-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, R9v6MYCSy0xeODRHB2jpixLtx3lwxxxRboLRrTUpRbxDcGmLblsnyt6IUF9JXZEG pK+3CBERF61Qh1SG/bJ5RA== 0000936392-99-000578.txt : 19990517 0000936392-99-000578.hdr.sgml : 19990517 ACCESSION NUMBER: 0000936392-99-000578 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HNC SOFTWARE INC/DE CENTRAL INDEX KEY: 0000945093 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 330248788 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-26146 FILM NUMBER: 99622232 BUSINESS ADDRESS: STREET 1: 5930 CORNERSTONE CT W CITY: SAN DIEGO STATE: CA ZIP: 92121-3728 BUSINESS PHONE: 6195468877 MAIL ADDRESS: STREET 1: 5930 CORNERSTONE CT WEST CITY: SAN DIEGO STATE: CA ZIP: 92121-3728 10-Q 1 FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 1999 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO . COMMISSION FILE NUMBER 0-26146 ================================================================================ HNC SOFTWARE INC. (Exact name of registrant as specified in its charter) ================================================================================ DELAWARE 33-0248788 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5930 CORNERSTONE COURT WEST SAN DIEGO, CA 92121 (Address of principal executive offices, including zip code) (619) 546-8877 (Registrant's telephone number, including area code) INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS: YES [X] NO [ ] AS OF APRIL 30, 1999 THERE WERE 24,554,477 SHARES OF REGISTRANT'S COMMON STOCK, $0.001 PAR VALUE, OUTSTANDING. ================================================================================ 2 INDEX LISTING ================================================================================
Page Number PART I FINANCIAL INFORMATION Item 1: FINANCIAL STATEMENTS Consolidated Balance Sheet at March 31, 1999 (unaudited) and December 31, 1998 3 Consolidated Statement of Income (unaudited) for the three months ended March 31, 1999 and 1998 4 Consolidated Statement of Cash Flows (unaudited) for the three months ended March 31, 1999 and 1998 5 Consolidated Statement of Changes in Stockholders' Equity and Comprehensive Income (unaudited) for the three months ended March 31, 1999 6 Notes To Consolidated Financial Statements (unaudited) 7 Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 12 Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 26 PART II OTHER INFORMATION Item 6: EXHIBITS AND REPORTS ON FORM 8-K 27 Signatures 28 Exhibit Index 29
2 3 PART I - FINANCIAL INFORMATION ================================================================================ Item 1: FINANCIAL STATEMENTS HNC SOFTWARE INC. CONSOLIDATED BALANCE SHEET (in thousands, except per share data) ASSETS
MARCH 31, DECEMBER 31, 1999 1998 --------- --------- (unaudited) Current assets: Cash and cash equivalents $ 38,900 $ 54,267 Investments available for sale 25,714 41,095 Accounts receivable, net 55,939 58,078 Current portion of deferred income taxes 10,163 10,163 Other current assets 5,777 5,459 --------- --------- Total current assets 136,493 169,062 Property and equipment, net 18,285 14,495 Deferred income taxes, less current portion 11,381 12,829 Long-term investments available for sale 71,814 57,978 Intangible assets, net 23,340 25,103 Other assets 6,240 4,447 --------- --------- $ 267,553 $ 283,914 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 5,645 $ 4,226 Accrued liabilities 11,034 16,123 Deferred revenue 10,899 9,427 Other current liabilities 21 78 --------- --------- Total current liabilities 27,599 29,854 Convertible Subordinated Notes 100,000 100,000 Other non-current liabilities 1,077 1,039 Stockholders' equity: Preferred stock, $0.001 par value - 4,000 shares authorized: no shares issued or outstanding -- -- Common stock, $0.001 par value - 50,000 shares authorized: 25,329 and 25,894 shares issued and outstanding, 25 26 respectively Paid-in capital 137,424 134,674 Retained earnings 20,605 18,481 Accumulated other comprehensive loss (398) (160) Common stock in treasury, at cost - 700 shares (18,779) -- --------- --------- Total stockholders' equity 138,877 153,021 --------- --------- $ 267,553 $ 283,914 ========= =========
See accompanying notes to consolidated financial statements. 3 4 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF INCOME (in thousands, except per share data) (unaudited)
THREE MONTHS ENDED MARCH 31, ------------------------------ 1999 1998 -------- -------- Revenues: License and maintenance $ 36,471 $ 26,882 Services and other 12,718 8,199 -------- -------- Total revenues 49,189 35,081 -------- -------- Operating expenses: License and maintenance 10,717 5,972 Services and other 8,657 4,772 Research and development 9,520 6,861 Sales and marketing 9,778 7,641 General and administrative 4,580 3,331 In-process research and development -- 1,750 Acquisition related amortization 2,252 -- -------- -------- Total operating expenses 45,504 30,327 -------- -------- Operating income 3,685 4,754 Other income, net 303 401 Minority interest in income of consolidated subsidiary -- (22) -------- -------- Income before income tax provision 3,988 5,133 Income tax provision 1,864 2,746 ======== ======== Net income $ 2,124 $ 2,387 ======== ======== Earnings per share: Basic net income per common share $ 0.08 $ 0.10 ======== ======== Diluted net income per common share $ 0.08 $ 0.09 ======== ======== Shares used in computing basic net income per common share 25,766 24,620 ======== ======== Shares used in computing diluted net income per common share 26,483 26,041 ======== ========
See accompanying notes to consolidated financial statements. 4 5 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands) (unaudited)
THREE MONTHS ENDED MARCH 31, --------------------------------- 1999 1998 --------- --------- Cash flows from operating activities: Net income $ 2,124 $ 2,387 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,314 1,598 Purchased research and development -- 1,750 Cash received from fixed asset disposals 179 -- Tax benefit from stock option transactions 257 1,168 Changes in assets and liabilities: Accounts receivable, net 2,139 (4,122) Other assets 485 (872) Deferred income taxes 1,448 2,746 Accounts payable 1,419 (1,221) Accrued liabilities (5,090) (1,263) Deferred revenue 1,472 2,690 Other liabilities 37 (6) --------- --------- Net cash provided by operating activities 8,784 4,855 --------- --------- Cash flows from investing activities: Purchases of investments (36,504) (41,145) Maturities of investments 16,900 10,670 Proceeds from sale of investments 21,014 -- Investments in unconsolidated subsidiaries (2,750) -- Cash purchased in business acquisition -- 559 Acquisitions of property and equipment (5,781) (1,778) --------- --------- Net cash used in investing activities (7,121) (31,694) --------- --------- Cash flows from financing activities: Net proceeds from issuance of common stock 2,047 2,681 Purchase of treasury stock (18,779) -- Proceeds from issuance of Convertible Subordinated Notes -- 100,000 Debt issuance costs -- (3,087) Repayment of capital lease obligations (56) (59) --------- --------- Net cash (used in) provided by financing activities (16,788) 99,535 --------- --------- Effect of exchange rate changes on cash (242) 125 --------- --------- Net (decrease) increase in cash and cash equivalents (15,367) 72,821 Cash and cash equivalents at the beginning of the period 54,267 18,068 --------- --------- Cash and cash equivalents at the end of the period $ 38,900 $ 90,889 ========= ========= Supplemental schedule of non-cash investing activities: Stock payable for acquisition of Retek Logistics $ -- $ 5,088 ========= ========= Assets assumed in acquisition of Retek Logistics $ -- $ 6,491 ========= ========= Liabilities assumed in acquisition of Retek Logistics $ -- $ 1,962 ========= =========
See accompanying notes to consolidated financial statements. 5 6 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (in thousands) (unaudited)
ACCUMULATED OTHER COMMON STOCK PAID-IN DEFERRED COMPREHENSIVE SHARES AMOUNT CAPITAL COMPENSATION LOSS ------ ------ ------- ------------ ---- BALANCE AT DECEMBER 31, 1998 . 25,894 $ 26 $ 137,182 $ (2,508) $ (160) Common stock options exercised 81 715 Common stock issued under Employee Stock Purchase Plan ............. 54 1,332 Tax benefit from stock option transactions ....... 257 Treasury stock ............... (700) (1) Unearned stock compensation expense amortization ......... 446 Unrealized gain on investments 4 Foreign currency translation adjustment .............. (242) Net income ................... --------- --------- --------- --------- --------- BALANCE AT MARCH 31, 1999 .... 25,329 $ 25 $ 139,486 $ (2,062) $ (398) ========= ========= ========= ========= =========
TOTAL RETAINED TREASURY STOCKHOLDER COMPREHENSIVE EARNINGS STOCK EQUITY INCOME -------- ----- ----------- ------ BALANCE AT DECEMBER 31, 1998 ... $ 18,481 $ 153,021 Common stock options exercised . 715 Common stock issued under Employee Stock Purchase Plan ............... 1,332 Tax benefit from stock option transactions ......... 257 Treasury stock ................. $(18,779) (18,780) Unearned stock compensation expense amortization ........... 446 Unrealized gain on investments 4 $ 4 Foreign currency translation adjustment ................ (242) (242) Net income ..................... 2,124 2,124 2,124 ------------ --------- --------- --------- BALANCE AT MARCH 31, 1999 ...... $ 20,605 $ (18,779) $ 138,877 $ 1,886 ============ ========= ========= =========
See accompanying notes to consolidated financial statements. 6 7 ================================================================================ HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 GENERAL In management's opinion, the accompanying unaudited consolidated financial statements for HNC Software Inc. (the "Company") for the three month periods ended March 31, 1999 and 1998 have been prepared in accordance with generally accepted accounting principles for interim financial statements and include all adjustments (consisting only of normal recurring accruals) that the Company considers necessary for a fair presentation of its financial position, results of operations, and cash flows for such periods. However, the accompanying financial statements do not contain all of the information and footnotes required by generally accepted accounting principles for complete financial statements. All such financial statements are unaudited except the December 31, 1998 balance sheet. This Report and the accompanying unaudited and audited financial statements should be read in conjunction with the Company's audited financial statements and notes thereto presented in its Annual Report on Form 10-K for the fiscal year ended December 31, 1998 (the "1998 Annual Report"). Footnotes which would substantially duplicate the disclosures in the Company's audited financial statements for the fiscal year ended December 31, 1998 contained in the 1998 Annual Report have been omitted. 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 full fiscal year ending December 31, 1999. NOTE 2 BASIS OF PRESENTATION The acquisition of Retek Logistics Inc. ("Retek Logistics"), formerly Practical Control Solutions, Inc., was completed on March 31, 1998 and accounted for as a purchase as of the acquisition date. In connection with the acquisition of Retek Logistics, acquired in-process research and development of $1.8 million was charged to operations at the acquisition date. NOTE 3 INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES Investments in corporate entities with less than 20% voting interest are generally accounted for under the cost method. On March 18, 1999, the Company made a minority equity investment in AIM Solutions, Inc. ("AIM"), a company which provides marketing process automation, campaign execution software, and client-to-vendor data management to direct marketers of enhancement services. The Company's total investment in AIM was $750,000. On March 31, 1999, the Company made a minority equity investment in Qpass, the first web-wide transaction and customer service network enabling commerce in digital goods and services. The Company's total investment in Qpass was $2.0 million. These investments are being accounted for under the cost method. 7 8 NOTE 4 RECONCILIATION OF NET INCOME AND SHARES USED IN PER SHARE COMPUTATIONS (in thousands)
THREE MONTHS ENDED MARCH 31, ---------------------------- 1999 1998 ------- ------- NET INCOME USED: Net income used in computing basic and diluted net income per common share $ 2,124 $ 2,387 ======= ======= SHARES USED: Weighted average common shares outstanding used in computing basic net income per common share 25,766 24,620 Weighted average options to purchase common stock as determined by application of the treasury stock method 695 1,406 Purchase Plan common stock equivalents 22 15 ------- ------- Shares used in computing diluted net income per common share 26,483 26,041 ======= =======
The conversion of the Company's 4.75% convertible subordinated notes for the three month periods ended March 31, 1999 and 1998 of 2,230 and 624 shares, respectively, was not used to calculate diluted net income per share as their effect would be anti-dilutive. NOTE 5 TREASURY STOCK During February 1999, the Company began acquiring shares of its common stock in connection with a stock repurchase program announced in February 1999. The program authorizes the Company to purchase approximately 700,000 common shares from time to time for cash at market prices in open market, negotiated or block transactions. The Company purchased 700,100 shares of common stock in the first quarter of 1999 at an average cost of $26.82 per share. The purpose of the stock repurchase program is to help cover the Company's annual "evergreen" stock option grants, which provide continued incentives to the Company's employees. NOTE 6 INCOME TAX PROVISION The 1998 income tax provision includes the tax effects of the non-deductible, one-time write-offs of in-process research and development related to the purchase of Retek Logistics. The 1999 income tax provision includes the tax effects of non-deductible acquisition related amortization expense. 8 9 NOTE 7 SEGMENT INFORMATION The Company's reportable segments are those that are based on the Company's method of internal reporting, which disaggregates its business by product category. The Company's major segments are as follows: the Financial Solutions Group ("FSG"), the Insurance Solutions Group ("ISG") and the Retail Solutions Group ("RSG"). The FSG's predictive customer relationship management applications analyze data to retrieve the relationship intelligence that financial institutions use to manage customer accounts. These solutions can be used to segment customer profiles to perform one-to-one marketing, maximize profitability, and manage risks such as fraud, bankruptcy, and delinquency. The ISG segment provides a medical bill repricing system for workers' compensation and auto liability and a suite of predictive technology-based products for maximized management of claims throughout their lifecycle. Designed to analyze large volumes of highly complex data efficiently, these solutions automate and improve insurance claim and healthcare management decision-making. The RSG segment offers a suite of enterprise-wide retail management solutions, which assimilate information from a variety of sources to provide retailers with the ability to predict the ever-changing behaviors of customers and to manage the warehouse, inventory and supply chain processes. This includes increasing the efficiency and reducing the costs of how retailers handle, track and optimize the global flow of merchandise from the vendor through the warehouse, to the stores, and finally on to customers. The remaining segments of HNC's business operations, reflected in the "Other" category, develop, market and support predictive software solutions for the Internet and telecommunication service industries. The Company is organized on the basis of products and services. The segments are strategic business units that offer different products and services. The table below presents information about the reported revenues and operating income of each segment, excluding all amortization and acquisition related expenses, for the quarters ended March 31, 1999 and 1998:
THREE MONTHS ENDED MARCH 31, ------------------------------ 1999 1998 -------- -------- Segment revenue: FSG $ 14,199 $ 10,744 RSG 16,646 11,141 ISG 13,649 11,130 Other 4,695 2,366 Intersegment elimination -- (300) -------- -------- Total consolidated revenue $ 49,189 $ 35,081 ======== ========
9 10
THREE MONTHS ENDED MARCH 31, ----------------------------- 1999 1998 ------- ------- Segment operating income (loss): FSG $ 2,152 $ 2,021 RSG 3,076 2,110 ISG 705 2,282 Other 4 336 ------- ------- Total segment operating income 5,937 6,749 ------- ------- Acquisition expense -- (245) In-process research and development -- (1,750) Acquisition related amortization (2,252) -- ------- ------- Consolidated operating income 3,685 4,754 ------- ------- Interest and other income 1,684 792 Interest expense (1,381) (391) Minority interest in income of consolidated subsidiary -- (22) ------- ------- Income before income tax provision $ 3,988 $ 5,133 ======= =======
Specified items included in segment operating income:
THREE MONTHS ENDED MARCH 31, -------------------------- 1999 1998 ------ ------ Segment depreciation expense: FSG $ 686 $ 599 RSG 440 238 ISG 504 349 Other 182 155 ------ ------ Total segment depreciation expense $1,812 $1,341 ====== ======
The table below presents information about the reported assets of the Company at March 31, 1999 and 1998. MARCH 31, --------------------------------- 1999 1998 --------- --------- Total segment assets: FSG $ 36,231 $ 35,154 RSG 31,513 20,157 ISG 25,435 10,809 Other 14,221 13,702 --------- --------- Total segment assets 107,400 79,822 --------- --------- Corporate 184,562 192,750 Eliminations (24,409) (38,837) --------- --------- Total consolidated assets $ 267,553 $ 233,735 ========= =========
Corporate assets are primarily comprised of cash, short-term and long-term investments available for sale, deferred tax assets and intersegment receivables. Eliminations primarily relate to intersegment payables. 10 11 The following represents capital expenditures by segment for the three months ended March 31, 1999 and 1998:
THREE MONTHS ENDED MARCH 31, -------------------------- 1999 1998 ------ ------ Segment capital expenditures: FSG $1,248 $ 685 RSG 1,926 943 ISG 2,354 310 Other 393 51 ------ ------ Total capital expenditures $5,921 $1,989 ====== ======
The following is revenue and long-lived asset information by geographic areas for the three months ended March 31, 1999 and 1998:
THREE MONTHS ENDED MARCH 31, ---------------------------- 1999 1998 ------- ------- Revenue by geographic area: United States $34,887 $23,015 Foreign 14,302 12,066 ------- ------- Total revenue $49,189 $35,081 ======= =======
MARCH 31, ---------------------------- 1999 1998 ------- ------- Long-lived assets by geographic area: United States $44,949 $20,892 Foreign 166 306 ------- ------- Total long-lived assets $45,115 $21,198 ======= =======
The Company's foreign sales represent revenues from export sales and international operations. Export sales include sales from the United States to foreign countries. International operations include sales by foreign operations. NOTE 8 SUBSEQUENT EVENTS On April 8, 1999, the Board of Directors authorized the Company to repurchase up to an additional 10% of its outstanding common shares under certain conditions from time to time for cash at market prices in open market, negotiated or block transactions. On April 16, 1999, the Company made a minority equity investment of $6.0 million in Open Solutions Inc., a developer of client/server core data processing solutions for community banks and credit unions. 11 12 HNC SOFTWARE INC. ================================================================================ Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS: NO ASSURANCES INTENDED This Report (including the following section regarding Management's Discussion and Analysis of Financial Condition and Results of Operations) contains forward-looking statements regarding the Company and its business, financial condition, results of operations and prospects. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this Report. Additionally, statements concerning future matters such as the development of new products, enhancements or technologies, international sales, expense levels, possible changes in legislation and other statements regarding matters that are not historical are forward-looking statements. Although forward-looking statements in this Report reflect the good faith judgment of the Company's management, such statements can only be based on facts and factors currently known by the Company. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include without limitation those discussed in "Potential Fluctuations in Operating Results" as well as those discussed elsewhere in this Report and those discussed in the Company's 1998 Annual Report. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Report. The Company undertakes no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Report. Readers are urged to carefully review and consider the various disclosures made by the Company in this Report, which attempt to advise interested parties of the risks and factors that may affect the Company's business, financial condition, results of operations and prospects. POTENTIAL FLUCTUATIONS IN OPERATING RESULTS The Company's revenues and operating results have varied significantly in the past and may do so in the future. Factors affecting the Company's revenues and operating results include: market acceptance of the Company's products; the relatively large size and small number of customer orders that may be received during a given period; customer cancellation of long-term contracts yielding recurring revenues or customers' ceasing their use of the Company's products for which the Company's fees are usage based; the length of the sales cycle of the Company's products; the Company's ability to develop, introduce and market new products and product enhancements; the timing of new product announcements and introductions by the Company and its competitors; changes in the mix of the Company's distribution channels; changes in the level of the Company's operating expenses; the Company's ability to achieve progress on percentage-of-completion contracts; the Company's success in completing certain pilot installations for 12 13 contracted fees; competitive conditions in the industry; domestic and international economic conditions; and market conditions in the Company's targeted markets. In addition, license agreements entered into during a quarter may not meet HNC's revenue recognition criteria. Therefore, even if the Company meets or exceeds its forecast of aggregate licensing and other contracting activity, it is possible that the Company's revenues would not meet expectations. Furthermore, the Company's operating results may be affected by factors unique to certain of its product lines. For example, the Company derives a substantial and increasing portion of its revenues from its retail products, which are generally priced as "perpetual" license transactions in which the Company receives a one-time license fee. The Company recognizes these fees as revenue upon delivery of the software and acceptance by the customer. Thus, failure to complete a perpetual license transaction during a fiscal quarter would preclude the Company from recognizing revenue from that transaction in that quarter, and thus would have a disproportionate adverse impact on the Company's operating results for that quarter. The Company expects fluctuations in its operating results to continue for the foreseeable future. Consequently, the Company believes that period-to-period comparisons of its financial results should not be relied upon as an indication of future performance. Because the Company's expense levels are based in part on its expectations regarding future revenues and in the short term are fixed to a large extent, the Company may be unable to adjust its spending in time to compensate for any unexpected revenue shortfall. Accordingly, the Company may not be able to maintain profitability on a quarterly or annual basis in the future. Due to the foregoing factors, it is possible that in some future quarter the Company's operating results will be below the expectations of public market analysts and investors. In that event, the price of the Company's Common Stock and, in turn, the price of the Company's 4.75% Convertible Subordinated Notes due 2003, would likely be materially adversely affected. RESULTS OF OPERATIONS The Company develops, markets and supports predictive software solutions for leading service industries, including financial, insurance and retail. These predictive software solutions employ proprietary neural-network predictive decision engines, profiles, traditional statistical modeling, business models, expert rules and context vectors to convert existing data and business experiences into meaningful recommendations and actions. The Company's major segments are as follows: the Financial Solutions Group ("FSG"), the Insurance Solutions Group ("ISG") and the Retail Solutions Group ("RSG"). The FSG's predictive customer relationship management applications analyze data to retrieve the relationship intelligence that financial institutions use to manage customer accounts. These solutions can be used to segment customer profiles to perform one-to-one marketing, maximize profitability, and manage risks such as fraud, bankruptcy, and delinquency. The ISG segment provides a medical bill repricing system for workers' compensation and auto liability and a suite of predictive technology-based products for maximized management of claims throughout their lifecycle. Designed to analyze large volumes of highly complex data efficiently, these solutions automate and improve insurance claim and healthcare management decision-making. The RSG segment offers a suite of enterprise-wide retail management solutions, which assimilate information from a variety of sources to provide retailers with the ability to predict the ever-changing behaviors of customers and to manage the warehouse, inventory and supply chain processes. This includes increasing the efficiency and reducing the costs of how retailers handle, track and optimize the global flow of merchandise 13 14 from the vendor through the warehouse, to the stores, and finally on to customers. The remaining segments of HNC's business operations develop, market and support predictive software solutions for the Internet and telecommunication service industries. The Company's revenues are comprised of license and maintenance revenues, and services and other revenues. The Company's revenues for the three months ended March 31, 1999 were $49.2 million, an increase of 40.2% over revenues of $35.1 million for the same period in the prior year. LICENSE AND MAINTENANCE REVENUES. The Company's license and maintenance revenues are derived from annual license fees, monthly license fees, perpetual license fees and annual maintenance fees. The Company licenses many of its products for an annual or monthly usage fee under long-term contracts that include software licenses, decision model updates, application consulting, and on-line or on-site support and maintenance. The Company's revenues from periodic software license and maintenance agreements are generally recognized ratably over the respective license or agreement periods. Revenues from certain short-term periodic software license and maintenance agreements with a guaranteed minimum license fee are recognized as related services are performed. Transactional fees are recognized as revenue based on system usage or when fees based on system usage exceed the monthly minimum license fees. Revenues from perpetual licenses of the Company's software for which there are no significant continuing obligations and collection of the related receivables is probable are recognized on delivery of the software and acceptance by the customer. License and maintenance revenues were $36.5 million for the quarter ended March 31, 1999, an increase of 35.7% from $26.9 million for the comparable quarter in 1998. License and maintenance revenues from the insurance solutions segment were $11.9 million for the quarter ended March 31, 1999, an increase of 32.4% from $9.0 million for the comparable quarter in 1998. The increase in the insurance solutions segment was a result of an increase in revenues derived by the COMPADVISOR (formerly CRLink) product. License and maintenance revenues from the retail solutions segment were $11.7 million for the quarter ended March 31, 1999, an increase of 29.1% from $9.0 million for the comparable quarter in 1998. The increase in the retail solutions segment was attributable to an increase in sales of the Retek suite of products, primarily related to the Retek Trade Management and Retek Distribution Management products. License and maintenance revenues from the financial solutions segment were $9.7 million for the quarter ended March 31, 1999, an increase of 22.5% from $7.9 million for the comparable quarter in 1998. The increase in the financial solutions segment was attributable to sales generated by FTI and an increase in the sales of the Falcon suite of products. SERVICES AND OTHER REVENUES. Services and other revenues are comprised of installation and implementation revenues, service bureau operations revenues and revenues which are derived from consulting contracts, new product development contracts with commercial customers and, to a lesser extent, research and development contracts with the United States government. Revenues from installation and implementation services and contract services are generally recognized as the services are performed using the percentage of completion method based on costs incurred to date compared to total estimated costs at completion. Service bureau revenues are derived from the Company's service bureau operations, which provide COMPADVISOR's (formerly CRLink) functionality to customers that do not wish to obtain a license, that use this service until they can implement their own internal COMPADVISOR 14 15 (formerly CRLink) operation or that use this service when their volumes peak to high levels. Service bureau customers typically subscribe for services under month-to-month agreements and service bureau fees are recognized as revenue when the processing services are performed. Services and other revenues were $12.7 million for the quarter ended March 31, 1999, an increase of 55.1% from $8.2 million for the comparable quarter in 1998. Services and other revenues from the retail solutions segment were $5.0 million for the quarter ended March 31, 1999, an increase of 136.6% from the $2.1 million for the comparable quarter in 1998. This increase was due to an increase in consulting contracts with commercial customers as a result of an expanding customer base and an increase in the services offered. Services and other revenues from the financial solutions segment were $4.5 million for the quarter ended March 31, 1999, an increase of 59.6% from the $2.8 million for the comparable quarter in 1998. This increase was attributable to an increase in implementations of the Capstone product, and to a lesser extent the Falcon suite of products, in the financial solutions segment. Services and other revenues from the insurance solutions segment were $1.8 million for the quarter ended March 31, 1999, a decrease of 18.2% from the $2.2 million for the comparable quarter in 1998. This decrease was attributable to the loss of one of the insurance solutions segment's service bureau customers during the first quarter of 1999 due to industry consolidation. LICENSE AND MAINTENANCE GROSS MARGIN. License and maintenance costs primarily represent the Company's expenses for personnel engaged in customer support, travel to customer sites and preparation of documentation materials. The Company's gross margin on license and maintenance revenues was 70.6% for the first quarter of 1999 and 77.8% for the first quarter of 1998. License and maintenance gross margin from the retail solutions segment was 88.0% for the first quarter of 1999 and 93.0% for the first quarter of 1998. The primary reason for the decrease in gross margin from the retail solutions segment was an increase in staffing and associated costs in client services to support the increased volume of business. License and maintenance gross margin from the insurance solutions segment was 40.3% for the first quarter of 1999 and 59.6% for the first quarter of 1998. The decrease was attributable to an increase in the Preferred Provider Organization bill repricing, which typically have lower margins than the overall bill review business. License and maintenance gross margin from the financial solutions segment was 80.7% for the first quarter of 1999 and 82.9% for the first quarter of 1998. SERVICES AND OTHER GROSS MARGIN. Services and other expenses consist of personnel and other expenses associated with providing installation and implementation services and performing development, consulting, and research and development contracts and the costs associated with the service bureau operations. The Company's gross margin on services and other revenues was 31.9% for the first quarter of 1999 and 41.8% for the first quarter of 1998. Services and other gross margin from the retail solutions segment was 42.2% for the first quarter of 1999 and 39.2% for the first quarter of 1998. This increase is primarily attributable to an increase in pricing on consulting contracts and an increase in the utilization of the services employees and less use of subcontracted labor in the retail solutions segment during the first quarter of 1999. Services and other gross margin from the financial solutions segment was 33.2% and 36.4% for the first quarter of 1998, respectively. The decrease in the margin was attributable to the increase in temporary labor, which has a negative impact on margins due to the 15 16 high cost. Services and other gross margin from the insurance solutions segment was (1.9)% and 48.6% for the first quarter of 1999 and 1998, respectively. The decrease in the gross margin was the result of the loss of one of the insurance solutions segment's service bureau customers during the first quarter of 1999 due to industry consolidation and the continuation of employee staffing at the prior quarter's levels. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses consist primarily of salaries and other personnel-related expenses, subcontracted development services, depreciation for development equipment and supplies. Research and development expenses in the first quarter of 1999 were $9.5 million or 19.4% of total revenues compared to $6.9 million or 19.6% of total revenues in the first quarter of the prior year. The insurance solutions segment accounted for approximately $1.8 million and $1.6 million during the quarters ended March 31, 1999 and 1998, respectively. The retail solutions segment accounted for approximately $4.3 and $2.9 million during the quarters ended March 31, 1999 and 1998, respectively. The financial solutions segment accounted for approximately $2.5 and $2.3 million during the quarters ended March 31, 1999 and 1998, respectively. The increase in these expenses in absolute dollars was due primarily to increases in staffing and related costs to support increased product development activities, primarily related to enhancements to the insurance solutions and retail solutions products and, to a lesser extent, the financial solutions products. Research and development expenses also increased in absolute dollars due to increased efforts required to support the research and development functions of businesses acquired by the Company in fiscal 1998. Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," requires capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on the Company's product development process, technological feasibility is not established until completion of a working model. Costs incurred by the Company between completion of the working model and the point at which a product is ready for general release have been insignificant. As a result, no significant software development costs were capitalized through March 31, 1999. The Company anticipates that research and development expenses will increase in dollar amount and could increase as a percentage of total revenues for the foreseeable future. SALES AND MARKETING EXPENSES. Sales and marketing expenses consist primarily of salaries and benefits, commissions, travel, entertainment and promotional expenses. Sales and marketing expenses were $9.8 million or 19.9% of total revenues in the first quarter of 1999 compared to $7.6 million or 21.8% of total revenues in the first quarter of 1998. The retail solutions segment accounted for approximately $3.8 million and $3.3 million during the quarters ended March 31, 1999 and 1998, respectively. The financial solutions segment accounted for approximately $3.3 million and $2.5 million during the quarters ended March 31, 1999 and 1998, respectively. The insurance solutions segment accounted for approximately $956,000 and $1.3 million during the quarters ended March 31, 1999 and 1998, respectively. The increases in sales and marketing expenses were due primarily to increases in staffing related to the Company's expansion of its direct sales and marketing staff. Contributing to the increases were increased expenses for trade shows, advertising, corporate marketing programs and other expenses to support the recently acquired businesses. The Company expects sales and 16 17 marketing expenses to continue to increase for the foreseeable future. Such expenses could also increase as a percentage of total revenues as the Company continues to develop a direct sales force in Europe and other international markets, expand its domestic sales and marketing organization and increase the breadth of its product lines. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist primarily of personnel costs for finance, contract administration, human resources and general management, as well as acquisition, insurance and professional services expenses. General and administrative expenses were $4.6 million or 9.3% of total revenues in the first quarter of 1999, compared to $3.3 million or 9.5% of total revenues in the first quarter of the prior year. Included in general and administrative expenses were acquisition related costs of $245,000 for the three month period ended March 31, 1998. Excluding acquisition costs, the retail solutions segment accounted for approximately $1.2 million and $934,000 during the quarters ended March 31, 1999 and 1998, respectively. Excluding acquisition costs, the financial solutions segment accounted for approximately $1.6 million and $729,000 during the quarters ended March 31, 1999 and 1998, respectively. Excluding acquisition costs, the insurance solutions segment accounted for approximately $1.3 million and $1.1 million during the quarters ended March 31, 1999 and 1998, respectively. The increase in absolute dollars was due primarily to increased staffing and related expenses, including recruiting costs, to support higher levels of sales and development activity across the Company resulting in part from the Company's recent acquisitions. The decrease of general and administrative expenses as a percentage of total revenues was the result of general and administrative expenses increasing at a lower rate than revenues in the same fiscal periods. IN-PROCESS RESEARCH AND DEVELOPMENT EXPENSES. In-process research and development expenses were $1.8 million or 5.0% of total revenues in the first quarter of 1998. These one-time write-offs were related to the acquisition of Retek Logistics. Retek Logistics Inc. (formerly Practical Control Solutions, Inc.) Retek Logistics is a supplier of fully integrated distribution center management software products that address the distribution needs of the retail, wholesale and manufacturing industries. Retek Logistics' products may be classified into two categories: Nautilus, an off-the-shelf warehouse management software system designed to provide the tools needed to control the course of warehouse operations and Nautilus CBT, an operational tutorial database which guides the user through Nautilus operations. Certain products were complete in certain areas and under development in others. The classification of the technology as complete or under development was made in accordance with the guidelines of Statement of Financial Accounting Standards No. 86 ("SFAS 86"), Statement of Financial Accounting Standards No. 2 ("SFAS 2") and Financial Accounting Standards Board Interpretation No. 4 ("FIN4"). At the time of acquisition, Retek Logistics had a number of new software products under development, including Nautilus Versions 6.0 and 7.0 and Nautilus CBT. Nautilus Version 6.0 and Nautilus CBT were both completed during 1998. Nautilus 7.0 was in an early stage of development as of the acquisition date. HNC assumed that it would incur approximately $974,000 of additional development costs through to technological feasibility, which was assumed to be during the second quarter of 1999. 17 18 The Retek Logistics in-process research and development (R&D) projects continue to progress, in all material respects, consistently with the assumptions that HNC provided to the independent appraiser for use in the valuation of the in-process R&D. The inability of HNC to complete this technology within the expected timeframes could materially impact future revenues and earnings, which could have a material adverse effect on HNC's business, financial condition and results of operations. Financial Technology, Inc. FTI has been a provider of management accounting software for financial institutions since 1982. Since 1994, FTI has focused on profitability measurement and other decision support systems. FTI's products are generally classified into six categories: ProfitVision, MarketVision, RiskVision, DataVision, Decision Support Products and Financial Platform Products. FTI had various new products under development in each of these categories, none of which had reached technological feasibility as of the acquisition date. The classification of each new technology as complete or under development was made in accordance with the guidelines of SFAS 86, SFAS 2 and FIN4. Each new product under development has varying release dates for completion ranging from July 1998 through December 1999. The valuation of in-process research and development was based on the assumption that the estimated cost to complete all products under development, measured as of the acquisition date, is approximately $2.1 million, of which $1.2 million would be incurred through December 1998 and an additional $900,000 would be incurred during 1999. The valuation approach also assumed that these products would generate revenues through the year 2002. These statements regarding revenues and expenses are forward-looking statements, which are subject to risks and uncertainties. Actual results may differ materially from those anticipated. The important factors that could cause actual results to differ include those discussed elsewhere in this Report and in the Company's 1998 Annual Report. The inability of HNC to complete this technology within the expected timeframes could materially impact future revenues and earnings, which could have a material adverse effect on HNC's business, financial condition and results of operations. The FTI in-process research and development projects continue to progress, in all material respects, consistently with management's original assumptions that were provided to the independent appraiser and used to value the in-process R&D. ATACS. ATACS is a fraud management software solution for the wireline, wireless and Internet telecommunication service provider industries. The system detects fraudulent traffic thereby avoiding significant financial losses to traditional telecommunication carriers and Internet Service Providers. ATACS' Version 4.2 includes significant enhanced features from its prior version, including new enhancements to Velocity, Message Handlers and a subsystem to support fraud detection of on-line transactions. ATACS Version 4.1 was completed and producing revenues prior to the acquisition date while Version 4.2, which includes new technology that allows the system to function on three interface platforms, was under development and had not yet reached technological feasibility as of the acquisition date. Although Version 4.2 has as its foundation technology from the completed as well as in-process technology, HNC believes that it will have changed significantly so as to be considered new research and development efforts. The classification of each research and development project as complete or under development was made in accordance with the guidelines of SFAS 86, SFAS 2 and FIN4. The valuation approach assumed that the cost to 18 19 reach technological feasibility would be approximately $250,000 and the release would be completed by July 1998. The ATACS in-process research and development projects continue to progress, in all material respects, consistently with HNC's original assumptions that were provided to the independent appraiser and used to value the in-process R&D. Valuation Approach. HNC used an independent appraisal firm to assist it with its valuation of the fair market value of the purchased assets of Retek Logistics, FTI and ATACS. Fair market value is defined as the estimated amount at which an asset might be expected to be exchanged between a willing buyer and willing seller assuming the buyer continues to use the assets in its current operations. HNC provided assumptions by product line of revenue, cost of goods sold and operating expense to the appraiser to assist in the valuation. The appraisal considered three traditional approaches to valuation: the cost approach, the market approach and the income approach. Retek Logistics Inc. (formerly Practical Control Solutions, Inc.) With respect to the forecasted earnings provided to the appraiser, Retek Logistics is forecasting slightly higher revenue growth rates as long as it can continue to meet market demands with new releases each year. These higher growth rates reflect Retek Logistics' expectation of greater market acceptance with the release of its ORACLE-based platform, as well as improvements planned to be incorporated into Nautilus versions 6 and 7. Retek Logistics' gross margins are forecasted to remain consistent relative to prior years. Retek Logistics is also expecting its current operating expense levels to increase only moderately in absolute dollars and, as a result, earnings before interest and taxes are expected to increase in later years. Management believes these growth expectations are reasonable if new product versions are offered according to schedule. The statements regarding expectations for Retek Logistics are forward-looking statements, which are subject to risks and uncertainties. Actual results may differ materially from those anticipated. The important factors that could cause actual results to differ include those discussed elsewhere in this Report and in the Company's 1998 Annual Report. Financial Technology Inc. Prior to 1997, FTI primarily sold financial reporting general ledger software to mid-sized banks. During 1997, FTI began to derive a significant amount of its revenue from ProfitVision, a customer profitability system for these same financial institutions. With respect to the forecasted earnings provided to the appraiser, FTI is forecasting significant revenue growth from a full line of new software measurement tools. The financial forecasts reflected in the appraiser's report reflect management's expectation of significant revenue growth from a number of new product offerings. Operating margins (before interest and taxes) are currently expected to increase from historical trends. Management currently believes that these projected increases are reasonable in light of the number of new product offerings and increased gross profit obtained from these new software measurement tools which is in contrast to those obtained from the financial reporting packages historically sold by FTI. The statements regarding expectations for FTI are forward-looking statements, which are subject to risks and uncertainties. Actual results may differ materially from those anticipated. The important factors that could cause actual results to differ include those discussed elsewhere in this Report and in the Company's 1998 Annual Report. 19 20 ATACS. ATACS represented a product line within Bedford Associates, Inc. since 1995. Management was provided with limited historical information but in conjunction with the acquisition, reviewed contracts that supported revenue. The Company identified and ultimately hired the development and support team that represents the underlying costs of revenue as well as development costs. Under Bedford, ATACS was not an aggressively marketed product and, as a result, sales growth slowed and margins dropped slightly. The product becomes more widely marketable with the offering of Version 4.2, which expands the functionality to three new operating environments. With respect to the forecasted earnings provided to the appraiser, the forecasts reflected higher growth rates than prior years' ranges, reflecting the new product offering and several years of prior marketing of the product now generating sales opportunities. Gross margins are also forecasted to increase rather significantly reflecting higher revenue levels and economies of scale in the production and support cost areas. The statements regarding expectations for ATACS are forward-looking statements, which are subject to risks and uncertainties. Actual results may differ materially from those anticipated. The important factors that could cause actual results to differ include those discussed elsewhere in this Report and in the Company's 1998 Annual Report. With respect to the discount rates used in the valuation approach, the incomplete technology represents a mix of near and mid-term prospects for the business and imparts a level of uncertainty to its prospects. It is the nature of the business to be constantly developing new software for future product releases. A reasonable expectation of return on the incomplete technology would be higher than that of completed technology due to these inherent risks. As a result, the earnings associated with incomplete technology were discounted at a rate of 40.0%, 27.0% and 22.5% for Retek Logistics, FTI and ATACS, respectively, based upon the following methodologies: Retek Logistics Inc. (formerly Practical Control Solutions, Inc.) Because Retek Logistics did not have short-term or long-term debt as of the date of acquisition, the Moody's seasoned Baa rate for March 31, 1998 was utilized as the cost of debt. The Capital Asset Pricing Model was used to determine the cost of equity. It combines a risk free rate of return with an equity risk premium multiplied by a factor, referred to as Beta, which is based on the performance of common stock prices of similar publicly traded companies. Employing these data, the discount rate attributable to the business was 30%, which was used for valuing completed technology. Since incomplete technology represents a mix of near and mid-term prospects for the business and imparts a certain level of uncertainty and would require a higher return than completed technology, the valuation report prepared by the Company's appraiser suggests that a rate of 40% be ascribed to the excess earnings of incomplete technology. Financial Technology Inc. The cash flows attributable to FTI's technology were discounted based on a weighted average cost of capital ("WACC") analysis attributable to the business. In determining an appropriate discount rate utilizing the WACC analysis, an analysis was made of short-term interest rates, the yields of long-term corporate and government bonds, and other alternative investment instruments, as well as the typical capital structure of companies in the industry. Employing this formula, the discount rate attributed to the business was 17%, which was used to discount the completed technology. Incomplete technology represents a mix of near- and mid-term prospects for the business and imparts a certain level of uncertainty. The valuation report prepared by the Company's appraiser suggests that a rate of 27% be ascribed to the excess earnings of incomplete technology. 20 21 ATACS. Because ATACS did not have short-term or long-term debt as of the date of acquisition, the Moody's seasoned Baa rate for May 19, 1998 was utilized as the cost of debt. The Capital Asset Pricing Model was used to determine the cost of equity. It combines a risk free rate of return with an equity risk premium multiplied by a factor, referred to as Beta, which is based on the performance of common stock prices of similar publicly traded companies. Employing these data, the discount rate attributable to the business was 17.5%, which was used for valuing completed technology. Since incomplete technology represents a mix of near- and mid-term prospects for the business and imparts a certain level of uncertainty and would require a higher return than completed technology, the valuation report prepared by the Company's appraiser suggests that a rate of 22.5% be ascribed to the excess earnings of incomplete technology. ACQUISITION RELATED AMORTIZATION EXPENSES. Acquisition related amortization expenses were $2.3 million or 4.6% of total revenues in the first quarter of 1999. These expenses primarily represent the amortization of intangible assets purchased in conjunction with the Company's 1998 acquisitions of Retek Logistics and FTI, the asset purchase of ATACS and the acquisition of the minority interest of Aptex, which was previously a majority-owned subsidiary. The average amortization life is approximately 4 years. OPERATING INCOME. The above factors resulted in operating income of $3.7 million in the first quarter of 1999, constituting 7.5% of total revenues in the same period, and operating income of $4.8 million in the first quarter of 1998, constituting 13.6% of total revenues in the same period. OTHER INCOME, NET. Other income for the first quarter of 1999 was $303,000 compared to $401,000 in the first quarter of the prior year. Other income is comprised of interest income earned on cash and investment balances, net of interest expense related to the 4.75% Convertible Subordinated Notes due 2003 (the "Notes"). HNC issued the Notes in February 1998. Other income for the first quarter of 1999 included a full quarter of interest expense related to the Notes as compared to the same period in the prior year. This was partially offset by an increase in interest income related to the investment of the proceeds from the public offering in March 1998 of $100 million related to the Notes. INCOME TAX PROVISION. The income tax provisions of $1.9 million in the first quarter of 1999 and $2.7 million in the first quarter of 1998 are based on management's estimates of the effective tax rates to be incurred by the Company during those respective full fiscal years. The 1998 income tax provision includes the tax effects of the non-deductible, one-time write-offs of in-process research and development related to the purchase of Retek Logistics. The 1999 income tax provision includes the tax effects of non-deductible acquisition related amortization expense. 21 22 LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities during the first three months of 1999 was $8.8 million, which included net income before depreciation and amortization of approximately $6.4 million. Cash was further increased by decreases in accounts receivable of $2.1 million and deferred income taxes of $1.4 million and increases in accounts payable of $1.4 million and deferred revenue of $1.5 million, offset by a decrease in accrued liabilities of $5.1 million which was primarily attributable to payment of acquisition costs and bonuses accrued for at December 31, 1998 and payment of interest on the 4.75% Convertible Subordinated Notes due 2003. Net cash used in investing activities was $7.1 million during the first three months of 1999, primarily due to purchases of investments available for sale of $36.5 million, offset by $16.9 million of maturities and $21.0 million of proceeds from the sales of investments available for sale. Contributing to the increase were acquisitions of property and equipment of $5.8 million and acquisitions of minority equity investments of $2.8 million during the first quarter of 1999. Net cash used by financing activities of $16.8 million during the first three months of 1999 was primarily related to the purchase of treasury stock of $18.8 million offset by net proceeds of $2.0 million from the issuance of common stock. At March 31, 1999, the Company had $136.4 million in cash, cash equivalents and investments. The Company believes that its current cash, cash equivalents and investments available for sale balances, borrowings under its credit facility and net cash provided by operating activities, will be sufficient to meet its working capital and capital expenditure requirements for at least the next 12 months. The Company expects to invest approximately $14.1 million in capital assets, including computer equipment and building improvements during 1999. Management intends to invest the Company's cash in excess of current operating requirements in short-term, interest-bearing, investment-grade securities. A portion of the Company's cash could also be used to acquire or invest in complementary businesses or products or otherwise to obtain the right to use complementary technologies or data. From time to time, in the ordinary course of business, the Company evaluates potential acquisitions of such businesses, products, technologies or data. The Company has no present understandings, commitments or agreements with respect to any material acquisition of businesses, products, technologies or data. YEAR 2000 COMPLIANCE GENERAL It is generally anticipated that many organizations will experience operational difficulties at the beginning of the Year 2000 as a result of the fact that many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. Significant uncertainty exists in the software and other industries concerning the scope and magnitude of problems associated with the century change. As early as 1997, the Company had begun the process of planning and updating, in some cases, its earlier versions of existing software products. More recent versions of these same products as well as new products were developed with Year 2000 date processing in mind. To track performance of completing any remaining compliance work as well as to assess the Year 2000 issue more broadly, the Company developed a Year 2000 project plan. 22 23 PROJECT The Company initiated a company-wide Year 2000 Project (Y2k Project) during 1998 to more formally monitor compliance of its year 2000 exposure for each major business unit and has divided the project into three major sections that address its critical date sensitive components: software products, information technology ("IT") infrastructure, and non-IT systems. The Y2k Project consists of (1) assessing the current state of readiness for all critical components, (2) developing project plans that track the status of work performed toward completing planned solutions and (3) developing contingency plans. In August 1998, IT directors of all significant business units were asked to inventory all major components and provide the current state of readiness as well as an indication as to when readiness would otherwise be expected. In addition, each major business unit was asked to provide project plan status reports that indicate how compliance would be achieved, as well as to quantify the extent and timing of the effort and to identify when testing of the solution would be completed. Finally, each major business unit was asked to consider various scenarios that might impact successful implementation of their Year 2000 solutions and to develop alternative or back-up plans to mitigate the risk of not being ready on time. CURRENT STATUS The Company completed the initial stage of its Y2k Project during 1998 by taking inventory of its more major software products, identifying the state of readiness for each and developing project plans for completing and implementing designed solutions. Based on the Company's assessment of its major software products, the Company believes that the current version of each is Year 2000 compliant. However, there can be no assurance that all of the Company's customers will install the Year 2000 compliant version of the Company's products in a timely manner, which could lead to failure of customer systems and product liability claims against the Company. 23 24 The Company has also substantially completed its review of major non-IT system components for Year 2000 compliance and is undertaking appropriate repair or replace actions based on the results of the review. Non-IT systems include hardware and other electronic systems, excluding application systems, used in operations of the Company's business. In general, the Company relies on manufacturer's recommendations, certifications and warranties as validation of Year 2000 compliance. The Company's plan for the Year 2000 calls for compliance verification of third parties supplying software and information systems to the Company for both IT and non-IT systems and communication with significant suppliers to determine the readiness of third parties' remediation of their own Year 2000 issues. As part of its assessment, the Company is evaluating the level of validation it will require of third parties to ensure their Year 2000 readiness and the necessary contingency plans should such a situation arise. To date, the Company has not encountered any material Year 2000 issues concerning its computer systems. Potential worst case Year 2000 scenarios currently being considered by the Company address issues arising from non-compliance by its customers, suppliers or internal operating systems. Although the Company's Y2k Project will strive to uncover significant non-compliance issues, in the worst case not all Y2k problems may be uncovered by the year 2000, which could have a material adverse effect on the Company's business. However, the Company believes that its most probable worst case scenario is more likely to arise from its customers' and vendors' inability to become Year 2000 compliant than from the Company's failure to bring its own products into compliance. As a result, the Company's supply chain and revenues could be adversely impacted. As discussed below, the Company generates a significant portion of its revenues from usage-based license fees which would be at risk if its customers are unable to operate their computer systems due to Year 2000 problems caused by software developed internally by the customer or purchased from a third party vendor. Some considerations include quantifying the impact that usage-based fees may have on the Company's business and understanding the compliance programs and contingency plans, if any, the Company's vendors and customers have developed. COSTS All costs associated with carrying out the Company's plan for the Year 2000 compliance are being expensed as incurred. The total cost associated with preparation for the Year 2000 has not been, and is not expected to be, material to the Company's business, financial condition or results of operations. Nevertheless, the Company may not timely identify and remediate all significant Year 2000 problems and remedial efforts may involve significant time and expense. Failure to identify such problems could, for example, impair the Company's internal product development efforts and internal management systems. There can be no assurance that any Year 2000 compliance problems of the Company or its customers or suppliers will not have a material adverse effect on the Company's business, financial condition and results of operations. RISKS The inability of the Company to complete its assessment and any necessary modifications to recently acquired products could have a material adverse effect on the Company's business, financial condition and results of operations. Even if the Company's products are Year 2000 compliant, the Company may in the future be subject to claims based on Year 2000 issues in the 24 25 products of other companies, or issues arising from the integration of multiple products within a system. The costs of defending and resolving Year 2000-related disputes, and any liability of the Company for Year 2000 related damages, including consequential damages, could have a material adverse effect on the Company's business, financial condition and results of operations. Further, the Company's products are generally used with enterprise systems involving complex software products developed by other vendors, which may not be Year 2000 compliant. In particular, many of the Company's customers are financial institutions, insurance companies and other companies with insurance and financial services businesses, all of which use legacy computer systems that are expected to be particularly susceptible to Year 2000 compliance issues. If the Company's customers are unable to use their information systems because of the failure of such non-compliant systems or software or for any other reason, there would be a decrease in the volume of transactions that the Company's customers process using the Company's products. As a result, the Company's recurring revenue in the form of usage-based transactional fees from customers in the insurance and financial solutions markets would decline, which would have a material adverse effect on the Company's business, financial condition and results of operations. Such failure could also affect the perceived performance of the Company's products, which could have a negative effect on the Company's competitive position. In addition, the Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to correct or patch their current software systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase software products such as those offered by the Company, which could result in a material adverse effect on the Company's business, financial condition and results of operations. 25 26 Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to a variety of risks, including foreign currency fluctuations and changes in the market value of its investments. In the normal course of business, the Company employs established policies and procedures to manage its exposure to fluctuations in foreign currency values and changes in the market value of its investments. The Company's foreign currency risks are mitigated principally by contracting primarily in US dollars and maintaining only nominal foreign currency cash balances. Working funds necessary to facilitate the short term operations of the Company's subsidiaries are kept in the local currencies in which they do business, with excess funds transferred to the Company's offices in the United States for investment. For the quarter ended March 31, 1999, approximately 14.0% of the Company's sales were denominated in currencies other than the Company's functional currency, which is the US dollar. These foreign currencies are primarily those of Western Europe, Canada and Australia. The fair value of the Company's investments available for sale at March 31, 1999 was $97.5 million. The objectives of the Company's investment policy are the safety and preservation of invested funds and liquidity of investments that is sufficient to meet cash flow requirements. The Company's policy is to place its cash, cash equivalents and investments available for sale with large financial institutions and commercial companies and government agencies in order to limit the amount of credit exposure. It is also the Company's policy to maintain certain concentration limits and to invest only in certain "allowable securities" as determined by the Company's management. The Company's investment policy also provides that its investment portfolio must not have an average portfolio maturity of beyond one year and that the Company must maintain certain liquidity positions. Investments are prohibited in certain industries and speculative activities. Investments must be denominated in U.S. dollars. 26 27 Item 6: EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27.01 Financial Data Schedule (b) Reports on Form 8-K Report on Form 8-K filed dated January 22, 1999 reporting the acquisition of Aptex Software Inc. under Item 5. 27 28 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized. HNC SOFTWARE INC. Date: May 14, 1999 By: /s/ Raymond V. Thomas -------------------------------- Raymond V. Thomas Vice President, Finance & Administration and Chief Financial Officer (for Registrant as duly authorized officer and as Principal Financial Officer) 28 29 EXHIBIT INDEX
Exhibits -------- 27.01 Financial Data Schedule
29 EX-27.01 2 EXHIBIT 27.01
5 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 38,900 25,714 58,989 (3,050) 450 136,493 33,908 (15,623) 267,553 27,599 100,000 0 0 25 139,250 267,553 49,189 49,189 19,374 19,374 26,130 0 1,381 3,988 1,864 2,124 0 0 0 2,124 0.08 0.08
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