a target price of $58.00 following the announcement of COGN to be acquired by IBM. INVESTMENT SUMMARY: According to the firm, IBM's acquisition of COGN makes strategic sense, as it fills a void in its software suite.

Zacks Investment Research Page 8 www.zackspro.com Goldman – Neutral ($58.00 target price): 12/21/07: The firm adhered to a Neutral rating with a target price of $58.00, attributable to acquisition. INVESTMENT SUMMARY: The firm views Cognos as one of the key assets for purchase in the consolidating sector. It believes the company is likely to continue benefiting from ongoing growth in the business intelligence market, particularly as large enterprises standardize on a single BI vendor.

Jefferies – Hold ($58.00 target price): 12/20/07. The firm maintained a Hold rating but raised the target price from $48.00 to $58.00. INVESTMENT SUMMARY: The firm does not expect any competitive bid to IBM's all-cash offer. It believes IBM is paying a rich price and the strategic fit looks stronger than with any other company.

MorganStanley – Equal weight ($58.00 target price): 12/20/07. INVESTMENT SUMMARY: The firm believes Cognos can continue to leverage the strong demand trends in BI, despite management’s reluctance to reflect this strength in its forward guidance and that margin improvement should enable Cognos to outperform throughout FY08. The firm continues to see the successful completion of the announced acquisition of Cognos by IBM as the most likely outcome for the stock and forecasts limited potential for upside from the current level.

Pacific Growth – Neutral (No target price): 11/12/07. INVESTMENT SUMMARY: The firm maintained a Neutral rating, attributable to the acquisition announcement.

Raymond James – Market Perform ($58.00 target price): 12/21/07: The firm reiterated a Market Perform rating and a target price of $58.00, attributable to the proposed acquisition.

UnionBankSwitz. – Neutral (No target price): 12/20/07: The firm reiterated a Neutral rating with a target price of $58.00 following the announcement of COGN to be acquired by IBM.

NEGATIVE RATINGS

NOT EXPLICITLY RATED

National Bank Financial – Tender ($58.00 target price): 12/21/07: The firm downgraded its rating from Sector Perform to Tender following the announcement of COGN to be acquired by IBM and in the absence of a competitive bid.

GMP - Tender to the Offer ($58.00 target price): 12/20/07. INVESTMENT SUMMARY: Based on the strong valuation, the firm offers a “tender to the offer” stance.

DROPPED COVERAGE

Deutsche Bank – 11/12/07: The firm dropped coverage on COGN following the acquisition announcement.

Thomas Weisel – 12/20/07: The firm has suspended the rating and the target price following the announcement of COGN to be acquired by IBM.

Research Associate: Ruchika Banka Copy Editor: Pushpanjali B. Content Ed.: Jyoti Lakhotia

Zacks Investment Research Page 9 www.zackspro.com