-----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, PjPKp48EWFIHvNE/VYyNWFFkPj4AZM18XS4bupwDfNMAz4E9ucFIc1/369dAJFxF 6JXzB81iFubg4YsNeGZiRA== 0000936392-00-000395.txt : 20000922 0000936392-00-000395.hdr.sgml : 20000922 ACCESSION NUMBER: 0000936392-00-000395 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20000630 FILED AS OF DATE: 20000814 DATE AS OF CHANGE: 20000907 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HNC SOFTWARE INC/DE CENTRAL INDEX KEY: 0000945093 STANDARD INDUSTRIAL CLASSIFICATION: 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: 701883 BUSINESS ADDRESS: STREET 1: 5935 CORNERSTONE CT W CITY: SAN DIEGO STATE: CA ZIP: 92121-3728 BUSINESS PHONE: 8585468877 MAIL ADDRESS: STREET 1: 5935 CORNERSTONE CT WEST CITY: SAN DIEGO STATE: CA ZIP: 92121-3728 10-Q 1 e10-q.txt FORM 10-Q FOR QUARTERLY PERIOD ENDED JUNE 30, 2000 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 JUNE 30, 2000 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.) 5935 CORNERSTONE COURT WEST SAN DIEGO, CA 92121 (Address of principal executive offices, including zip code) (858) 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 JULY 31, 2000 THERE WERE 27,329,634 SHARES OF REGISTRANT'S COMMON STOCK, $0.001 PAR VALUE, OUTSTANDING. 2 TABLE OF CONTENTS
HNC Retek --- ----- Page ---- PART I. FINANCIAL INFORMATION ITEM 1: FINANCIAL STATEMENTS Consolidated Balance Sheet as of June 30, 2000 (Unaudited) and December 31, 1999....................................................... 3 28 Consolidated Statement of Operations (Unaudited) for the three and six months ended June 30, 2000 and 1999......................................... 4 29 Consolidated Statement of Cash Flows (Unaudited) for the six months ended June 30, 2000 and 1999................................. 5 30 Consolidated Statement of Changes in Stockholders' Equity and Comprehensive Income (Unaudited) for the six months ended June 30, 2000.................................................. 6 31 Notes to Consolidated Financial Statements (Unaudited)......................... 7 32 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................................ 15 35 ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..................... 48 48 PART II. OTHER INFORMATION ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K............................................... 51 -- Signatures .................................................................................... 52 -- Exhibit Index ................................................................................. 53 --
2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS HNC SOFTWARE INC. CONSOLIDATED BALANCE SHEET (In thousands, except per share data)
ASSETS JUNE 30, DECEMBER 31, 2000 1999 --------- --------- (Unaudited) Current assets: Cash and cash equivalents $ 80,983 $ 136,340 Short-term investments available for sale - debt 55,397 22,368 Short-term investments available for sale - equity 1,833 6,810 Trade accounts receivable, net 62,938 64,189 Deferred income taxes 1,454 20,384 Other current assets 16,040 11,144 --------- --------- Total current assets 218,645 261,235 --------- --------- Long-term investments available for sale-debt 76,654 68,563 Equity investments 11,469 14,219 Property and equipment, net 34,585 22,219 Intangible assets, net 137,501 29,068 Deferred income taxes 54,719 18,085 Other assets 4,883 3,032 ========= ========= $ 538,456 $ 416,421 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities $ 33,276 $ 30,049 Deferred revenue 45,286 15,274 Other current liabilities 3,539 -- --------- --------- Total current liabilities 82,101 45,323 --------- --------- Non-current liabilities 5,325 4,111 --------- --------- Convertible Subordinated Notes 100,000 100,000 --------- --------- Contingencies (Note 9) Minority interest in consolidated subsidiaries 14,855 17,414 --------- --------- Stockholders' equity: Preferred stock, $0.001 par value -- 4,000 shares authorized; no shares issued or outstanding -- -- Common stock, $0.001 par value -- 120,000 shares authorized; 27,180 and 25,704 shares issued and outstanding, respectively 27 26 Common stock in treasury, at cost -- 233 and 882 shares, respectively (15,507) (19,613) Paid-in capital 389,214 275,955 Retained earnings (deficit) (20,152) 12,209 Accumulated other comprehensive income (loss) (2,120) 1,507 Unearned stock-based compensation (15,287) (20,511) --------- --------- Total stockholders' equity 336,175 249,573 ========= ========= $ 538,456 $ 416,421 ========= =========
See accompanying notes to consolidated financial statements. 3 4 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF OPERATIONS (In thousands, except per share data) (Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------- ------------------------- 2000 1999 2000 1999 --------- --------- --------- --------- Revenues: License and maintenance $ 42,393 $ 41,336 $ 74,184 $ 77,807 Services and other 25,039 14,597 47,811 27,315 --------- --------- --------- --------- Total revenues 67,432 55,933 121,995 105,122 --------- --------- --------- --------- Operating expenses: License and maintenance (excluding non-cash stock-based Compensation expense of $167 and $293 for the three and six months ended June 30, 2000) 13,669 10,122 26,288 20,839 Services and other (excluding non-cash stock based compensation expense of $401 and $795 for the three and six months ended June 30, 2000) 18,414 10,327 33,462 18,984 Research and development (excluding non-cash stock based compensation expense of $1,348 and $2,553 for the three and six months ended June 30, 2000) 18,965 11,608 35,186 21,128 Sales and marketing (excluding non-cash stock based compensation expense of $1,020 and $1,601 for the three and six months ended June 30, 2000) 18,582 10,763 35,160 20,541 General and administrative (excluding non-cash stock based compensation income of $315 and $705 for the three and six months ended June 30, 2000, and excluding acquisition- related amortization) 9,047 5,063 16,832 9,643 Stock-based compensation 2,621 -- 4,537 -- Acquisition-related amortization 11,546 2,056 15,512 4,308 In-process research and development 5,050 -- 6,472 -- --------- --------- --------- --------- Total operating expenses 97,894 49,939 173,449 95,443 Operating income (loss) (30,462) 5,994 (51,454) 9,679 Interest and other income, net 2,995 1,325 6,335 2,970 Interest expense related to convertible debt (1,342) (1,342) (2,684) (2,684) Minority interest in losses of consolidated subsidiaries 3,028 -- 5,419 -- --------- --------- --------- --------- Income (loss) before income taxes (25,781) 5,977 (42,384) 9,965 Income tax provision (benefit) (5,636) 2,632 (10,023) 4,496 --------- --------- ========= ========= Net income (loss) $ (20,145) $ 3,345 $ (32,361) $ 5,469 ========= ========= ========= ========= Net income (loss) per share: Basic net income (loss) per share $ (0.75) $ 0.14 $ (1.22) $ 0.22 ========= ========= ========= ========= Diluted net income (loss) per share $ (0.75) $ 0.13 $ (1.22) $ 0.21 ========= ========= ========= ========= Shares used in computing basic net income (loss) per share 26,955 24,498 26,529 25,078 ========= ========= ========= ========= Shares used in computing diluted net income (loss) per share 26,955 25,000 26,529 25,706 ========= ========= ========= =========
See accompanying notes to consolidated financial statements. 4 5 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands) (Unaudited)
SIX MONTHS ENDED JUNE 30, -------------------------- 2000 1999 --------- --------- Cash flows from operating activities: Net income (loss) $ (32,361) $ 5,469 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Provision for doubtful accounts 1,797 2,099 Depreciation and amortization 20,314 8,571 In-process research and development 6,450 -- (Gain) loss on disposals of property and equipment (2) 141 Stock-based compensation expense 4,537 -- Deferred income tax benefit (10,023) -- Tax benefit from stock option transactions 20,691 777 Minority interest in losses of consolidated subsidiary (5,419) -- Changes in assets and liabilities: Trade accounts receivable (20,228) (6,080) Deferred income taxes (20,640) 2,334 Other assets (4,598) 1,379 Accounts payable and accrued liabilities 4,268 809 Deferred revenue 29,419 569 --------- --------- Net cash provided by (used in) operating activities (5,795) 16,068 --------- --------- Cash flows from investing activities: Net sales (purchases) of investments available for sale (40,847) 24,153 Equity investments (2,500) (11,720) Issuance of employee loans (1,300) -- Acquisitions of property and equipment (16,045) (10,339) Cash paid in business acquisitions, net of cash acquired (18,811) -- Proceeds from sale of property and equipment -- 184 --------- --------- Net cash provided by (used in) investing activities (79,503) 2,278 --------- --------- Cash flows from financing activities: Net proceeds from issuance of HNC common stock 24,408 2,666 Net proceeds from issuance of Retek common stock 5,635 -- Repurchase of HNC common stock for treasury (18,616) (50,381) Net proceeds from sales of receivables 20,730 -- Repayment of debt and capital lease obligations (1,553) (60) --------- --------- Net cash provided by (used in) financing activities 30,604 (47,775) --------- --------- Effect of exchange rate changes on cash (663) (432) --------- --------- Net decrease in cash and cash equivalents (55,357) (29,861) Cash and cash equivalents at beginning of the period 136,340 54,267 --------- --------- Cash and cash equivalents at end of the period $ 80,983 $ 24,406 ========= =========
See accompanying notes to consolidated financial statements. 5 6 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (Unaudited, in thousands)
ACCUMULATED OTHER COMMON STOCK TREASURY STOCK PAID-IN RETAINED COMPREHENSIVE --------------------- ----------------------- SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS INCOME (LOSS) ------ ------ ------ ------ ------- -------- ------------- BALANCE AT DECEMBER 31, 1999......... 25,704 $ 26 882 $ (19,613) $ 275,955 $ 12,209 $ 1,507 Common stock options exercised....... 982 1 (882) 23,056 (354) Purchase of HNC common stock for treasury....................... (250) 250 (18,616) Release of FTI escrow shares into treasury (49) 49 (1,808) Common stock issued under Employee Stock Purchase Plan....... 66 (66) 1,474 231 Effect of common stock issued under Retek Employee Stock Purchase Plan............................... 3,635 Tax benefit from stock option transactions....................... 20,691 Amortization of unearned stock-based compensation expense... Stock-based compensation expense..... (515) Retek initial public offering costs.. (243) Common stock issued in business acquisitions....................... 727 84,382 Effect of Retek common stock issued in business acquisition............ 5,432 Unrealized loss on investments, net of tax.............................. (2,952) Foreign currency translation adjustment, net of tax............. (675) Net loss............................. (32,361) ------ ----- --- -------- --------- --------- -------- BALANCE AT JUNE 30, 2000............. 27,180 $ 27 233 $(15,507) $ 389,214 $ (20,152) $ (2,120) ====== ===== === ======== ========= ========= ========
UNEARNED TOTAL STOCK-BASED STOCKHOLDERS' COMPREHENSIVE COMPENSATION EQUITY INCOME (LOSS) ------------ ------ ------------- BALANCE AT DECEMBER 31, 1999......... $ (20,511) $ 249,573 $ (4,605) Common stock options exercised....... 22,703 Purchase of HNC common stock for treasury....................... (18,616) Release of FTI escrow shares (1,808) into treasury Common stock issued under Employee Stock Purchase Plan....... 1,705 Effect of common stock issued under Retek Employee Stock Purchase Plan............................... 3,635 Tax benefit from stock option transactions....................... 20,691 Amortization of unearned stock-based compensation expense... 172 172 Stock-based compensation expense..... 5,052 4,537 Retek initial public offering costs.. (243) Common stock issued in business acquisitions....................... 84,382 Effect of Retek common stock issued in business acquisition............ 5,432 Unrealized loss on investments, net of tax.............................. (2,952) (2,952) Foreign currency translation adjustment, net of tax............. (675) (675) Net loss............................. (32,361) (32,361) --------- --------- ---------- BALANCE AT JUNE 30, 2000............. $ (15,287) $ 336,175 $ (35,988) ========= ========= ==========
See accompanying notes to consolidated financial statements. 6 7 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 1 -- GENERAL HNC Software Inc. Headquartered in San Diego, California, we develop, market, and support predictive software solutions for leading service industries. These predictive software solutions employ proprietary neural-network predictive decision engines, profiles, traditional statistical modeling, business models, expert rules and context vector technology to convert existing data and business experiences into meaningful recommendations and actions. We provide innovative predictive software systems in the insurance, financial services, telecommunications, e-business, and retail markets. In this Report, HNC Software Inc. is referred to as "we," "our," and "HNC". Our subsidiary, Retek Inc., is referred to as "Retek". Basis of Presentation We have prepared the accompanying interim consolidated financial statements, without audit, in accordance with the instructions to Form 10-Q and, therefore, have not necessarily included all information and footnotes required for audited financial statements. In our opinion, the accompanying unaudited interim consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of our financial position and results of operations. These consolidated financial statements and notes thereto should be read in conjunction with our audited financial statements and notes thereto presented in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 1999. 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 an entire fiscal year. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain prior period balances have been reclassified to conform to the current presentation. Sales of Receivables From time to time, we enter into agreements to sell an undivided interest in specifically identified trade accounts receivable. We generally sell these trade accounts receivable at a discount to a bank, based upon defined short-term market rates. Uncollected receivables that have been sold are not included in our trade accounts receivable balance on our consolidated balance sheet. In the quarters ended March 31, 2000, and June 30, 2000, we sold $5.6 and $15.1 million of receivables (of which $0.0 and $14.6 million were Retek receivables), respectively, representing approximately 8% and 18% of our total cash collected from customers during these respective periods. We did not sell any receivables during the first six months of 1999. Expenses related to receivables sold totaled $43 and $73 during the three and six months ended June 30, 2000, respectively, and are included in interest and other income, net in our consolidated statement of operations. New Accounting Pronouncements In June 1998, the Financial Accounting Standards Board, or FASB, issued Statement of Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities", or FAS 133. This statement establishes a new model for accounting for derivatives and hedging activities. Under FAS 133, all derivatives must be recognized as assets and liabilities and measured at fair value. In July 1999, the FASB issued Statement of Accounting Standards No. 137 "Accounting for Derivative Instruments and Hedging Activities- Deferral of the Effective Date of FASB Statement No. 133" which defers the adoption 7 8 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) requirement to the first quarter of 2001. We have not yet determined the impact of the adoption of this new accounting standard on our consolidated financial position, results of operations or disclosures. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements", or SAB 101, which provides additional guidance in applying generally accepted accounting principles for the recognition and reporting of revenue for certain transactions that existing accounting rules do not specifically address. An amendment in June 2000 delayed SAB 101's effective date until the fourth quarter of 2000. We are currently evaluating the impact, if any, that SAB 101 may have on our consolidated financial statements. In January 2000, the Financial Accounting Standards Board's Emerging Issues Task Force published Issue No. 00-2 "Accounting for Web Site Development Costs", or EITF 00-2. EITF 00-2 applies the guidance given in the American Institute of Certified Public Accountants's Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", or SOP 98-1, to Web site development costs. Under SOP 98-1, software development costs, consisting of internally developed software and Web site development costs, including internal and external costs incurred to develop internal-use computer software during the application development stage are capitalized. Application development stage costs generally include software configuration, coding, installation to hardware and testing. Costs of significant upgrades and enhancements that result in additional functionality are also capitalized. Costs incurred for maintenance and minor upgrades and enhancements are expensed as incurred. The estimated useful lives are based on planned or expected significant modification or replacement of software applications, in response to the rapid rate of change in the internet industry and technology in general. Adoption of EITF 00-2 is required for the third quarter of 2000. We are currently evaluating the impact, if any, that EITF 00-2 may have on our consolidated financial statements. NOTE 2 -- INITIAL PUBLIC OFFERING AND SPIN-OFF OF RETEK INC. On September 10, 1999, Retek filed a registration statement with the Securities and Exchange Commission relating to an initial public offering of Retek's common stock. The offering was consummated in November 1999. In the offering, 6,325 shares of Retek's common stock were sold by Retek. Prior to the offering, we transferred to Retek all of the shares of our wholly owned subsidiary, Retek Information Systems, Inc. We now own approximately 84.5% of the outstanding shares of Retek common stock. As discussed in Note 9, we announced on August 7, 2000, that our board of directors declared a dividend on our common stock of all the shares of Retek common stock that we own, and that we have received a private letter ruling from the Internal Revenue Service that this stock dividend will be tax-free to HNC and our stockholders for U.S. federal income tax purposes. NOTE 3 -- ACQUISITIONS In March 2000, we acquired all of the outstanding stock and other securities of Onyx Technologies, Inc., or Onyx, in exchange for approximately 383 shares of our common stock, including shares subject to options we assumed, and $1,500 in cash. We applied the purchase method of accounting for the acquisition of Onyx, which resulted in a purchase price of $49,555, including $3,500 which represents our initial 1999 investment in Onyx. In March 2000, we acquired all of the outstanding stock and other securities of the Center for Adaptive Systems Applications, Inc., or CASA, in exchange for approximately 142 shares of our common stock, 38 of which are in escrow, including shares subject to options and warrants we assumed. These shares are in escrow to secure indemnification obligations of the former CASA stockholders. We applied the purchase method of accounting for the acquisition of CASA, which resulted in a purchase price of $23,756. In March 2000, we also acquired all of the outstanding stock and other securities of Adaptive Systems Applications, Inc., or AIM, in exchange for approximately 9 shares of our common stock, including shares subject to options we assumed. We applied the purchase method of accounting for the acquisition of AIM, which resulted in a purchase price of $1,656, including $750 which represents our initial 1999 investment in AIM. 8 9 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) In April 2000, we acquired all of the outstanding stock and other securities of Celerity Technologies, Inc., or Celerity, in exchange for approximately 220 shares of our common stock and $2,400 in cash. We applied the purchase method of accounting for the acquisition of Celerity, which resulted in a purchase price of $18,591. In May 2000, Retek acquired all of the outstanding stock and other securities of HighTouch Technologies, Inc., or HighTouch, in exchange for approximately 389 shares of Retek's common stock and $18,000 in cash. Retek applied the purchase method of accounting for the acquisition of HighTouch, which resulted in a purchase price of $26,308. In connection with the CASA, Celerity and HighTouch acquisitions, we recorded in-process research and development expenditures totaling $1,400, $1,050 and $4,000, respectively, relating to the write-off of acquired in-process research and development in connection with these acquisitions. We made our assessment of whether acquired technologies in these acquisitions were complete or under development in accordance with the guidelines prescribed by Statement of Financial Accounting Standards No. 86, Statement of Financial Accounting Standards No. 2, and Financial Accounting Standards Board Interpretation No. 4. The unaudited pro forma results of operations below present the impact on our results of operations as if the Celerity, HighTouch, Onyx, CASA and AIM acquisitions had occurred on January 1, 1999, instead of on their respective later acquisition dates (unaudited):
SIX MONTHS ENDED JUNE 30, --------------------------------------------------------------- 2000 1999 --------------------------------------------------------------- PRO FORMA PRO FORMA HISTORICAL COMBINED HISTORICAL COMBINED ---------- -------- ---------- -------- Total revenues $ 121,995 $ 124,104 $ 105,122 $ 111,373 Net income (loss) (32,361) (34,737) 5,469 3,054 Basic net income (loss) per share $ (1.22) $ (1.31) $ 0.22 $ 0.12 Diluted net income (loss) per share $ (1.22) $ (1.31) $ 0.21 $ 0.12
In May 2000, we entered into a settlement agreement with the former shareholders of Financial Technology Inc., or FTI, pertaining to the release and distribution of the 97 shares of our common stock that were placed into escrow to secure potential indemnification obligations resulting from our April 1998 acquisition of FTI. In accordance with this settlement agreement, one-half of the escrow shares were released to us and placed into treasury while the remaining escrow shares were released to the former FTI shareholders, representing a full and complete release of the former FTI shareholders' indemnification obligations to us. NOTE 4 -- EQUITY INVESTMENTS In March 2000, Open Solutions Inc., or OSI, completed a private placement of its preferred stock. We participated in this financing by purchasing 161 shares of OSI Series F preferred stock for $9.32 per share in order to maintain our approximate 6% ownership of OSI. In June 2000, Burning Glass Technologies LLC, or Burning Glass, completed a private placement of its preferred and common stock. We participated in this financing by purchasing 239 shares of Burning Glass Preferred Issue stock for $4.18 per share, representing an approximate 3.9% ownership in Burning Glass. 9 10 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 5 -- TREASURY SHARE PURCHASE During April 2000, we repurchased 250 shares of our outstanding common stock for our treasury at an aggregate purchase price of $18,616. NOTE 6 -- PER SHARE DATA
THREE MONTHS ENDED JUNE 30, ----------------------- 2000 1999 -------- -------- (unaudited) Net income (loss) $(20,145) $ 3,345 ======== ======== Shares used in computing basic net income (loss) per common share 26,955 24,498 Weighted average options to purchase common stock as determined by application of the treasury stock method -- 450 Employee Stock Purchase Plan common stock equivalents -- 52 -------- -------- Shares used in computing diluted net income (loss) per common share 26,955 25,000 ======== ========
SIX MONTHS ENDED JUNE 30, ----------------------- 2000 1999 -------- -------- (unaudited) Net income (loss) $(32,361) $ 5,469 ======== ======== Shares used in computing basic net income (loss) per common share 26,529 25,078 Weighted average options to purchase common stock as determined by application of the treasury stock method -- 576 Employee Stock Purchase Plan common stock equivalents -- 52 -------- -------- Shares used in computing diluted net income (loss) per common share 26,529 25,706 ======== ========
The 2,230 shares of our common stock now issuable upon the conversion of our 4.75% convertible subordinated notes were not used to calculate diluted net income (loss) per common share for the three and six month periods ended June 30, 2000 and 1999, as the effect would be anti-dilutive. 10 11 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) For the three and six month periods ended June 30, 2000, weighted average options to purchase 1,355 and 2,320 shares of common stock and Employee Stock Purchase Plan common stock equivalents of 24 and zero shares, and warrant common stock equivalents of 6 and 6 shares, respectively, were not included in the computation of diluted net loss per common share, as their effect in these periods would be anti-dilutive. NOTE 7 -- SEGMENT DATA Our reportable segments are based upon our method of internal reporting to management, whom view our business by functional market. Our operating segments reflect the way our management team organizes and evaluates internal financial information, in order to make operating decisions and assess performance. Each segment represents a strategic business unit that offers unique products and services to its functional market. Our segments are as follows: the Service Industries Group, which includes our HNC Insurance Solutions segment, or IS, our HNC Financial Solutions segment, or FS, and HNC Telecom Solutions, or TS; eHNC; and Retek Inc., or Retek. IS provides users with the ability to reduce fraud losses and streamline operations in the containment of the medical costs of workers' compensation and automobile accident insurance claims, workers' compensation loss reserving, workers' compensation fraud, managed care effectiveness and provider effectiveness. FS provides transaction-based, real-time fraud detection, authorization and action decisions for applications such as credit card charge authorization and the loan approval decision process. TS provides our telecommunications users with the ability to reduce fraud losses and determine customer profitability. eHNC serves e-businesses by providing products that allow online merchants to maximize customer service capabilities and point-of-sale transactions. Retek offers predictive software solutions that allow retailers to build forecasting and marketing models. For presentation purposes in this Report, our former Aptex entity's historical financial information has been combined with eHNC's. Reflected in our "Other" category are TS and our Advanced Technology Solutions group, which primarily provides research and development for the United States government, as well as any corporate activity. The table below presents segment data for the three and six months ended June 30, 2000 and 1999. Segment revenue and operating income (loss), which excludes all non-cash expenses such as stock-based compensation expense, acquisition related amortization, and in-process research and development expenses, are as follows (unaudited):
THREE MONTHS ENDED JUNE 30, ------------------------------- 2000 1999 ------------ -------- Segment revenue: IS $ 20,055 $ 14,838 FS 22,124 16,357 Other 3,844 2,148 -------------- ------------- Service Industries Group 46,023 33,343 eHNC 1,821 1,547 Retek 19,588 21,043 ============== ============= Total consolidated revenue $ 67,432 $ 55,933 ============== =============
SIX MONTHS ENDED JUNE 30, ------------------------------- 2000 1999 ------------ -------- Segment revenue: IS $ 39,477 $ 28,487 FS 40,728 30,556 Other 5,065 4,926 -------------- ------------- Service Industries Group 85,270 63,969 eHNC 3,173 3,464 Retek 33,552 37,689
11 12 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ============== ============= Total consolidated revenue $ 121,995 $ 105,122 ============== =============
THREE MONTHS ENDED JUNE 30, --------------------------- 2000 1999 -------- -------- Segment operating income (loss): IS $ 1,848 $ 2,721 FS 3,613 2,878 Other (769) (523) -------- -------- Service Industries Group 4,692 5,076 eHNC (3,200) (259) Retek (12,737) 3,233 -------- -------- Total segment operating income (loss) (11,245) 8,050 Stock-based compensation (2,621) -- Acquisition related amortization (11,546) (2,056) In-process research and development (5,050) -- -------- -------- Consolidated operating income (loss) (30,462) 5,994 Interest and other income, net 2,995 1,325 Interest expense (1,342) (1,342) Minority interest in losses of consolidated subsidiary 3,028 -- ======== ======== Income (loss) before income tax provision (benefit) $(25,781) $ 5,977 ======== ========
SIX MONTHS ENDED JUNE 30, ------------------------ 2000 1999 -------- -------- Segment operating income (loss): IS $ 4,917 $ 3,426 FS 7,297 5,030 Other (2,719) (723) -------- -------- Service Industries Group 9,495 7,733 eHNC (6,996) (55) Retek (27,432) 6,309 -------- -------- Total segment operating income (loss) (24,933) 13,987 Stock-based compensation (4,537) -- Acquisition related amortization (15,512) (4,308) In-process research and development (6,472) -- -------- -------- Consolidated operating income (loss) (51,454) 9,679 Interest and other income, net 6,335 2,970 Interest expense (2,684) (2,684) Minority interest in losses of consolidated subsidiary 5,419 -- ======== ======== Income (loss) before income tax provision (benefit) $(42,384) $ 9,965 ======== ========
Corporate assets are primarily comprised of cash, short-term and long-term investments available for sale, deferred tax assets and inter-segment receivables. All tax related assets and liabilities are included within the Corporate line item. Eliminations primarily relate to intercompany payables and investments in subsidiaries. Total assets: 12 13 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
AS OF JUNE 30, ------------------------- 2000 1999 --------- --------- Total segment assets: IS $ 59,733 $ 27,174 FS 101,685 38,236 Other 43,498 5,409 --------- --------- Service Industries Group 204,916 70,819 eHNC 7,154 8,101 Retek 158,049 34,980 --------- --------- Total segment assets 370,119 107,400 Corporate 290,893 154,432 Eliminations (122,556) (24,325) ========= ========= Total consolidated assets $ 538,456 $ 244,007 ========= =========
NOTE 8 -- STOCK-BASED COMPENSATION Net compensation expense related to stock-based awards totaled $2,621 and $4,537 for the three and six months ended June 30, 2000, respectively. This net compensation expense included net compensation income related to stock-based awards of $651 and $1,364, and amortization of unearned stock-based compensation of $3,272 and $5,901, of which $2,794 and $5,424 related to Retek, during the three and six month periods ended June 30, 2000, respectively. The compensation income was related to reversals of compensation expense recorded in the fourth quarter of 1999, due to a decrease in the fair values of the options on March 31, 2000 and June 30, 2000. The stock-based awards were granted to consultants, and the fair values of these awards were estimated using the Black-Scholes option pricing model with the following weighted average assumptions: dividend yield of 0.0%, risk-free interest rate of 6.42%, volatility of 100.0%, and an expected life of 5 months. The unearned stock-based compensation was related to options granted to eHNC employees in the first quarter of 2000. The expense was generated as the options were granted at an exercise price less than deemed fair value for financial reporting purposes. This expense will be amortized over the option vesting periods. Retek's amortization of unearned stock-based compensation was related to the stock options Retek granted in connection with its initial public offering in the fourth quarter of 1999. The expense was generated as these options were granted at an exercise price less than the deemed fair value for financial reporting purposes. NOTE 9 -- CONTINGENCIES Various claims arising in the course of business, seeking monetary damages and other relief, are pending. The amount of the liability, if any, cannot be determined with certainty; however, in the opinion of management, the ultimate liability will not have a material adverse effect on our consolidated financial position, results of operations or cash flows. In November 1998, Nestor filed a complaint against us in the United States District Court for the District of Rhode Island (C.A. No. 98 569). In the complaint, Nestor alleged that we violated the federal Sherman Antitrust Act and the Rhode Island Antitrust Act and tortuously interfered with prospective contractual business relationships of Nestor in connection with our marketing of our Falcon credit card fraud detection product. The complaint also alleged that we infringed United States patents Nos. 4,326,259 and 4,760,604 held by Nestor. Nestor seeks to recover unspecified compensatory damages, treble damages and punitive damages and to obtain injunctive relief arising from these claims. The complaint also sought a declaratory judgment that a United States patent we hold relating to technology used in our Falcon products is invalid and unenforceable due to our alleged inequitable conduct in obtaining this patent, and that Nestor's products do not infringe this patent. In January 2000, Nestor dropped its claim of patent infringement against us. In July 2000 we filed a motion with the Court to dismiss our counter-claim that Nestor infringes our patent, and Nestor's claims that the 13 14 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) patent is invalid or unenforceable. That motion is still before the court in Rhode Island. The other Nestor claims for antitrust and unfair competition were severed by the court in an earlier ruling and will not be considered until after resolution of the patent issues. Our claims for patent infringement and unfair competition which were pending in the United States District Court venued in San Diego against Nestor's distributors Transaction Systems Architects, Inc., or TSAI, and ACI Worldwide, Inc., or ACI, where dismissed in April 2000. We agreed with TSAI and ACI to dismiss our lawsuit against them in order to enable us to commence discussions with them regarding a possible future business relationship. However, no agreements have been reached to date with TSAI or ACI. We believe that these legal proceedings will not result in a material negative impact on our results of operations, liquidity or financial condition. NOTE 10 -- SUBSEQUENT EVENTS We announced on August 7, 2000 that our board of directors declared a dividend on our common stock of all the shares of Retek common stock we own. The Retek shares will be distributed on or about September 29, 2000 to our stockholders who are holders of record of our common stock at 5 p.m. Eastern Daylight Time on September 15, 2000, the record date for the dividend. We currently own 40 million Retek shares, representing approximately 84.5% of Retek's outstanding common stock. We have received a private letter ruling from the Internal Revenue Service that the dividend of our shares of Retek stock will be tax-free to HNC and our stockholders for U.S. federal income tax purposes. Our stockholders of record at the record date will receive whole shares of Retek common stock and cash payments for fractional shares. Cash received in lieu of fractional shares will be taxable for U.S. federal income tax purposes. The number of Retek shares that will be distributed as a dividend on each share of HNC common stock that is outstanding on the September 15, 2000 dividend record date will be determined by the total number of shares of HNC common stock that are outstanding on September 15, 2000. On August 7, 2000, HNC accelerated the vesting of 25 percent of its outstanding stock options that would have been unvested as of the September 15, 2000 record date to afford its option holders the opportunity to participate in receipt of the dividend. As a result of this vesting acceleration, options to purchase approximately 2.8 million shares of HNC common stock will be vested and exercisable between August 7, 2000 and the September 15 record date. In addition, HNC has $100 million of convertible notes outstanding that could be converted into approximately 2.2 million shares of HNC common stock before the record date. In connection with the Retek dividend, HNC will adjust the exercise price of all of its stock options that are outstanding immediately following payment of the dividend. Because HNC anticipates that this adjustment will be less than the change in value of unvested HNC stock options resulting from the Retek distribution, HNC will pay cash bonuses to employees who hold unvested stock options as of the record date. Based on current analyses, HNC estimates that the aggregate amount of these cash bonuses will be approximately $39 million. HNC anticipates that the adjustment to the exercise price of its unvested options and the cash bonus, taken together, will be less than the change in value of unvested HNC options arising from the Retek distribution. HNC does not plan to pay any cash bonuses to holders of its stock options that vest on or before the record date. As of July 31, 2000 there were approximately 7.2 million stock options outstanding. As mentioned above, on August 7, 2000 HNC vested 25 percent of its outstanding stock options that would have been unvested as of the September 15, 2000 record date. Such options are exercisable for approximately 1.4 million shares of HNC common stock, resulting in options to purchase approximately 2.8 million shares of HNC common stock vested and exercisable between now and the September 15 record date. 14 15 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Report (including without limitation the following section regarding Management's Discussion and Analysis of Financial Condition and Results of Operations) contains forward-looking statements regarding HNC and its business, financial condition, results of operations and prospects. Words like "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and similar expressions or variations of these 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, for example the development of new products, enhancements or technologies, possible changes in legislation, and other statements regarding matters that are not historical are forward-looking statements. In this Report, HNC Software Inc. is referred to as "we," "our," and "HNC". Although forward-looking statements in this Report reflect the good faith judgment of our management, these statements can only be based on facts and factors currently known to us and might change if future factual circumstances change. Consequently, all forward-looking statements have inherent 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 differences in results and outcomes include without limitation whether we are successful in integrating new businesses we have recently acquired, decisions we make regarding future strategic directions of our business units, whether we are successful in transitioning many of our products to solutions based on the application service provider, or ASP, business model, as well as those factors discussed in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 1999, or 1999 Annual Report, and this Report should be read in conjunction with our 1999 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. We undertake 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 in this Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects. OVERVIEW We are a business-to-business software company that develops, markets, licenses and supports predictive software solutions for various service industries, including companies in the insurance, financial services, telecommunications, e-commerce, and retail industries. Our predictive software solutions help service industry companies manage and optimize their customer relationships. By analyzing high volumes of customer transactions in real-time, our predictive solutions help companies shift the decision-making process from a retrospective to prospective basis. The increasing conduct of e-business over the Internet increases the demand for analysis of large volumes of real-time information, which our products provide. Electronic customer interaction is necessary to manage and respond to customer activity and expectations in all markets. Our business is currently organized as follows: the Service Industries Group, which includes the HNC Insurance Solutions segment, or IS, the HNC Financial Solutions segment, or FS, and the HNC Telecom Solutions, or TS; eHNC; and Retek Inc., or Retek. - - - SERVICE INDUSTRIES GROUP Our Service Industries Group delivers predictive solutions and services that automate key decision functions for customers in the insurance, financial services and telecommunications markets. Most of our predictive solutions address customer relationship management, or CRM, issues to optimize interactions with customers over the life-cycle of the customer relationship, including customer acquisition, account management, customer service, marketing and risk management. INSURANCE SOLUTIONS IS develops software solutions for the insurance industry that are designed to add value to its customers' businesses through cost reduction and improved management of risks. Customers in this segment include insurance carriers, third-party administrators, managed care organizations, preferred provider organizations, insurance industry trade groups, brokers, and other service organizations. Our current product offerings are targeted to the workers' compensation and 15 16 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) automobile segments of the property and casualty insurance market, as well as the group health segment of the insurance market. FINANCIAL SOLUTIONS FS provides a suite of Predictive CRM products that addresses the customer-lifecycle management needs of banks and other financial institutions. TELECOM SOLUTIONS TS provides solutions designed to help telecommunications carriers acquire more customers and enhance relationships with existing customers in order to retain customers for longer periods. - - - eHNC eHNC helps online merchants and merchant service providers increase sales and minimize risks through an Applications Service Provider, or ASP, product delivery model. eHNC's solutions analyze electronic interactions with consumers, and help online merchants manage risk and understand, forecast and recommend critical next steps in each consumer relationship. For presentation purposes in this Report, our former Aptex subsidiary's historical financial information has been combined with eHNC's. - - - RETEK Retek completed its initial public offering in November of 1999 and, as of June 30, 2000, we owned approximately 84.5% of Retek's outstanding common stock. Retek provides Internet-based, business-to-business software solutions for retailers and their trading partners, including retail.com, an electronic commerce network that connects retailers to members of their supply chain. Retek also provides a suite of software solutions that address the particular needs of retailers. Our revenues and operating results have varied significantly in the past and may do so in the future. Factors affecting our revenues and operating results include: the degree of market acceptance of our 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 our products for which our fees are based on customer useage; the length of our products' sales cycle; our ability to successfully develop, introduce and market new products and product enhancements; the timing of new product announcements and introductions by us and our competitors; changes in the mix of our distribution channels; changes in the level of our operating expenses; our ability to achieve progress on percentage-of-completion contracts; our success in completing pilot product installations for contracted fees; competitive conditions in the industry; domestic and international economic conditions; and market conditions in our targeted markets. In addition, license agreements we enter into during a given quarter may not meet our revenue recognition criteria, and thus may not produce revenue in that quarter. Therefore, even if we meet or exceed our forecast of aggregate licensing and other contracting activity, it is possible that our revenues would not meet our expectations or those of securities analysts. Furthermore, our operating results may be affected by other factors unique to our product lines. For example, in the past we have, through our Retek subsidiary, derived a substantial portion of our revenues from our retail products, which generally have been priced as "perpetual" license transactions in which we receive a one-time license fee, most of which is typically recognized as revenue upon signing and delivery. Thus, failure to sign a significant perpetual license in the quarter it was anticipated to be signed could result in a material shortfall of revenue for that quarter. Beginning in the fourth quarter of 1999, Retek began to enter into their software licensing agreements with revised terms for the majority of their software sold, and this is expected to continue going forward. Revenue from the sale of software licenses and technical advisory services under these agreements will be recognized as the services are performed over the contract period, which we generally expect to be 12 to 24 months, as determined by the customers' objectives. As Retek begins to recognize license and service revenues over a period of time, rather than upon delivery of their products, they will recognize significantly less revenue and their associated margins will be lower for several quarters as compared to their prior quarters, and they will incur operating losses during these periods. In the past, we recognized many of these perpetual license agreements as revenue according to the revenue recognition criteria set 16 17 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) forth in the Statement of Position 97-2 "Software Revenue Recognition", and related pronouncements. Failure to complete a perpetual license transaction during a fiscal quarter would preclude us from recognizing revenue from that transaction in that quarter, and thus would harm our operating results for that quarter. We expect fluctuations in our operating results to continue for the foreseeable future. Consequently, we believe that period-to-period comparisons of our financial results should not be relied upon as an indication of our future performance. Because our expense levels are based in part on our expectations regarding future revenues and in the short term are fixed to a large extent, we may be unable to adjust our spending in time to compensate for any unexpected revenue shortfall. We 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 our operating results will be below the expectations of public market analysts and investors. In that event, the price of our Common Stock and, in turn, the price of our 4.75% Convertible Subordinated Notes due 2003, would likely be harmed. RESULTS OF OPERATIONS REVENUES Our revenues are comprised of license and maintenance revenues and services and other revenues. Our revenues for the three months ended June 30, 2000 were $67.4 million, an increase of 20.6% over revenues of $55.9 million for the same period in the prior year. Our revenues for the six months ended June 30, 2000 were $122.0 million, an increase of 16.1% over revenues of $105.1 million for the same period in the prior year. For a discussion of Retek's license and maintenance revenues and services and other revenues, see pages 37 and 38. LICENSE AND MAINTENANCE REVENUES. We recognize license and maintenance revenues in several different ways, depending on the terms on which the software and maintenance are provided. Revenue from periodic software license and maintenance agreements is generally recognized ratably over the respective license periods. Revenue from short-term periodic software license and maintenance agreements, with guaranteed minimum license fees, is recognized as related services are performed. Transaction-based fees are recognized as revenue based on system usage or when fees based on system usage exceed the monthly minimum license fees. Revenue from perpetual licenses of our software for which there are no significant continuing obligations and collection of the related receivables is probable is recognized on delivery of the software and acceptance by the customer. Amounts received under contracts in advance of performance are recorded as deferred revenue and are generally recognized within one year from receipt. 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. Revenue from software installation and implementation and from contract services is 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. Amounts received under contracts in advance of performance are recorded as deferred revenue and are generally recognized within one year from receipt. Contract losses are recorded as a charge to income in the period any losses are first identified. Unbilled accounts receivable are stated at estimated realizable value. Service bureau fees are derived from review of and re-pricing of customers' medical bills and are assessed to customers on the basis of volume of bills processed. 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. 17 18 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) THREE MONTHS ENDED JUNE 30, 2000 LICENSE AND MAINTENANCE REVENUES. License and maintenance revenues were $42.4 million for the second quarter in 2000, an increase of 2.6% from $41.3 million for the second quarter in 1999. This $1.1 million increase from the prior year quarter was driven by a $4.1 million decrease at Retek, and offset by a combined increase of $5.2 million at our Service Industries Group and eHNC. The decrease in our Retek segment's license and maintenance revenues quarter over quarter is due to Retek's revised contract terms, generally resulting in revenue being recognized over a number of quarters rather than upon delivery. Our recurring license and maintenance revenues, as a percentage of total license and maintenance revenues, increased to 73.6% in the second quarter of 2000, up from 59.0% for the same period in 1999. Within our Service Industries Group, our IS segment license and maintenance revenues decreased by $.5 million, or 4.1%, from the second quarter in 1999 to the second quarter in 2000, offset primarily by a $3.6 million, or 33.1%, increase at our FS segment and a $1.6 million, or 112%, increase in our other aggregated Service Industries Group revenues. The decrease at our IS segment resulted in part from IS's transfer of customer contracts for the CompCompare and ProviderCompare products to a third party under a master license agreement signed in the third quarter of 1999. We no longer receive license and maintenance fees from the transferred contracts and instead receive royalty fees which are classified as services and other. Also contributing to the IS decrease was a decline in PPO revenues as a result of industry consolidations and increasing price competition, offset in part by the addition of new customers. The increase at our FS segment is primarily due to increases in sales of our Falcon and Capstone products while the increase in other aggregated Service Industies Group revenues is attributable primarily to growth in the TS license and maintenance business. SERVICES AND OTHER REVENUES. Services and other revenues increased 71.5% from the second quarter in 1999 to the second quarter in 2000, from $14.6 million to 25.0 million. This $10.4 million increase from the prior year quarter was driven primarily by a $7.9 million increase at our Service Industries Group and a $2.7 million increase at Retek. Within our Service Industries Group, our IS segment services and other revenues increased $5.7 million, or 208.1%, from the second quarter in 1999 to the second quarter in 2000. Of this increase, $2.7 million is related to the commencement of full-scale service bureau operations for a primary customer. The remaining $3.0 million is primarily due to overall growth in our service bureau customer base at IS. Our FS segment services and other revenues increased $2.1 million, or 39.6%, from the second quarter in 1999 to the second quarter in 2000. The increase at FS was primarily related to a higher volume of Capstone implementations. SIX MONTHS ENDED JUNE 30, 2000 LICENSE AND MAINTENANCE REVENUES. License and maintenance revenues were $74.2 million for the six months ended June 30, 2000, a decrease of 4.7% from $77.8 million for the same period in 1999. This $3.6 million decrease from the prior year quarter was driven by a $9.4 million decrease at Retek, and offset by an increase of $5.8 million at our Service Industries Group and eHNC. The decrease in our Retek segment's license and maintenance revenues from the six months ended June 30, 1999 to the six months ended June 30, 2000 is due to Retek's revised contract terms, generally resulting in revenue being recognized over a number of quarters rather than upon delivery. Our recurring license and maintenance revenues, as a percentage of total license and maintenance revenues, increased to 77.5% in the six months ended June 30, 2000, up from 62.0% for the same period in 1999. Within our Service Industries Group, our IS segment license and maintenance revenues decreased $.9 million, or 3.7%, from the six months ended June 30, 1999 to the six months ended June 30, 2000, offset primarily by a $6.2, or 29.8%, increase at our FS segment and a $.3 million, or 8.5%, increase in our other aggregated Service Industries Group revenues. The decrease in the six months ended June 30, 2000 at our IS segment resulted in part from IS's transfer of customer contracts for the CompCompare and ProviderCompare products to a third party under a master license agreement signed in the third quarter of 1999. We no longer receive license and maintenance fees from the transferred contracts and instead 18 19 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) receive royalty fees, which are classified as services and other. Also contributing to the decrease was a decline in PPO revenues as a result of industry consolidations and increasing price competition, offset in part by the addition of new customers. The increase at our FS segment is primarily due to increases in sales of our Falcon and Capstone products while the increase in other aggregated Service Industies Group revenues is attributable primarily to growth in the TS license and maintenance business. SERVICES AND OTHER REVENUES. Services and other revenues increased 75.0% from the six months ended June 30, 1999 to the six months ended June 30, 2000, from $27.3 million to $47.8 million. This $20.5 million increase from the prior year was driven primarily by a $15.7 million increase at our Service Industries Group and eHNC and a $5.2 million increase at Retek. Within our Service Industries Group, our IS segment services and other revenues increased $11.9 million, or 263.7%, from the second quarter in 1999 to the second quarter in 2000. Of this increase, $6.9 million is related to the commencement of full scale service bureau operations for a primary customer. The remaining $5.0 million is primarily due to growth in our service bureau customer base at IS. Our FS segment services and other revenues increased $4.0 million, or 40.6%, from the six months ended June 30, 1999 to the six months ended June 30, 2000. The increase at FS was primarily related to a higher volume of Capstone implementations. GROSS MARGIN LICENSE AND MAINTENANCE GROSS MARGIN. License and maintenance costs primarily represent our expenses for personnel engaged in customer support, travel to customer sites and documentation materials, and exclude non-cash stock compensation expense of $167 and $293 for the three and six months ended June 30, 2000, respectively. For discussion of Retek's license and maintenance cost of revenues, see page 38. 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 service bureau operations and exclude non-cash stock compensation expense of $401 and $795 for the three and six months ended June 30, 2000, respectively. For discussion of Retek's services and other cost of revenues, see page 38. THREE MONTHS ENDED JUNE 30, 2000 LICENSE AND MAINTENANCE GROSS MARGIN. Our gross margins on license and maintenance revenues decreased 7.7% from the second quarter in 1999 to the second quarter in 2000, from 75.5% to 67.8%. This decrease was driven by a 29.8% decline at Retek, and was offset by an increase of 4.1% at our Service Industries Group. Within our Service Industries Group from the second quarter of 1999 to the second quarter of 2000, license and maintenance gross margin from our IS segment remained relatively constant, decreasing 1.5%, while gross margin from our FS segment also remained relatively constant, increasing 2.2%. Gross margin from our other aggregated Service Industries Group's segments increased by 6.9% due primarily to growth in the TS license and maintenance business. SERVICES AND OTHER GROSS MARGIN. Our gross margin on services and other revenues decreased 2.8%, to 26.5% for the second quarter of 2000 from 29.3% for the second quarter of 1999. The decrease in our services and other gross margin was driven by a 6.7% decrease for our Service Industries Group, and was offset by a 5.9% increase at Retek. Within our Service Industries Group, services and other gross margin from our IS segment improved 5.0% from the second quarter of 1999 to the second quarter of 2000, while gross margin from our FS segment decreased by 16.3%. Our IS segment's gross margins increased quarter over quarter primarily because 19 20 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) of improved efficiencies in their service bureau operations. FS decreased primarily due to the increased use of third party consultants, who have a higher average cost and lower gross margin than internal resources, for Capstone implementations. SIX MONTHS ENDED JUNE 30, 2000 LICENSE AND MAINTENANCE GROSS MARGIN. Our gross margins on license and maintenance revenues decreased 8.6% from the six months ended June 30, 1999 to the six months ended June 30, 2000, from 73.2% to 64.6%, respectively. This decrease was driven by a 37.0% decline at Retek, and was offset by an increase of 5.1% at our Service Industries Group. Within our Service Industries Group from the six months ended June 30, 1999 to the six months ended June 30, 2000, license and maintenance gross margin from our IS segment increased 4.2%, while gross margin from our FS segment remained relatively constant, increasing by 2.3%. IS gross margins increased primarily due to reductions in PPO access fees and the re-alignment of resources. SERVICES AND OTHER GROSS MARGIN. Our gross margin on services and other revenues remained relatively flat, to 30.0% for the six months ended June 30, 2000 from 30.5% for the six months ended June 30, 1999. The activity in our services and other gross margin was driven by a 3.2% increase for our Service Industries Group, and was offset by a 5.4% decrease at Retek. Within our Service Industries Group, services and other gross margin from our IS segment improved 20.4% from the six months ended June 30, 1999 to the six months ended June 30, 2000, while gross margin from our FS segment decreased by 9.0%. Our IS segment's gross margins increased primarily because of improved efficiencies in their service bureau operations. Our FS segment's gross margins decreased primarily due to the increased use of third party consultants, who have a higher average cost and lower gross margin than internal resources, for Capstone implementations. RESEARCH AND DEVELOPMENT EXPENSE Research and development expenses consist primarily of salaries and other personnel-related expenses, subcontracted development services, depreciation for development equipment, and supplies and exclude non-cash stock compensation expense of $1,348 and $2,553 for the three and six months ended June 30, 2000, respectively. For a discussion of Retek's research and development expense see page 38. THREE MONTHS ENDED JUNE 30, 2000 Research and development expenses increased $7.4 million or 63.4%, to $19.0 million in the second quarter of 2000 from $11.6 million in the second quarter of 1999. Research and development expenses from the Service Industries Group increased to $9.3 million in the second quarter of 2000 from $5.6 million in the second quarter of 1999. Research and development expenses from our Insurance Solutions segment increased to $3.4 million in the second quarter of 2000 from $1.9 million in the second quarter of 1999; research and development expenses from our Financial Solutions segment increased to $4.5 million in the second quarter of 2000 from $3.0 million in the second quarter of 1999; and research and development expenses associated with our other aggregated Service Industries Group segments increased to $1.4 million in the second quarter of 2000 from $0.7 million in the second quarter of 1999. The increases in absolute dollars quarter over quarter were attributable to increases in staffing and related costs to support new product development activities primarily for our CompAdvisor, Capstone and Falcon products. We anticipate that research and development expenses will increase in dollar amount and could increase as a percentage of total revenues for the foreseeable future. SIX MONTHS ENDED JUNE 30, 2000 20 21 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) Research and development expenses increased $14.1 million or 66.5%, to $35.2 million in the six months ended June 30, 2000 from $21.1 million in the six months ended June 30, 1999. Research and development expenses from the Service Industries Group increased to $16.1 million in the six months ended June 30, 2000 from $10.5 million in the six months ended June 30, 1999. Research and development expenses from our Insurance Solutions segment increased to $5.9 million in six months ended June 30, 2000 from $3.7 million in the six months ended June 30, 1999, research and development expenses from our Financial Solutions segment increased to $7.7 million in the six months ended June 30, 2000 from $5.6 million in the six months ended June 30, 1999, while research and development expenses associated with our other aggregated Service Industries Group segments increased to $2.4 million in the six months ended June 30, 2000 from $1.2 million in the six months ended June 30, 1999. The increases in absolute dollars period over period were attributable to increases in staffing and related costs to support new product development activities primarily for our CompAdvisor, Capstone and Falcon products. We anticipate 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 EXPENSE Sales and marketing expenses consist primarily of salaries and benefits, commissions, travel, entertainment and promotional expenses and exclude non-cash stock compensation expense of $1,020 and $1,601 for the three and six months ended June 30, 2000, respectively. For a discussion of Retek's sales and marketing expenses see page 39. THREE MONTHS ENDED JUNE 30, 2000 Sales and marketing expenses increased 72.6% to $18.6 million in the second quarter of 2000, from $10.8 million in the second quarter of 1999. This increase was primarily driven by a 111.6% increase at Retek, and by a 24.6% increase from the Service Industries Group. Within our Service Industries Group, sales and marketing expense increased by 89.3% at our IS segment, remained relatively constant at our FS segment, increasing by 2.0%, and increased by 45.3% within our other aggregated Service Industries Group segments, primarily related to our TS business unit. The increases in IS and TS sales and marketing expenses were due primarily to increases in staffing related to the expansion of direct sales and marketing staff. Contributing to the increases were increased expenses for trade shows, advertising, corporate marketing programs and other expenses to support recently acquired businesses. We expect sales and marketing expenses to continue to increase in absolute dollars for the foreseeable future. These expenses could also increase as a percentage of total revenues as we continue to develop a direct sales force in Europe and other international markets, expand our domestic sales and marketing organization and increase the breadth of our product lines. SIX MONTHS ENDED JUNE 30, 2000 Sales and marketing expenses increased 71.2% to $35.2 million in the six months ended June 30, 2000, from $20.5 million in the six months ended June 30, 1999. This increase was primarily driven by a 118.7% increase at Retek, and by a 17.8% increase from the Service Industries Group. Within our Service Industries Group, sales and marketing expense increased 94.4% at our IS segment, remained relatively flat at our FS segment, decreasing by 2.0%, and increased by 10.9% within our other aggregated Service Industries Group segments, primarily related to our TS business unit. The increases in IS and TS sales and marketing expenses were due primarily to increases in staffing related to the expansion of direct sales and marketing staff. Contributing to the increases were increased expenses for trade shows, advertising, corporate marketing programs and other expenses to support recently acquired businesses. The decrease FS experienced during the six months ended June 30, 2000, was related to the timing of various marketing efforts. We expect sales and marketing expenses to continue to increase in absolute dollars for the foreseeable future. These expenses could also increase as a percentage of total revenues as we continue to develop a direct sales force in Europe and other international markets, expand our domestic sales and marketing organization and increase the breadth of our product lines. 21 22 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) GENERAL AND ADMINISTRATIVE EXPENSE 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 and exclude non-cash stock compensation income of $315 and $705 for the three and six months ended June 30, 2000, respectively. For a discussion of Retek's general and administrative expenses see page 39. THREE MONTHS ENDED JUNE 30, 2000 General and administrative expenses increased 78.6%, to $9.0 million in the second quarter of 2000, from $5.1 million in the second quarter of 1999. This growth was primarily driven by a 99.3% increase at Retek, and related to increased staffing and related expenses, including recruiting costs, to support higher levels of sales and development activity, resulting in part from our recent acquisitions and to support Retek's status as a public company. Our Service Industries Group's general and administrative expense increased $1.5 million quarter over quarter, driven by a $0.7 million increase at our FS segment, a $0.5 million increase at our IS segment and a $.3 million increase at our other aggregated Service Industries Group segments, due primarily to increased staffing to support a higher volume of business SIX MONTHS ENDED JUNE 30, 2000 General and administrative expenses increased 74.5%, to $16.8 million in the six months ended June 30, 2000, from $9.6 million in the six months ended June 30, 1999. This growth was primarily driven by a 78.6% increase at Retek, and related to increased staffing and related expenses, including recruiting costs, to support higher levels of sales and development activity, resulting in part from our recent acquisitions and to support Retek's status as a public company. Our Service Industries Group's general and administrative expense increased $2.9 million from the prior year, driven by a $1.3 million increase at our FS segment, a $0.8 million increase at our IS segment and a $0.8 million increase at our other aggregated Service Industries Group segments, due primarily to increased staffing to support a higher volume of business. STOCK-BASED COMPENSATION EXPENSE THREE MONTHS ENDED JUNE 30, 2000 We recognized $2.6 million of stock-based compensation expense related to stock-based compensation agreements, calculated at fair value. This net expense consisted of approximately $2.8 million of stock-based compensation expense for Retek, offset by approximately $0.2 million of stock-based compensation income, net, for our Service Industries Group and eHNC in the second quarter of 2000. Stock-based awards issued to non-employees are accounted for using a fair value method and are marked to fair value at each period end until the earlier of the date the performance by the non-employee is complete or the awards are fully vested. See Note 8 to the financial statements in this Report for further discussion. SIX MONTHS ENDED JUNE 30, 2000 We recognized $4.5 million of stock-based compensation expense related to stock-based compensation agreements, calculated at fair value. This net expense consisted of approximately $5.4 million of stock-based compensation expense for Retek, offset by $0.9 million of stock-based compensation income, net, for our Service Industries Group and eHNC in the six months ended June 30, 2000. Stock-based awards issued to non-employees are accounted for using a fair value method and are marked to fair value at each period end until the earlier of the date the performance by the non-employee is complete or the awards are fully vested. See Note 8 to the financial statements in this Report for further discussion. For a discussion of Retek's stock-based compensation expense see page 41. ACQUISITION-RELATED AMORTIZATION EXPENSE 22 23 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) THREE MONTHS ENDED JUNE 30, 2000 Acquisition-related amortization expense was $11.5 million in the second quarter of 2000, compared to $2.1 million in the second quarter of 1999. These expenses represent the amortization of intangible assets purchased in conjunction with our acquisitions of Celerity and HighTouch in the second quarter of 2000; AIM, CASA and Onyx in the first quarter of 2000; WebTrak in 1999; and our acquisitions of Practical Control Systems Technologies, Inc. or PCS, FTI (now HNC Financial Solutions, Inc.) and the Advanced Telecommunications Abuse Control System, or ATACS product line assets during 1998. The average amortization period and useful life for these intangible assets is approximately 3.5 years. SIX MONTHS ENDED JUNE 30, 2000 Acquisition-related amortization expense was $15.5 million in the six months ended June 30, 2000, compared to $4.3 million in the six months ended June 30, 1999. These expenses represent the amortization of intangible assets purchased in conjunction with our acquisitions of Celerity and HighTouch in the second quarter of 2000; AIM, CASA and Onyx in the first quarter of 2000; WebTrak in 1999; and our acquisitions of Practical Control Systems Technologies, Inc. or PCS, FTI (now HNC Financial Solutions, Inc.) and the Advanced Telecommunications Abuse Control System, or ATACS product line assets during 1998. The average amortization period and useful life for these intangible assets is approximately 3.5 years. For a discussion of Retek's acquisition related amortization expense see page 39. IN-PROCESS RESEARCH AND DEVELOPMENT EXPENSE THREE AND SIX MONTHS ENDED JUNE 30, 2000 During the quarter ended March 31, 2000, we recorded in-process research and development expense of $1.4 million related to our acquisition of CASA. During the quarter ended June 30, 2000, we recorded additional in-process research and development expense of $5.1 million, consisting of $1.1 million and $4.0 million related to our acquisitions of Celerity and HighTouch, respectively. CASA is an advanced analytics solutions company that provides account optimization and precision marketing solutions through an ASP delivery platform. 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, Statement of Financial Accounting Standards No. 2 and Financial Accounting Standards Board Interpretation No. 4. Prior to 2000, CASA primarily sold its Adaptive Dynamic Marketing ("ADM") ASP solution to businesses to improve revenue and customer retention. At the time of acquisition, CASA had a number of new technologies under development related to account management algorithms and pricing algorithms. These in-process R&D projects were estimated to achieve technological feasibility in the second quarter of 2000. Celerity is involved in electronic data interchange ("EDI") for the workers' compensation industry. The company is a developer and provider of translation software, desktop software, and value-added network services in support of the claims handling process. 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, Statement of Financial Accounting Standards No. 2 and Financial Accounting Standards Board Interpretation No. 4. Prior to its acquisition, Celerity primarily sold its software and network services to insurance carriers, third party administrators managed care organizations, employers, and medical providers to facilitate the workers compensation claims handling process. At the time of acquisition, Celerity had a number of new technologies under development related to world-wide web-enabling and EDI network technology. These in-process R&D projects were estimated to achieve technological feasibility in the second and third quarters of 2000. HighTouch is a provider of customized software and services relating to customer relationship management ("CRM"). 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, Statement of Financial Accounting Standards No. 2 and Financial Accounting Standards Board Interpretation No. 4. 23 24 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) Prior to its acquisition, HighTouch primarily sold customized software and services to a variety of customers in the retail industry. At the time of acquisition, HighTouch had technology under development relating to the creation of the company's first fully integrated standardized off-the-shelf CRM product. This in-process R&D project was estimated to achieve technological feasibility in the third quarter of 2000. We used an independent appraisal firm to assist us with our valuations of the fair market values of the purchased assets of CASA, Celerity and HighTouch. 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. The in-process R&D projects were valued through the use of a discounted cash flow analysis, taking into account projected future cash flows associated with these projects once they achieve technological feasibility, their stage of completion as of the acquisition date, and the expected return requirements (i.e. discount rate) for present valuing of the projected cash flows. Stage of completion was estimated by considering time, cost, and complexity of tasks completed prior to the acquisition as a percentage of total time, cost and effort required for the total project up to achieving technological feasibility. With respect to the projected financial information provided to our appraiser, CASA prepared a detailed set of projections forecasting revenue from the new algorithms as well as gross profit and operating profit margins, Celerity prepared a detailed set of projections forecasting revenue from the web-enabling and EDI technology as well as gross profit and operating profit margins, and Retek prepared a detailed set of projections forecasting revenue from the CRM technology as well as gross profit and operating profit margins. These projections were made based on an assessment of customer needs and the expected pricing and cost structure. 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. 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, for CASA, Celerity and HighTouch, the earnings associated with incomplete technology were discounted at rates of 27.0%, 24.3% and 26.2%, respectively, based upon the methodologies described below. 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 for CASA, Celerity and HighTouch, the discount rates attributable to the businesses were 22.0%, 19.3%, and 21.2%, respectively, which was used for valuing completed technology. Since incomplete technology would require a higher return than completed technology, the valuation report prepared by our appraiser used rates of 27.0%, 24.3% and 26.2% for CASA, Celerity and HighTouch, respectively, to present value cash flows (in excess of a return on other assets of the business) attributable to in-process research and development projects. The Casa, Celerity and HighTouch in-process research and development projects continue to progress, in all material respects, consistently with our original assumptions that were provided to the independent appraiser and used to value the in-process research and development. 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. Our inability to complete the in-process technologies within the expected timeframes could materially impact future revenues and earnings, which could have a negative impact on our business, financial condition and results of operations. For a discussion of Retek's in-process research and development, see page 40. OTHER INCOME, NET 24 25 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) THREE AND SIX MONTHS ENDED JUNE 30, 2000 Other income, net is comprised primarily of interest income earned on cash and investment balances. Other income, net for the second quarter of 2000 was $3.0 million, compared to $1.3 million in the second quarter of 1999. Other income, net for the six months ended June 30, 2000 was $6.3 million, compared to $3.0 million in the six months ended June 30, 1999. The increase in other income, net during the three and six months ended June 30, 2000 was attributable primarily to an increase in interest income as a result of higher average cash and investment balances during the first and second quarters in 2000 as compared to the same periods in 1999. The higher cash and investment balances can be attributed in part to the net proceeds received from Retek's initial public offering in November 1999, proceeds from stock option exercises and employee stock purchase plan contributions, as well as the net effect of other operating, investing and financing activities between the respective periods. INCOME TAXES THREE MONTHS ENDED JUNE 30, 2000 The income tax benefit was $5.6 million in the second quarter of 2000, compared to an income tax expense of $2.6 million in the second quarter of 1999. The income tax benefit for the second quarter of 2000 includes the effects of: non-deductible, one-time write-offs of in-process research and development related to the purchases of AIM, CASA, Onyx, Celerity and HighTouch; Retek minority interest; stock-based compensation expense; and non-deductible acquisition related amortization expense. The income tax expense for the second quarter of 1999 includes the effects of non-deductible acquisition related amortization expense. These provisions are based on our estimates of the effective tax rates during those respective full fiscal years. SIX MONTHS ENDED JUNE 30, 2000 The income tax benefit was $10.0 million in the six months ended June 30, 2000, compared to an income tax expense of $4.5 million in the six months ended June 30, 1999. The income tax benefit for the six months ended June 30, 2000 includes the effects of: non-deductible, one-time write-offs of in-process research and development related to the purchases of AIM, CASA, Onyx, Celerity and HighTouch; Retek minority interest; stock-based compensation expense; and non-deductible acquisition related amortization expense. The income tax expense for the six months ended June 30, 1999 includes the effects of non-deductible acquisition related amortization expense. These provisions are based on our estimates of the effective tax rates during those respective full fiscal years. LIQUIDITY AND CAPITAL RESOURCES SIX MONTHS ENDED JUNE 30, 2000 Net cash used in operating activities was $5.8 million for the six months ended June 30, 2000, compared to net cash provided by operating activities of $16.1 million during the same period in 1999. Cash used in operating activities during the first six months of 2000 includes $6.0 million of net cash provided by operations, offset by $11.8 million of net working capital requirements. The net working capital requirements primarily reflect increases in trade accounts receivable and deferred income taxes, offset by an increase in deferred revenue. Net cash used in investing activities was $79.5 million for the six months ended June 20, 2000, compared to net cash provided by investing activities of $2.3 million during the same period in 1999. Cash used in investing activities during the first six months of 2000 included $40.8 million in net investment purchases, $16.1 million expended for the purchase of property and equipment, $18.8 million paid in connection with our business acquisitions, net of cash acquired, and $3.8 million paid out in connection with equity investments and employee loans made. 25 26 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) Net cash provided by financing activities was $30.6 million for the six months ended June 30, 2000, compared to net cash used in financing activities of $47.8 million during the same period in 1999. Cash provided by financing activities during the first six months of 2000 includes $30.0 million in proceeds resulting from stock option exercises and employee stock purchase plan contributions under both HNC and Retek plans and $20.7 million in proceeds from the sale of trade receivables, offset by $18.6 million in cash expended to repurchase HNC common stock for treasury and $1.5 million used to repay debt and capital lease obligations. As of June 30, 2000, we had $150.0 million in cash, cash equivalents and investments available for sale. We believe that our current cash, cash equivalents and investments available for sale balances, borrowings under our credit facility as well as expected net cash provided by operating activities, will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months. We expect to continue making significant investments in capital assets, including computer equipment and building improvements, during 2000. We intend to invest our cash in excess of current operating requirements in short-term, interest-bearing, investment-grade securities. A portion of our 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. The proceeds from the Notes will continue to be used for general corporate purposes, including working capital and possibly to acquire complementary businesses, products or technologies. During March 1998, we completed an offering of $100,000 of 4.75% Convertible Subordinated Notes, or the Notes, due on March 1, 2003. We fully and unconditionally guarantee the Notes. The Notes are convertible into our common stock at any time prior to the close of business on the maturity date at a conversion rate of 22.30 shares per $1,000 principal amount of the Notes (equivalent to a conversion price of $44.85 per share). We have the right to redeem the Notes, in whole or in part, on or after March 6, 2001, at redemption prices (plus accrued interest), as follows: a premium of 101.9 after one year, 100.95 after two years, and at par as of the third year. As a result of the Retek spin-off that we intend to complete during 2000, and pursuant to a resolution by our Board of Directors, our Notes conversion price may be significantly reduced based upon a formula that calculates a revised conversion rate using the relative per common share values of HNC and Retek as of the date of the spin. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board, or FASB, issued Statement of Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities", or FAS 133. This statement establishes a new model for accounting for derivatives and hedging activities. Under FAS 133, all derivatives must be recognized as assets and liabilities and measured at fair value. In July 1999, the FASB issued Statement of Accounting Standards No. 137 "Accounting for Derivative Instruments and Hedging Activities- Deferral of the Effective Date of FASB Statement No. 133" which defers the adoption requirement to the first quarter of 2001. We have not yet determined the impact of the adoption of this new accounting standard on our consolidated financial position, results of operations or disclosures. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements", or SAB 101, which provides additional guidance in applying generally accepted accounting principles for the recognition and reporting of revenue for certain transactions that existing accounting rules do not specifically address. An amendment in June 2000 delayed SAB 101's effective date until the fourth quarter of 2000. We are currently evaluating the impact, if any, that SAB 101 may have on our consolidated financial statements. In January 200, the Financial Accounting Standards Board's Emerging Issues Task Force published Issue No. 00-2 "Accounting for Web Site Development Costs", or EITF 00-2. EITF 00-2 applies the guidance 26 27 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) given in the American Institute of Certified Public Accountants's Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", or SOP 98-1, to Web site development costs. Under SOP 98-1, software development costs, consisting of internally developed software and Web site development costs, include internal and external costs incurred to develop internal-use computer software during the application development stage are capitalized. Application development stage costs generally include software configuration, coding, installation to hardware and testing. Costs of significant upgrades and enhancements that result in additional functionality are also capitalized. Costs incurred for maintenance and minor upgrades and enhancements are expensed as incurred. The estimated useful lives are based on planned or expected significant modification or replacement of software applications, in response to the rapid rate of change in the internet industry and technology in general. Adoption of EITF 00-2 is required for the third quarter of 2000. We are currently evaluating the impact, if any, that EITF 00-2 may have on our consolidated financial statements. 27 28 RETEK INC. CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT PER SHARE DATA)
JUNE 30, DECEMBER 31, 2000 1999 --------- --------- (unaudited) ASSETS Current assets: Cash and cash equivalents $ 38,379 $ 83,680 Short-term investments available for sale - debt 3,898 -- Trade accounts receivable, net 22,044 24,383 Current portion of deferred income taxes 1,589 11,177 Other current assets 9,861 5,560 --------- --------- Total current assets 75,771 124,800 --------- --------- Long-term investments available for sale 6,045 -- Property and equipment, net 17,078 8,291 Intangible assets, net 32,978 8,958 Deferred income taxes, less current portion 34,746 12,151 Other assets 59 33 ========= ========= $ 166,677 $ 154,233 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 5,494 $ 5,946 Accrued liabilities 3,600 3,030 Deferred revenue 33,766 5,883 Note payable 3,501 -- Payable to HNC Software Inc. 755 15,399 --------- --------- Total current liabilities 47,116 30,258 --------- --------- Deferred revenue, net of current portion 762 -- --------- --------- Total liabilities 47,878 30,258 --------- --------- Stockholders' equity: Preferred stock, $0.01 par value -- 5,000 shares authorized; no shares issued and outstanding; -- -- Common stock, $0.01 par value -- 150,000 shares authorized and outstanding at June 30, 200 and December 31, 1999, respectively; 47,356 and 46,503 shares issued and outstanding at June 30, 2000 and December 31, 1999,respectively 474 465 Paid-in capital 156,638 140,089 Unearned stock-based compensation (14,554) (19,978) Accumulated other comprehensive loss (1,240) (582) Retained earnings (deficit) (22,519) 3,981 --------- --------- Total stockholders' equity 118,799 123,975 ========= ========= $ 166,677 $ 154,233 ========= =========
See accompanying notes to consolidated financial statements. 28 29 RETEK INC. CONSOLIDATED STATEMENT OF OPERATIONS (In thousands, except share and per share data) (Unaudited)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- --------------------------- 2000 1999 2000 1999 -------- -------- -------- -------- Revenue: License and maintenance $ 11,508 $ 15,656 $ 17,938 $ 27,314 Services and other 8,081 5,387 15,615 10,376 -------- -------- -------- -------- Total Revenue 19,589 21,043 33,553 37,690 -------- -------- -------- -------- Cost of revenue: License and maintenance (1), (2) 5,305 1,854 9,473 3,258 Services and other (1) 5,878 4,577 11,387 7,462 -------- -------- -------- -------- Total cost of revenue 11,183 6,431 20,860 10,720 -------- -------- -------- -------- Gross Profit 8,406 14,612 12,693 26,970 Operating expenses: Research and development (1) 8,786 5,460 16,794 9,737 Sales and marketing(1) 9,642 4,556 18,313 8,374 General and administrative 2,715 1,363 5,018 2,551 Amortization of stock-based compensation 2,794 5,424 Acquired in-process research and development 4,000 4,000 Acquisition related amortization of intangibles 1,763 258 2,542 516 -------- -------- -------- -------- Total operating expenses 29,700 11,637 52,091 21,178 -------- -------- -------- -------- Operating (loss) income (21,294) 2,975 (39,398) 5,792 Other income, net 409 (2) 1,451 14 -------- -------- -------- -------- (Loss) income before tax (benefit) provision (20,885) 2,973 (37,947) 5,806 Income tax (benefit) provisions (5,671) 1,201 (11,447) 2,346 -------- -------- -------- -------- Net (loss) income (15,214) 1,772 (26,500) 3,460 ======== ======== ======== ======== Basic and diluted net loss per common share (0.32) (0.57) ======== ======== Weighted average shares used in computing basic and diluted net loss per common share 47,036 46,770 ======== ======== Pro forma basic net income per common share 0.04 0.09 ======== ======== Weighed average shares used in computing pro forma basic net income per common share 40,000 40,000 ======== ======== (1) Excludes non-cash, amortization of stock- based compensation as follows: Cost of revenue: License and maintenance 158 306 Services and other 401 779 Operating expenses: Research and development 1,334 589 Sales and marketing 626 1,216 General and administrative 275 534 -------- -------- Total amortization of stock-based compensation $ 2,794 $ 5,424 ======== ======== (2) Excludes non-cash, acquisitions related amortization of tangibles: License and maintenance $ 770 $ 92 $ 1,273 $ 183 ======== ======== ======== ========
See accompanying notes to consolidated financial statements. 29 30 RETEK INC. CONSOLIDATED STATEMENT OF CASH FLOWS (In thousands) (Unaudited)
SIX MONTHS ENDED JUNE 30, --------------------------- 2000 1999 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income ......................................... $(26,500) $ 3,460 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Provision for doubtful accounts ........................... 445 1,491 Depreciation and amortization expense ..................... 4,608 1,873 Amortization of stock-based compensation .................. 5,424 -- Acquired in-process research and development .............. 4,000 -- Deferred tax benefit ............................... (14,868) (206) Tax benefit from stock option transactions ................ 3,420 37 Changes in assets and liabilities, excluding business Acquisitions: Accounts receivable ................................. 1,894 (8,165) Other assets ........................................ (4,282) 1,415 Accounts payable .................................... (523) 1,552 Accrued liabilities ................................. 274 276 Deferred revenue .................................... 28,034 (435) -------- -------- Net cash provided by operating activities ............. 1,926 1,298 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Cash purchased in business acquisitions ................... 166 -- Cash paid for business acquisition ........................ (18,694) -- -------- Net purchases of investments for sale .................... (9,953) -- Acquisitions of property and equipment .................... (10,646) (2,753) -------- -------- Net cash used in investing activities ................. (39,127) (2,753) -------- -------- CASH FLOWS FROM FINANCING ACTIVITES: Net proceeds from the insurance of Retek common stock ....... 5,635 -- Proceeds from insurance notes ............................... 2,250 -- Repayment of debt ........................................... (693) -- Borrowings from HNC Software Inc. ........................... 755 28,656 Repayments to HNC Software Inc. ............................. (15,399) (26,673) -------- -------- Net cash (used in) provided by financing activities ... (7,452) 1,983 -------- -------- Effect of exchange rate changes on cash ...................... (658) (13) -------- -------- Net (decrease) increase in cash and cash equivalents ........ (45,311) 515 Cash and cash equivalents at beginning of period ............. 83,680 415 -------- -------- Cash and cash equivalents at end of period ................... $ 38,369 $ 930 ======== ======== SIGNIFICANT NON-CASH FINANCING ACTIVITES: Business acquisitions through issuance of Retek Common stock and options ........................................................ $ 7,503 ========
See accompanying notes to consolidated financial statements. 30 31 RETEK INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS FOR THE SIX MONTHS ENDED JUNE 30, 2000 (In thousands) (Unaudited)
ACCUMULATED COMMON STOCK DEFERRED OTHER ----------------------- PAID-IN STOCK-BASED COMPREHENSIVE SHARES AMOUNT CAPITAL COMPENSATION INCOME (LOSS) ------ ------ ------- ------------ ------------- BALANCE AT DECEMBER 31, 1999 ........................ 46,503 $465 $ 140,089 $(19,978) $ (582) Tax benefit from exercise of HNC Software Inc. stock options ...................... -- -- 3,420 -- -- Common stock issuance Costs ........................ -- -- (287) -- -- Common stock issued under employee stock purchase plan.. 464 5 5,917 -- -- Common stock and stock options issues for acquisition of High Touch ................ 389 4 7,499 -- -- Amortization of stock-based compensation ................. -- -- -- 5,424 -- Unrealized loss on investments .................. -- -- -- -- (54) Foreign currency translation adjustment ................... -- -- -- -- (604) Net loss ...................... -- -- -- -- -- ------ ---- --------- -------- ------- BALANCE AT MARCH 31, 2000 ..... 47,356 $474 $ 156,638 $(14,554) $(1,240) ====== ==== ========= ======== =======
RETAINED STOCKHOLDERS' COMPREHENSIVE EARNINGS EQUITY INCOME (LOSS) -------- ------ ------------- BALANCE AT DECEMBER 31, 1999 ........................ $ 3,981 $ 123,975 -- Tax benefit from exercise of HNC Software Inc. stock options ...................... -- 3,420 -- Common stock issuance Costs ........................ -- (287) -- Common stock issued under employee stock purchase plan.. -- 5,922 -- Common stock and stock options issues for acquisition of High Touch ................ -- 7,503 -- Amortization of stock-based compensation ................. -- 5,424 -- Unrealized loss on investments .................. -- (54) $ (54) Foreign currency translation adjustment ................... -- (604) (604) Net loss ...................... (26,554) (26,500) (26,554) -------- --------- -------- BALANCE AT MARCH 31, 2000 ..... $(22,519) $ 118,799 $(27,212 ======== ========= ========
See accompanying notes to consolidated financial statements. 31 32 RETEK INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 1 -- THE COMPANY AND BASIS OF PRESENTATION The Company Retek Inc. and its wholly owned subsidiaries, Retek Information Systems, Inc., WebTrak Limited and HighTouch Technologies ("Retek" or the "Company") develop Internet based business-to-business commerce networks, warehouse management software solutions, and market and support management decision software products for retailers and their trading partners. The Internet based business-to-business commerce networks provide retailers a single point of access for all members of the retail supply chain. Additional solutions offered through the retail.com portal provide a collaborative approach to traditional retail challenges. These solutions are designed to increase efficiencies by sharing data among retailers and their trading partners, effectively shortening their supply chains. The 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 is headquartered in Minneapolis, Minnesota. Basis of Presentation We have prepared the accompanying interim condensed consolidated financial statements, without audit, in accordance with the instructions to Form 10-Q and, therefore, do not necessarily include all information and footnotes necessary for a fair presentation of our financial position, results of operations and cash flows in accordance with generally accepted accounting principles. In our opinion, the accompanying unaudited financial information for interim periods presented reflects all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation. These condensed consolidated financial statements and notes thereto should be read in conjunction with our audited financial statements and notes thereto presented in our Annual Report on Form 10-K for the fiscal year ended December 31, 1999. 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 an entire fiscal year. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain prior year balances have been reclassified to conform to the current presentation. New Accounting Pronouncements In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Accounting Standards No. 133 ("FAS 133"), "Accounting for Derivative Instruments and Hedging Activities" which is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. This statement establishes a new model for accounting for derivatives and hedging activities. Under FAS 133, all derivatives must be recognized as assets and liabilities and measured at fair value. In July 1999, the FASB issued Statement of Accounting Standards No. 137 "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133" which defers the effective date to all fiscal quarters of fiscal years beginning after June 15, 2000. The adoption of FAS 133 is not expected to have a significant impact on our consolidated financial position or results of operations. In January 200, the Financial Accounting Standards Board's Emerging Issues Task Force published Issue No. 00-2 "Accounting for Web Site Development Costs", or EITF 00-2. EITF 00-2 applies the guidance given in the American Institute of Certified Public Accountants's Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", or SOP 98-1, to Web site development costs. Under SOP 98-1, software development costs, consisting of internally developed software and Web site development costs, include internal and external costs incurred to develop internal- 32 33 RETEK INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) use computer software during the application development stage are capitalized. Application development stage costs generally include software configuration, coding, installation to hardware and testing. Costs of significant upgrades and enhancements that result in additional functionality are also capitalized. Costs incurred for maintenance and minor upgrades and enhancements are expensed as incurred. The estimated useful lives are based on planned or expected significant modification or replacement of software applications, in response to the rapid rate of change in the internet industry and technology in general. Adoption of EITF 00-2 is required for the third quarter of 2000. We have not yet determined the impact of the adoption of this new accounting standard on our consolidated financial position, results of operations or disclosures. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition." Amendments to the Bulletin delayed the effective date until the fourth quarter of 2000. Retek is reviewing the requirements of this standard and have not yet determined the impact of this standard on its consolidated financial statements. NOTE 2 -- PER SHARE DATA Basic net loss per share is calculated based only on the weighted average common shares outstanding during the period. Diluted earnings per share is computed on the basis of the weighted average basic shares outstanding plus the dilutive effect of outstanding stock options using the "treasury stock" method. For periods prior to Retek's initial public offering, the weighted average basic shares outstanding is a pro forma amount which reflects the September 1999 reincorporation of Retek Inc. and the 40 for .001 stock split of Retek Inc. common shares. For the three months and six months ended June 30, 2000, the calculation of diluted loss per share excludes the impact of the potential exercise of 8,503,101outstanding stock options outstanding at June 30, 2000, because their effect would be antidilutive. Pro forma unaudited income per common share for the three months and six months ended June 30, 1999 is calculated for basic income per share only since Retek had no outstanding stock options during those periods. NOTE 3 -- CONTINGENCIES At June 30, 2000, Retek has factored accounts receivable to a financial institution aggregating $14.6 million, which we are contingently liable in the event of non-collection. NOTE 4 -- ACQUISITIONS On May 10, 2000, Retek acquired HighTouch Technologies, Inc. ("HighTouch") for a cash payment of $18.7 million, including direct acquisition costs and 389 shares of Retek common stock. The application of the purchase method of accounting for the acquisition resulted in an excess of cost over net assets acquired of approximately $29.6 million, of which $25.6 million has been allocated to intangible assets and $4 million has been allocated to in-process research and development. In connection with Retek's acquisition of HighTouch in May 2000, acquired research and development of $4 million was charged to operations on the acquisition date. HighTouch's products provide real-time transaction management and customer service solutions that support multi-channel customer interactions. HighTouch owns certain direct consumer management technologies that we have incorporated into Retek CRM, our enterprise-level customer interaction system. 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, Statement of Financial Standards No. 2 and Financial Accounting Standards Board Interpretation No. 4. At the time of the acquisition, HighTouch had three products under development including Customer Order Management, which was subsequently completed by Retek in July of 2000 and Customer Direct Marketing and Customer Loyalty and Retention , which are still in development. 33 34 RETEK INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The following table presents the consolidated results of operations on an unaudited pro forma basis as if the acquisition of HighTouch Technologies, Inc. had taken place at the beginning of each year (dollars in thousands).
JUNE 30, JUNE 30, 2000 1999 -------- ------- Net revenues ........................ $ 33,586 $38,963 Net (loss) income ................... (30,649) 1,873 Pro forma net (loss) income per share......................... (0.65) 0.05
The unaudited pro forma results of operations are for comparative purposes only and do not necessarily reflect the results that would have occurred had the acquisition occurred at the beginning of the periods presented or the results which may occur in the future. NOTE 5 -- SUBSEQUENT EVENTS On August 7, 2000, HNC Software Inc. announced that its board of directors has declared a dividend on HNC common stock of all the shares of Retek Inc. common stock owned by HNC. The 40 million Retek common shares owned by HNC will be distributed by HNC on or about September 29, 2000 as a dividend on each share of HNC common stock that are outstanding on the September 15, 2000 dividend record date. Currently, HNC owns approximately 84.5% of the outstanding Retek common stock. HNC has received a private letter ruling from the Internal Revenue Service that HNC's dividend of its shares of Retek common stock will be tax-free to HNC and its stockholders for U.S. federal income tax purposes. Effective August 6, 2000, Charles H. Gaylord resigned from our board of directors. NOTE 6 -- RECLASSIFICATIONS Certain reclassifications have been made to our December 31, 1999 consolidated balance sheet to conform with the presentation at June 30, 2000. These reclassifications had no impact on previously reported stockholders' equity. 34 35 RETEK INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of Retek's, financial condition and results of operations should be read in conjunction with Retek's consolidated financial statements and the related notes, and the other financial information included in Retek's Quarterly Report on Form 10-Q. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Retek's actual results may differ materially from those anticipated in these forward-looking statements as a result of specified factors, including those set forth in the section below entitled "Factors That May Impact Future Results of Operations" and elsewhere in this Quarterly Report on Form 10-Q. Retek is a subsidiary of HNC Software Inc., and in this Report, HNC Software Inc. is referred to as "we," "our," and "HNC". OVERVIEW Retek completed its initial public offering on November 23, 1999. Prior to the completion of Retek's initial public offering, they were our wholly owned subsidiary. As of March 31, 2000, we owned approximately 84.5% of Retek's outstanding common stock. On August 7, 2000, HNC Software Inc. announced that its board of directors has declared a dividend on HNC common stock of all the shares of Retek Inc. common stock owned by HNC. The 40 million Retek common shares owned by HNC will be distributed by HNC on or about September 29, 2000 as a dividend on each share of HNC common stock that are outstanding on the September 15, 2000 dividend record date. Currently, HNC owns approximately 84.5% of the outstanding Retek common stock. HNC has received a private letter ruling from the Internal Revenue Service that HNC's dividend of its shares of Retek common stock will be tax-free to HNC and its stockholders for U.S. federal income tax purposes. Retek's business combines the business activities of Retek Information Systems, Inc. and Retek Inc., formerly Retek Logistics, Inc. Founded in 1995, Retek Information Systems, a developer and marketer of Internet-based, business-to-business software solutions for retailers, was acquired by HNC in 1996. On September 9, 1999, Retek Logistics was reincorporated as a Delaware corporation and renamed "Retek Inc." Immediately prior to the completion of our initial public offering on November 23, 1999, in connection with the separation of our business from HNC, HNC contributed all of the outstanding capital stock of Retek Information Systems to Retek Inc. Retek Information Systems currently operates as a wholly owned subsidiary. Our acquisition of Retek Information Systems allowed for the integration of HNC's patented predictive technology into Retek's software solutions for retailers. Retek formalized a marketing relationship with Oracle in September 1998, providing Retek with an effective partnership with a world leader in electronic commerce, an international channel to the largest retailers and the support of Oracle's worldwide sales force. Retek generates revenue from the sale of software licenses, maintenance and support contracts, and professional consulting and contract development services. Until the fourth quarter of 1999, Retek generally licensed products to customers on a perpetual basis and recognized revenue upon delivery of the products. Starting in the fourth quarter of 1999, Retek revised the terms of our software licensing agreements for the majority of our software products sold. Under the revised terms, Retek provides technical advisory services after the delivery of its products to help customers exploit their full value and functionality. Revenue from the sale of software licenses under these agreements will be recognized as the technical advisory services are performed. Retek expects the periods of technical advisory services will generally be from 12 to 24 months, as determined by the customers' objectives. As Retek begins to recognize license and service revenue over a period of time, rather than upon delivery of the product, it will recognize significantly less revenue, have lower associated margins for several quarters, as compared to previous quarters, have higher operating expenses as a percentage of total revenues and incur operating losses for several quarters. Deferred revenue consists principally of the unrecognized portion of revenue received under license and maintenance service agreements. Deferred license revenue is recognized ratably or as a percentage of completion based on the contract terms. Deferred maintenance revenue is recognized ratably over the term of the service agreement. Customers who license Retek's software generally purchase maintenance contracts, typically covering renewable annual periods. In addition, customers may purchase consulting services, which are 35 36 RETEK INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) customarily billed at a fixed daily rate plus out-of-pocket expenses. Contract development services, including new product development services, are typically performed for a fixed fee. Retek also offers training services that are billed on a per student or per class session basis. The growth in Retek's customer base has resulted from a combination of increased market penetration and an expanding product offering. Retek's investment in research and development, acquisitions and alliances have helped bring new software solutions to market. These investments produced a suite of decision support solutions in 1997; the re-tooling of its applications for the Web in 1998; and the delivery of Internet-based, business-to-business collaborative planning, critical path and product design solutions in 1999; and several additional collaborative offerings on the retail.com network through the first quarter of 2000. To support Retek's growth during these periods, it also continued to invest in internal infrastructure by hiring employees throughout various departments of the organization. Retek markets its software solutions worldwide through direct and indirect sales channels. Revenue generated from direct sales channel accounted for approximately 91.1% and 90.0% for the three months and six months ended June 30, 2000, respectively as compared to 64.1% and 73.6% for the same periods as of June 30, 1999. Indirect sales channel revenue primarily arises from our relationship with Oracle. On October 29, 1999, Retek completed the purchase of all the outstanding capital stock of WebTrak Limited. WebTrak owns the WebTrack Critical Path and Portfolio Private Label products that Retek currently distributes. In connection with the purchase of WebTrak, Retek issued to former WebTrak shareholders notes, which were due on November 26, 1999, in the principal amount of $5.33 million and a convertible note, which was due on November 26, 1999, in the principal amount of $2.67 million. The convertible note was at the option of the holder convertible at the time of payment into the number of shares of Retek's common stock equal to the principal amount of the note divided by the initial offering price of $15.00. On November 29, 1999 Retek issued 177,778 shares of its common stock to the holder of the convertible note in full satisfaction of its obligations. The remaining notes were satisfied in full on their due date. On May 10, 2000, Retek completed its purchase of all of the outstanding capital stock of HighTouch Technologies, Inc., or HighTouch, a provider of real-time transaction management and customer service solutions, which support multi-channel customer interactions. HighTouch owns certain direct consumer management technologies that Retek has incorporated into its Retek Retail CRM, an enterprise-level customer interaction system. In connection with the purchase of HighTouch, Retek paid $18.7 million, including direct acquisition costs in cash and issued approximately 389,057 shares of its common stock to the former sole shareholder of HighTouch. Revenue attributable to customers outside of North America accounted for approximately 28.9% and 29.9% for the three months and six months ended June 30, 2000, respectively as compared to 30.4% and 42.6% for the same periods as of June 30, 1999. Approximately 6.1 % and 8.9% of Retek's sales were denominated in currencies other than the U.S. dollar for the three months and six months as of June 30, 2000, respectively as compared to 3.6% and 19.4% for the same periods as of June 30, 1999. Retek primarily sells perpetual licenses for which it recognizes revenue in accordance with generally accepted accounting principles, upon meeting each of the following criteria: - execution of a written purchase order, license agreement or contract; - delivery of software authorization keys; - the license fee is fixed and determinable; - collectibility of the proceeds is assessed as being probable; and - vendor-specific objective evidence exists to allocate the total fee to elements of the arrangement. 36 37 RETEK INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) Vendor-specific objective evidence is based on the price charged when an element is sold separately, or if not yet sold separately, is established by authorized management. All elements of each order are valued at the time of revenue recognition. Retek recognizes revenue: - for sales made through our distributors, resellers and original equipment manufacturers, at the time these partners report to us that they have sold the software to the end-user and after all revenue recognition criteria have been met; - from maintenance agreements related to our software, over the respective maintenance periods; - from customer modifications, as the services are performed using the percentage of completion method; and - from services, using the percentage of completion method, based on costs incurred to date compared to total estimated costs at completion. Retek records amounts received under contracts in advance of performance as deferred revenue and generally recognize these amounts within one year from receipt. Any amount not to be recognized within one year of receipt recorded in non-current deferred revenue. RESULTS OF OPERATIONS The following table presents selected financial data for the periods indicated as a percentage of our total revenue. Retek's historical reporting results are not necessarily indicative of the results to be expected for any future
AS A PERCENTAGE OF AS A PERCENTAGE OF TOTAL REVENUE TOTAL REVENUE THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------ ------------------------ 2000 1999 2000 1999 ------ ------ ------ ------ Revenue: License and maintenance .......................... 58.7% 74.4% 53.5% 72.5% Services and other ............................... 41.3 25.6 46.5 27.5 Total revenue ............................ 100.0 100.0 100.0 100.0 Cost of revenue: License and maintenance .......................... 27.1 8.8 28.2 8.6 Services and other ............................... 30.0 21.8 33.9 19.8 Total cost of revenue .................... 57.1 30.6 62.2 28.4 Gross margin ....................................... 42.9 69.4 37.8 71.6 Operating expenses: Research and development ......................... 44.8 25.9 50.1 25.8 Sales and marketing .............................. 49.2 21.7 54.6 22.2 General and administrative ....................... 13.9 6.5 15.0 6.8 Amortization of stock-based compensation ......... 14.3 -- 16.2 -- Acquired in-process research and development ..... 20.4 -- 11.9 -- Acquisition related amortization of intangibles .. 9.0 1.2 7.6 1.4 Total operating expenses ................. 151.6 55.3 155.2 56.2 Operating (loss) income ............................ (108.7) 14.1 (117.4) 15.4 Other income, net .................................. 2.1 -- 4.3 -- (Loss) income before income tax (benefit) provision (106.6) 14.1 (113.1) 15.4 Income tax (benefit) provision ..................... (28.8) 5.7 (34.1) 6.2 Net (loss) income .................................. (77.7) 8.4 (79.0) 9.2 Cost of license and maintenance revenue, as a percentage of license and maintenance revenue ...... 46.1 11.8 52.8 11.9 Cost of services and other revenue, as a percentage of services and other revenue ...................... 72.7 85.0 72.9 71.9
TOTAL REVENUES. Total revenue decreased 26.5% and 34.3% to $19.6 and $33.6 million for the quarter and six months ended June 30, 2000, respectively, from $21.0 and $37.7 million for the same periods in 1999. LICENSE AND MAINTENANCE REVENUES. License and maintenance revenue decreased to $11.5 and $17.9 million for the quarter and six months ended June 30, 2000, respectively, a decrease of 26.5% and 34.3% from comparable periods in prior year. The decrease in license revenue for the quarter and six months 37 38 RETEK INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) ended June 30, 2000 was primarily due to the revised terms used in negotiating license contracts. As noted above in the section entitled "Overview", Retek recently revised the terms of their software license agreements so that revenue is recognized over a number of quarters rather than upon delivery. As a result, year over year period revenue decreased in the quarter and six-month period ended June 30, 2000 compared to similar periods in 1999. Maintenance revenue increased $1.3 and $2.5 million for the quarter and six months ended June 30, 2000, respectively, due to the growing base of customers that have installed Retek's software solutions. SERVICES AND OTHER REVENUES. Services and other revenue totaled $8.1 and $15.6 million for the quarter and six months ended June 30, 2000, respectively, an increase of 50.0% and 50.5% from comparable periods in prior year. The increase was due to a $3.4 and $6.9 million increase in consulting services and custom development projects for the quarter and six months ended in June 30, 2000, respectively. The number of billable employees increased to 89 as of June 30, 2000 from 65 as of June 30, 1999. In addition, third party consultants are used on an as needed basis depending upon our allocation of internal resources. COST OF REVENUES COST OF LICENSE AND MAINTENANCE REVENUES. Cost of license and maintenance revenue consists primarily of fees for third party software products that are integrated into Retek's products; third party license consultant costs; salaries and related expenses of their customer support organization; and an allocation of their facilities and depreciation expense. Cost of license and maintenance revenue increased to $5.3 and $9.5 million for the quarter and six months ended June 30, 2000, respectively an increase of 186.1% and 190.8% over comparable periods in prior year. As license and maintenance revenue increases, Retek expects to experience increased costs resulting from increased royalty fees and an increase in the number of support personnel required to service their growing customer base. The number of cost of license and maintenance revenue personnel increased to 35 as of June 30, 2000 from 8 as of June 30, 1999. In addition, Retek incurred higher third party license consultant costs. They expect the cost of license and maintenance revenue to continue to increase in absolute dollars as license and maintenance revenue increases. COST OF SERVICES AND OTHER REVENUES. Cost of services and other revenue includes salaries and related expenses of Retek's consulting organization; cost of third parties contracted to provide consulting services to their customers; and an allocation of facilities and depreciation expense. Cost of services and other revenue increased to $5.9 and $11.4 million for the quarter and six months ended June 30, 2000, respectively an increase of 28.4% and 52.6% over comparable periods in prior year. As a percentage of services and other revenue, cost of services and other revenue was 72.7% and 85.0% in the quarter ended June 30, 2000 and 1999 respectively and 72.9% and 71.9% for the six-month period ended June 30, 2000 and 1999, respectively. During the second quarter of 2000, Retek continued to expand its consulting services business by increasing the number of personnel to 89 from 65 as of June 30, 2000 and 1999, respectively. RESEARCH AND DEVELOPMENT EXPENSE Research and development expenses, which are expensed as incurred, consist primarily of salaries and related costs of Retek's engineering organization; fees paid to third-party consultants; and an allocation of facilities and depreciation expenses. Retek increased investment in research and development in absolute dollars each year since 1995. Research and development expenses increased to $8.8 million and $16.8 million for the quarter and six months ended June 30, 2000 and 1999, respectively, an increase of 60.9% and 72.5% over comparable periods in prior year. The absolute dollar increase in research and development expenses was due to significant increases in personnel costs, which included hired personnel and third party consultants. In the second quarter of 2000, research and development personnel increased to 296 from 139 in the second quarter of 1999. Retek invested heavily in the development of new product solutions during the first two quarters of 2000. Also, the allocation for facilities and depreciation expense increased as a result of expenditures required for additional office space and capital equipment to support the additional personnel. Retek expects the absolute dollar increase in research and development to continue as it invests in the development of other new solutions. 38 39 RETEK INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) SALES AND MARKETING EXPENSE Sales and marketing expenses consist primarily of salaries and related costs of the sales and marketing organization; sales commissions; costs of marketing programs, including public relations, advertising, trade shows and sales collateral; and an allocation of facilities and depreciation expenses. Sales and marketing expenses increased to $9.6 and $18.3 million for the quarter and six months ended June 30, 2000, respectively, an increase of 111.6% and 118.7% over comparable periods in prior year. The increase was primarily due to an increase in personnel and related costs of $1.8 and $3.9 million for the quarter and six-month period ended June 30, 2000, respectively, an increase in third party consulting of $978,000 and $1.5 million for the quarter and six-month period ended June 30, 2000, respectively, and an increase in marketing costs of $1.6 and $3.1 million for the quarter and six-month period ended June 30, 2000, respectively. In the second quarter of 2000 personnel and related costs increased due to an increase in the number of sales and marketing employees to 139 from 60 in the second quarter of 1999. The increase during the second quarter of 2000 in personnel and related costs was due to the continued build up of Retek's sales force and marketing operations. Also, the allocation for facilities and depreciation expense increased as a result of expenditures required for additional office space and capital equipment to support the additional personnel. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expenses consist primarily of costs from finance and human resources organizations; legal and other professional service fees; and an allocation of facilities costs and depreciation expenses. General and administrative expenses increased to $2.7 million and $5.0 million for the quarter and six-month period ended June 30, 2000, respectively, an increase of 99.2% and 96.7% over comparable periods in prior year. The increase in absolute dollars in general and administrative expenses in the quarter and six months ended June 30, 2000 was attributable to the growth of the administrative organization to support overall growth. Personnel costs increased $440,000 and $1.0 million for the quarter and six-month period ended June 30, 2000, respectively. In the second quarter of 2000 total general and administrative employees increased to 61 from 38 in the second quarter of 1999. The increase was also due to us incurring additional compliance expenses and other professional fees associated with being an independent public company. Also, the allocation for facilities and depreciation expense increased as a result of expenditures required for additional office space and capital equipment to support the additional personnel. Retek expects general and administrative expenses to increase in absolute dollars in the foreseeable future to support infrastructure growth. STOCK-BASED COMPENSATION EXPENSE Deferred stock-based compensation represents the difference between the exercise price and the fair value of Retek's common stock for accounting purposes on the date that certain stock options were granted. This deferred amount is included as a component of stockholders' equity and is being amortized on an accelerated basis by charges to operations over the vesting period of the options, consistent with the method described in Financial Accounting Standards Board Interpretation No. 28. Retek granted stock options to its employees under the 1999 Equity Incentive Plan and the HighTouch Technologies, Inc 1999 Stock Option Plan and to members of its board of directors through both the 1999 Equity Incentive Plan and the 1999 Directors Stock Option Plan. Amortization of stock-based compensation was $2.8 and $5.4 million for the quarter and six-month period ended June 30, 2000 respectively. ACQUISITION-RELATED AMORTIZATION EXPENSE Acquisition-related amortization of intangibles increased to $1.8 and $2.5 million for the quarter and six-month period ended June 30, 2000, respectively from $258,000 and $516,000 for the comparable period in 1999. In connection with the purchase of HighTouch Technologies, Inc in 2000 the application of the purchase method of accounting for the acquisition resulted in an excess of cost over net assets acquired of $19.3 million, of which $15.3 million was allocated to intangibles and $4.0 million was allocated to in-process research and development. In conjunction with the purchase, Retek recorded various intangible assets, which are being 39 40 RETEK INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) amortized over estimated useful lives ranging from three to five years. In connection with the purchase of WebTrak in 1999, the application of the purchase method of accounting for the acquisition resulted in an excess of cost over net assets acquired of $8.1 million, of which $6.6 million was allocated to intangibles and $1.5 million was allocated to in-process research and development. In conjunction with the purchase, Retek recorded various intangible assets, which are being amortized over estimated useful lives ranging from three to five years. In connection with the purchase of Retek Logistics in 1998, the application of the purchase method of accounting for the acquisition resulted in an excess of cost over net assets acquired of approximately $5.8 million, of which $4.0 million was allocated to intangibles and $1.8 million was allocated to in-process research and development. In conjunction with the purchase, Retek recorded various intangible assets, which are being amortized over estimated useful lives ranging from three to five years. IN-PROCESS RESEARCH AND DEVELOPMENT HighTouch is a provider of customized software and services relating to customer relationship management ("CRM"). 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, Statement of Financial Accounting Standards No. 2 and Financial Accounting Standards Board Interpretation No. 4. Prior to its acquisition, HighTouch primarily sold customized software and services to a variety of customers in the retail industry. At the time of acquisition, HighTouch had technology under development relating to the creation of the company's first fully integrated standardized off-the-shelf CRM product. This in-process R&D project was estimated to achieve technological feasibility in the third quarter of 2000. We used an independent appraisal firm to assist us with our valuation of the fair market value of the purchased assets of HighTouch. 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. The in-process R&D projects were valued through the use of a discounted cash flow analysis, taking into account projected future cash flows associated with these projects once they achieve technological feasibility, their stage of completion as of the acquisition date, and the expected return requirements (i.e. discount rate) for present valuing of the projected cash flows. Stage of completion was estimated by considering time, cost, and complexity of tasks completed prior to the acquisition as a percentage of total time, cost and effort required for the total project up to achieving technological feasibility. With respect to the projected financial information provided to the appraiser, Retek prepared a detailed set of projections forecasting revenue from the CRM technology as well as gross profit and operating profit margins. These projections were made based on an assessment of customer needs and the expected pricing and cost structure. 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. 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 26.2% based upon the methodology outlined below: 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 21.2%, which was used for valuing completed technology. Since incomplete technology would require a higher return than completed technology, the valuation report prepared by the Company's appraiser used a rate of 26.2% to present value cash flows (in excess of a return on other assets of the business) attributable to in-process research and development projects. The HighTouch in-process research and development project continues to progress, in all material respects, consistently with our original assumptions that were provided to the independent appraiser and used to value the in-process research and development. 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. Our inability to complete the in-process technologies within the expected timeframes could materially impact future revenues and earnings, which could have a material adverse effect on our business, financial condition and results of operations. 40 41 RETEK INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) OTHER INCOME (EXPENSE) Other income, net increased to $409,000 and $1.5 million for the quarter months and six months ended June 30, 2000, respectively up from (2,000) and 14,000 for the same period in 1999. The increase was due to interest income earned on cash equivalents and investments. INCOME TAXES The income tax (benefit)/provision was ($5.7) and ($11.4) million for the period ending June 30, 2000, respectively, from $1.2 million and $2.3 million for the same periods in 1999. These amounts are based on management's estimates of the effective tax rates to be incurred by Retek during those respective fiscal years. LIQUIDITY AND CAPITAL RESOURCES Prior to its initial public offering, Retek funded operations primarily through funding from HNC in the form of intercompany advances. Since the initial public offering, Retek has not obtained any additional funding from HNC. At June 30, 2000, Retek's cash and cash equivalent balance was $38.4 million. In addition, it had investments of $9.9 million. Net cash provided by operating activities was $4.1 million for the six months ended June 30, 2000 and $1.3 million for the comparable period in 1999. Principal operating cash flow adjustments that offset Retek's net loss were amortization of stock-based compensation, acquired in-process research and development, depreciation and amortization, increases in deferred revenue and accrued liabilities, and decreases in accounts receivable. Uses of cash in the for the six months ended June 30, 2000 were due to increases in deferred income taxes and other assets and a decrease in accounts payable. Net cash used in investing activities was $42.0 million for the six months ended June 30, 2000 and $2.8 million for the comparable period in 1999. In the six months ended June 30, 2000, uses of cash were due to the cash paid for business acquisitions, acquisition of capital equipment, primarily computer equipment and software and purchase of investments. Net cash used by financing activities was $6.8 million in the six months ended June 30, 2000. Net cash provided by financing activities was $2.0 million for the six months ended June 30, 1999. Net cash used in 2000 included $755,000 in borrowings from HNC and $15.4 million in payments to HNC. Beginning in 1997, HNC implemented a cash management policy that all cash balances were transferred daily from all of HNC's subsidiaries, including Retek, into a centralized cash management account at HNC. The financing activities with HNC include borrowings and payment from these cash management activities in 1999. Starting in November 1999 these daily transfers to HNC ceased. Net cash provided by financing activities in 2000 included proceeds from the issuance of common stock and proceeds from the issuance of debt. Retek believes that the net proceeds of its initial public offering, together with its current cash and cash equivalents 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. Retek's management intends to invest the excess of current operating requirements in short-term, interest-bearing, investment-grade securities. A portion of Retek'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. Retek regularly evaluates, in the ordinary course of business, potential acquisitions of such businesses, products, technologies or data. In addition, Retek's ability to enter into any acquisition of a business or assets may be limited if HNC completes the distribution. Specifically, pursuant to the terms of a corporate rights agreement between HNC, and Retek until two years, and possibly longer, after the distribution of HNC's remaining shares of Retek's common stock, Retek's ability to issue common stock in connection with acquisitions, offerings or otherwise will be limited. 41 42 RETEK INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) FACTORS THAT MAY IMPACT FUTURE RESULTS OF OPERATIONS An investment in our common stock involves a high degree of risk. Investors evaluating our company and its business should carefully consider the factors described below and all other information contained in this Quarterly Report on Form 10-Q before purchasing our common stock. Any of the following factors could materially harm our business, operating results and financial condition. Additional factors and uncertainties not currently known to us or that we currently consider immaterial could also harm our business, operating results and financial condition. Investors could lose all or part of their investment as a result of these factors, in addition to others. While Retek's management is optimistic about our long-term prospects, the following factors, among others, could materially harm its business, operating results and financial condition and should be considered in evaluating Retek. Industry's rapid pace of change. If Retek is unable to develop new software solutions or enhancements to its existing products on a timely and cost-effective basis, or if new products or enhancements do not achieve market acceptance, its sales may decline. The life cycles of its products are difficult to predict because the business-to-business electronic commerce market for Retek's products is new and emerging and is characterized by rapid technological change and changing customer needs. The introduction of products employing new technologies could render its existing products or services obsolete and unmarketable. In developing new products and services, Retek may: - fail to respond to technological changes in a timely or cost-effective manner; - encounter products, capabilities or technologies developed by others that render our products and services obsolete or noncompetitive or that shorten the life cycles of its existing products and services; - experience difficulties that could delay or prevent the successful development, introduction and marketing of these new products and services; or - fail to achieve market acceptance of its products and services. Fluctuations in quarterly operating results. Retek's quarterly operating results have fluctuated in the past and are expected to continue to fluctuate in the future. If its quarterly operating results fail to meet analysts' expectations, the trading price of Retek common stock could decline. In addition, significant fluctuations in its quarterly operating results may harm business operations by making it difficult to implement its budget and business plan. Factors, many of which are outside of Retek's control, which could cause its operating results to fluctuate include: - the size and timing of customer orders, which can be affected by customer budgeting and purchasing cycles; - the demand for and market acceptance of its software solutions; - competitors' announcements or introductions of new software solutions, services or technological innovations; - its ability to develop, introduce and market new products on a timely basis; - customer deferral of material orders in anticipation of new releases or new product introductions; - its success in expanding our sales and marketing programs; 42 43 RETEK INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) - increased sales of Oracle Retail(TM) during its second fiscal quarter due to seasonally greater sales by Oracle near its fiscal year-end in May; - technological changes or problems in computer systems; and - general economic conditions which may affect its customers' capital investment levels. In addition, Retek has incurred, and will continue to incur, compensation expense in connection with its grant of options under the 1999 Equity Incentive Plan and the 1999 Directors Stock Option Plan. This expense will be amortized over the vesting period of these granted options, which is generally four years, resulting in lower quarterly income. Quarterly expense levels are relatively fixed and are based, in part, on expectations as to future revenue. As a result, if revenue levels fall below Retek's expectations, net income will decrease because only a small portion of its expenses vary with revenue. New type of license agreement. Until recently, Retek generally licensed its products to customers on a perpetual basis, and recognized revenue upon delivery of the products. In the fourth quarter of 1999, Retek entered into software licensing agreements with revised terms for the majority of new sales of software products. Under these agreements, it will provide technical advisory services after the delivery of the product to help customers exploit the full value and functionality of its products. Revenue from the sale of software licenses and technical advisory services under these agreements will be recognized as the services are performed over the contract period, which Retek expects will generally be 12 to 24 months, as determined by its customers' objectives. As Retek begins to recognize license and service revenues over a period of time, rather than upon the delivery of our products, it will recognize significantly less revenue, have lower associated margins for several quarters, as compared to previous quarters, have higher operating expenses as a percentage of total revenues and will incur operating losses for several quarters. Early stage of development of the retail.com network. Retek began operation of the retail.com network on September 26, 1999. Retek incurred, and will continue to incur, significant infrastructure costs in establishing this network. During the first quarter of 2000 it invested approximately $10.4 million in retail.com. Retek will continue to invest in new products and services to be offered over the retail.com network in the foreseeable future. Broad and timely acceptance of the retail.com network is subject to a number of significant risks. These risks include: - its need to provide value-enhancing software solutions and services on the retail.com network to achieve widespread commercial acceptance of this network; - whether its network will be able to support large numbers of retailers and the members of their supply chains; and - its need to significantly expand internal resources and incur associated expenses to support planned growth of the retail.com network. Retek has established a subscription pricing model for the software solutions provided on its retail.com network, whereby members pay an annual fee based on the number of the member's employees who will have access to the network. As additional services are added to the retail.com network, Retek will need to establish pricing models for these new services. If the pricing models for the retail.com network fail to be competitive and profitable or if they are not acceptable to customers, its network will not be commercially successful, which could harm Retek's revenue and business. Increased operating expenses. Retek intends to significantly increase operating expenses as it: - increases research and development activities; - increases services activities; 43 44 RETEK INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) - develops and build the retail.com network; - expands its distribution channels; - increases sales and marketing activities, including expanding our direct sales force; - builds its internal information technology system; and - operates as an independent public company. Retek will incur expenses before it generates any revenue from this increase in spending. If it does not significantly increase revenue from these efforts, its business and operating results could be seriously harmed. Competitive pressures. The market for Retek's software solutions is highly competitive and subject to rapidly changing technology. Competition could seriously impede its ability to sell additional products and services on terms favorable Retek. Competitive pressures could reduce its market share or require it to reduce prices, which would reduce its revenues and/or operating margins. Many of Retek's competitors have substantially greater financial, marketing or other resources, and greater name recognition. In addition, these companies may adopt aggressive pricing policies that could compel Retek to reduce the prices of its products and services in response. Retek's competitors may also be able to respond more quickly than Retek can to new or emerging technologies and changes in customer requirements. Retek's current and potential competitors may: - develop and market new technologies that render its existing or future products obsolete, unmarketable or less competitive; - make strategic acquisitions or establish cooperative relationships among themselves or with other solution providers, which would increase the ability of their products to address the needs of its customers; and - establish or strengthen cooperative relationships with its current or future strategic partners, which would limit its ability to sell products through these channels. As a result, Retek may not be able to maintain a competitive position against current or future competitors. Loss of key personnel. Retek believes that its future success will depend upon its ability to attract and retain highly skilled personnel, including John Buchanan, its chairman and chief executive officer; Gordon Masson, its president, core applications; John L. Goedert, its senior vice president, research and development; Gregory A. Effertz, its vice president, finance and administration and chief financial officer and Jeremy Thomas, its president, retail.com. Retek currently does not have any key-man life insurance relating to key personnel, who are employees at-will and are not subject to employment contracts except for Jeremy Thomas who has a two year employment contract. The loss of the services of any one or more of these key persons could harm Retek's ability to grow the business. Retek also must attract, integrate and retain skilled sales, research and development, marketing and management personnel. Competition for these types of employees is intense, particularly in Retek's industry. Failure to hire and retain qualified personnel would harm its ability to grow the business. Relationships with third parties who implement Retek's products. Retek relies, and expects to continue to rely, on a number of third parties to implement its software solutions at customer sites. If Retek is unable to establish and maintain effective, long-term relationships with these implementation providers, or if these providers do not meet the needs or expectations of its customers, its revenue will be reduced and its customer relationships will be harmed. Retek's current implementation partners are not contractually required to continue to help implement its software solutions. If the number of product implementations 44 45 RETEK INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) continues to increase, Retek will need to develop new relationships with additional third-party implementation providers to provide these services. Retek may be unable to establish or maintain relationships with third parties having sufficient qualified personnel resources to provide the necessary implementation services to support its needs. If third-party services are unavailable, Retek will be required to provide these services internally, which would significantly limit our ability to meet customers' implementation needs and would increase its operating expenses and could reduce gross margins. A number of Retek's competitors, including IBM and SAP, have significantly more established relationships with these third parties and, as a result, these third parties may be more likely to recommend competitors' products and services rather than Retek's. In addition, it cannot control the level and quality of service provided by its current and future implementation partners. Intellectual property of third parties. Retek must now, and may in the future have to, license or otherwise obtain access to the intellectual property of third parties and related parties, including HNC, Lucent, MicroStrategy and Oracle. Retek's business would be seriously harmed if the providers from whom it licenses such software cease to deliver and support reliable products or enhance their current products. In addition, the third-party software may not continue to be available to Retek on commercially reasonable terms or prices or at all. Retek's inability to maintain or obtain this software could result in shipment delays or reduced sales of its products. Furthermore, it might be forced to limit the features available in its current or future product offerings. Either alternative could seriously harm business and operating results. Confidentiality of intellectual property. Retek depends on its ability to develop and maintain the proprietary aspects of its technology. To protect proprietary technology, Retek relies primarily on a combination of contractual provisions, confidentiality procedures, trade secrets, and copyright and trademark laws. Retek seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. In addition, Retek cannot assure investors that any of its proprietary rights with respect to the retail.com network will be viable or of value in the future because the validity, enforceability and type of protection of proprietary rights in Internet-related industries are uncertain and still evolving. Despite Retek's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of its products or obtain and use information that it regards as proprietary. Policing unauthorized use of Retek's products is difficult and expensive, and while it is unable to determine the extent to which piracy of its software products exists, software piracy may be a problem. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent, as do the laws of the United States. Retek intends to vigorously protect intellectual property rights through litigation and other means. However, such litigation can be costly to prosecute and it cannot be certain that it will be able to enforce its rights or prevent other parties from developing similar technology, duplicating its products or designing around its intellectual property. Potential third party claims that Retek's products infringe on their intellectual property. There has been a substantial amount of litigation in the software industry and the Internet industry regarding intellectual property rights. It is possible that in the future third parties may claim that Retek's current or potential future products infringe their intellectual property. Retek expects that software product developers and providers of electronic commerce solutions will increasingly be subject to infringement claims as the number of products and competitors in its industry segment grow and the functionality of products in different industry segments overlap. Any claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require Retek to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to Retek or at all, which could seriously harm its business. International sales. Since Retek sells products worldwide, its business is subject to risks associated with doing business internationally. To the extent that its sales are denominated in foreign currencies, the revenue Retek receives could be subject to fluctuations in currency exchange rates. If the effective price of the products Retek sells to its customers were to increase due to fluctuations in foreign currency 45 46 RETEK INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) exchange rates, demand for Retek's technology could fall, which would, in turn, reduce its revenue. Retek has not historically attempted to mitigate the effect that currency fluctuations may have on its revenue through use of hedging instruments, and it does not currently intend to do so in the future. Retek anticipates that revenue from international operations will continue to represent a substantial portion of its total revenue. Accordingly, its future results could be harmed by a variety of factors, including: - changes in foreign currency exchange rates; - greater risk of uncollectible accounts; - changes in a specific country's or region's political or economic conditions, particularly in emerging markets; - trade protection measures and import or export licensing requirements; - potentially negative consequences from changes in tax laws; - difficulty in staffing and managing widespread operations; - international variations in technology standards; - differing levels of protection of intellectual property; and - unexpected changes in regulatory requirements. Acceptance of the Internet. As Retek's software solutions are Internet-based, it depends on the acceptance of the Internet as a communications protocol. However, this acceptance may not continue. Rapid growth of the Internet is a recent phenomenon. The Internet may not be accepted as a viable long-term communications protocol for businesses for a number of reasons. These reasons include: - potentially inadequate development of the necessary communications and computer network technology, particularly if rapid growth of the Internet continues; - delayed development of enabling technologies and performance improvements; - increased security risks in transmitting and storing confidential information over public networks; and - potentially increased governmental regulation. Errors and defects in Retek's products. Retek's products are complex and, accordingly, may contain undetected errors or failures when it first introduces them or as it releases new versions. This may result in loss of, or delay in, market acceptance of its products and could cause us to incur significant costs to correct errors or failures or to pay damages suffered by customers as a result of such errors or failures. In the past, Retek has discovered software errors in new releases and new products after their introduction. Retek has incurred costs during the period required to correct these errors, although to date such costs, including costs incurred on specific contracts, have not been material. Retek may in the future discover errors in new releases or new products after the commencement of commercial shipments. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"), which is 46 47 RETEK INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED) effective for all fiscal quarters of fiscal years beginning after June 15, 1999. This statement establishes a new model for accounting for derivatives and hedging activities. Under FAS 133, all derivatives must be recognized as assets and liabilities and measured at fair value. In July 1999, the FASB issued Statement of Accounting Standards No. 137 "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133," which defers the effective date to all fiscal quarters of fiscal years beginning after June 15, 2000. The adoption of FAS 133 is not expected to have a significant impact on Retek's consolidated financial position or results of operations. In January 200, the Financial Accounting Standards Board's Emerging Issues Task Force published Issue No. 00-2 "Accounting for Web Site Development Costs", or EITF 00-2. EITF 00-2 applies the guidance given in the American Institute of Certified Public Accountants's Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", or SOP 98-1, to Web site development costs. Under SOP 98-1, software development costs, consisting of internally developed software and Web site development costs, include internal and external costs incurred to develop internal-use computer software during the application development stage are capitalized. Application development stage costs generally include software configuration, coding, installation to hardware and testing. Costs of significant upgrades and enhancements that result in additional functionality are also capitalized. Costs incurred for maintenance and minor upgrades and enhancements are expensed as incurred. The estimated useful lives are based on planned or expected significant modification or replacement of software applications, in response to the rapid rate of change in the internet industry and technology in general. Adoption of EITF 00-2 is required for the third quarter of 2000. We have not yet determined the impact of the adoption of this new accounting standard on our consolidated financial position, results of operations or disclosures. 47 48 HNC SOFTWARE INC. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The following discusses our exposure to market risk related to changes in interest rates, foreign currency exchange rates and equity prices. INTEREST RATE RISK The fair value of our cash, cash equivalents and investments available for sale at June 30, 2000 was $48.4 million. The objectives of our investment policy are safety and preservation of invested funds and liquidity of investments that is sufficient to meet cash flow requirements. It is our policy to place cash, cash equivalents and investments available for sale with high credit quality financial institutions and commercial companies and government agencies in order to limit the amount of credit exposure. It is also our policy to maintain certain concentration limits and to invest only in certain "allowable securities" as determined by management. The investment policy also provides that our investment portfolio must not have an average portfolio maturity of beyond eighteen months. Investments are prohibited in certain industries and speculative activities. Investments must be denominated in U.S. dollars. An increase in market interest rates would not directly affect our financial results, as it has no short- or long-term debt. FOREIGN CURRENCY EXCHANGE RATE RISK We develop products in the United States and sell in North America, Asia and Europe. As a result, financial results could be affected by various factors, including changes in foreign currency exchange rates or weak economic conditions in foreign markets. Our 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 our subsidiaries are kept in local currencies in which they do business, with excess funds transferred to our offices in the United States. Approximately 6.1 % and 15.1% of our sales were denominated in currencies other than the U.S. dollar for the three and six months as of June 30, 2000, respectively as compared to 3.6% and 19.4% for the same periods as of June 30, 1999. EQUITY PRICE RISK We have several equity investments we entered into for strategic business purposes, and therefore are exposed to direct equity price risk. We mitigate this risk by monitoring the financial performance of our investments. However, many of our equity investments are in the common stock of privately held, non-public companies and thus we may be unable to sell or achieve liquidity in those investments prior to an adverse change in their values. IMPACT OF EUROPEAN MONETARY CONVERSION We are aware of the issues associated with the changes in Europe resulting from the formation of a European economic and monetary union, or EMU. One change resulting from this union required EMU member states to irrevocably fix their respective currencies to a new currency, the euro, as of January 1, 1999, at which date the euro became a functional legal currency of these countries. Through December 31, 2002, business in the EMU member states will be conducted in both the existing national currencies, such as the French franc or the Deutsche mark, and the euro. As a result, companies operating or conducting business in EMU member states will need to ensure that their financial and other software systems are capable of processing transactions and properly handling these currencies, including the euro. We are still assessing the impact that conversion to the euro will have on our internal systems, the sale of our solutions and the European and global economies. We will take appropriate corrective actions based on the results of our assessment. We have not yet determined the cost related to addressing this issue although we do not expect these costs to be significant. 48 49 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In November 1998, Nestor filed a complaint against us in the United States District Court for the District of Rhode Island (C.A. No. 98 569). In the complaint, Nestor alleged that we violated the federal Sherman Antitrust Act and the Rhode Island Antitrust Act and tortuously interfered with prospective contractual business relationships of Nestor in connection with our marketing of our Falcon credit card fraud detection product. The complaint also alleged that we infringed United States patents Nos. 4,326,259 and 4,760,604 held by Nestor. Nestor seeks to recover unspecified compensatory damages, treble damages and punitive damages and to obtain injunctive relief arising from these claims. The complaint also sought a declaratory judgment that a United States patent we hold relating to technology used in our Falcon products is invalid and unenforceable due to our alleged inequitable conduct in obtaining this patent, and that Nestor's products do not infringe this patent. In January 2000, Nestor dropped its claim of patent infringement against us. In July,2000 we filed a motion with the Court to dismiss our counter-claim that Nestor infringes our patent, and Nestor's claims that the patent is invalid or unenforceable. That motion is still before the court in Rhode Island. The other Nestor claims for antitrust and unfair competition were severed by the court in an earlier ruling and will not be considered until after resolution of the patent issues. Our claims for patent infringement and unfair competition which were pending in the United States District Court venued in San Diego against Nestor's distributors Transaction Systems Architects, Inc., or TSAI, and ACI Worldwide, Inc., or ACI, where dismissed in April, 2000. We agreed with TSAI and ACI to dismiss our lawsuit against them in order to enable us to commence discussions with them regarding a possible future business relationship. However, no agreements have been reached to date with TSAI or ACI. We believe that these legal proceedings will not result in a material negative impact on our results of operations, liquidity or financial condition. ITEM 2. CHANGES IN SECURITIES AND USES OF PROCEEDS (c) As disclosed in the Report on Form 10-Q filed by HNC Software Inc. ("HNC") for its fiscal quarter ended June 30, 2000, on April 10, 2000 we issued 220,000 shares of our common stock and paid $2,400,000 in cash as consideration for our acquisition of Celerity Technologies, Inc. or Celerity, a developer and provider of translation software, desktop software, and value-added network services in support of the claims handling process based in Dublin, Ohio. We issued these shares and paid cash in a merger transaction in which Celerity became our wholly-owned subsidiary. Of the 220,000 shares of common stock we issued to the sole former Celerity shareholder, 33,000 shares are subject to an escrow to secure certain indemnification obligations of this shareholder to HNC. The shares we issued in this transaction were offered and sold solely to the shareholder of Celerity in exchange for the transfer of the entire ownership interests in Celerity in the merger. Our common stock issued in the Celerity merger was issued without registration under the Securities Act of 1933, as amended (the "1933 Act") in reliance on the exemptions afforded by Section 4(2) of the 1933 Act and Rule 506 of Regulation D promulgated under the 1933 Act. In relying upon the foregoing exemptions, we took into account the limited number of Celerity shareholders (1 in total), the limitation of our offering to this sole shareholder, the information regarding Celerity , HNC and the merger furnished to this sole shareholder, the representation of Celerity and its sole shareholder by legal counsel in connection with the transaction and representations and warranties made by Celerity and the sole Celerity shareholder to us in connection with the transaction. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We held our annual meeting of stockholders in San Diego, California on May 25, 2000, and re-adjourned this meeting on June 5, 2000. Of the 26,957,948 shares outstanding as of the record date for the meeting, 23,006,910 were present or represented by proxy at the meeting on June 5, 2000. At our annual meeting the following actions were voted upon: 49 50 a. The election of five directors, each to serve until the next annual meeting of stockholders and until his successor has been elected and qualified or until his earlier resignation, death or removal:
NOMINEE FOR WITHHELD AGAINST INSTRUCTED Edward K. Chandler 22,946,677 55,728 -- 4,505 Thomas F. Farb 22,946,677 55,728 -- 4,505 Charles H. Gaylord, Jr. 22,946,677 55,728 -- 4,505 Alex W. Hart 22,946,677 55,728 -- 4,505 John Mutch 22,946,677 55,728 -- 4,505
b. To amend our Certificate of Incorporation to increase the authorized number of shares of common stock from 50,000,000 shares to 120,000,000. FOR AGAINST ABSTAIN 18,697,745 4,290,550 18,615 c. To approve an amendment to our 1995 Equity Incentive Plan to increase the number of shares of common stock reserved for issuance under the plan by 1,850,000 shares. FOR AGAINST ABSTAIN 9,793,919 9,419,856 166,126 d. To approve an amendment to our 1995 Employee Stock Purchase Plan to increase the number of shares of common stock reserved for issuance under the plan by 200,000 shares and to provide that the number of shares of common stock reserved for issuance under the plan will be automatically increased each January 1 by an amount equal to 1% of the total number of shares outstanding on the previous December 31. FOR AGAINST ABSTAIN 18,064,225 1,264,649 51,027 e. To approve an amendment to our 1995 Directors Stock Option Plan to increase the number of shares of common stock reserved for issuance under the plan by 100,000 shares. FOR AGAINST ABSTAIN 15,949,288 3,371,044 59,569 f. To ratify the selection of PricewaterhouseCoopers LLP as our independent accounts for 2000. FOR AGAINST ABSTAIN 22,984,809 6,329 15,772 ITEM 5. OTHER INFORMATION We announced on August 7, 2000 that our board of directors declared a dividend on our common stock of all the shares of Retek common stock we own. The Retek shares will be distributed on or about September 29, 2000 to our stockholders who are holders of record of our common stock at 5 p.m. Eastern Daylight Time on September 15, 2000, the record date for the dividend. We currently own 40 million Retek shares, representing approximately 84.5 percent of Retek's outstanding common stock. We have received a private letter ruling from the Internal Revenue Service that the dividend of our shares of Retek stock will be tax-free to HNC and our stockholders for U.S. federal income tax purposes. Our stockholders of record at the record date will receive whole shares of Retek common stock and cash payments for fractional shares. Cash received in lieu of fractional shares will be taxable for U.S. federal income tax purposes. 50 51 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.02 Registrant's Restated Certificate of Incorporation filed with the Secretary of State of Delaware on June 13, 1996 (Incorporated by reference to Exhibit Number 4.07 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.03 Certificate of Amendment to Registrant's Restated Certificate of Incorporation filed with the Secretary of State of Delaware on June 12, 2000 (Incorporated by reference to Exhibit Number 4.08 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.04 Registrant's Bylaws, as amended (Incorporated by reference to Exhibit Number 4.09 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.05 HNC Software Inc. 1995 Equity Incentive Plan, as amended through March 30, 2000 (Incorporated by reference to Exhibit Number 4.01 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.06 Form of 1995 Equity Incentive Plan Option Agreement and Stock Option Exercise Agreement (Incorporated by reference to Exhibit Number 4.02 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.07 HNC Software Inc. 1995 Employee Stock Purchase Plan, as amended through March 30, 2000 (Incorporated by reference to Exhibit Number 4.03 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.08 Form of 1995 Employee Stock Purchase Plan Subscription Agreement and Enrollment Form (Incorporated by reference to Exhibit Number 4.04 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.09 HNC Software Inc. 1995 Directors Stock Option Plan, as amended through April 30, 2000 (Incorporated by reference to Exhibit Number 4.05 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.10 Form of 1995 Directors Stock Option Plan Stock Option Plan and Stock Option Exercise Agreement (Incorporated by reference to Exhibit Number 4.06 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 27.02 Financial Data Schedule (b) Reports on Form 8-K Report on Form 8-K filed dated May 25, 2000 reporting the acquisition of HighTouch Technologies, Inc. under Item 5. 51 52 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: August 14, 2000 By: /s/ KENNETH J. SAUNDERS ------------------------------- Kenneth J. Saunders Chief Financial Officer and Secretary (for Registrant as duly authorized officer and as Principal Financial Officer) /s/ RUSSELL C. CLARK ------------------------------- Russell C. Clark Vice President, Corporate Finance and Principal Accounting Officer (for Registrant as Principal Accounting Officer) 52 53 EXHIBIT INDEX EXHIBITS - - -------- 10.02 Registrant's Restated Certificate of Incorporation filed with the Secretary of State of Delaware on June 13, 1996 (Incorporated by reference to Exhibit Number 4.07 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.03 Certificate of Amendment to Registrant's Restated Certificate of Incorporation filed with the Secretary of State of Delaware on June 12, 2000 (Incorporated by reference to Exhibit Number 4.08 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.04 Registrant's Bylaws, as amended (Incorporated by reference to Exhibit Number 4.09 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.05 HNC Software Inc. 1995 Equity Incentive Plan, as amended through March 30, 2000 (Incorporated by reference to Exhibit Number 4.01 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.06 Form of 1995 Equity Incentive Plan Option Agreement and Stock Option Exercise Agreement (Incorporated by reference to Exhibit Number 4.02 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.07 HNC Software Inc. 1995 Employee Stock Purchase Plan, as amended through March 30, 2000 (Incorporated by reference to Exhibit Number 4.03 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.08 Form of 1995 Employee Stock Purchase Plan Subscription Agreement and Enrollment Form (Incorporated by reference to Exhibit Number 4.04 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.09 HNC Software Inc. 1995 Directors Stock Option Plan, as amended through April 30, 2000 (Incorporated by reference to Exhibit Number 4.05 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 10.10 Form of 1995 Directors Stock Option Plan Stock Option Plan and Stock Option Exercise Agreement (Incorporated by reference to Exhibit Number 4.06 to Registrant's Form S-8 filed on June 28, 2000, File Number 333-40344) 27.02 Financial Data Schedule 53 EX-10.01 2 ex10-01.txt EXHIBIT 10.01 1 EXHIBIT 10.01 AGREEMENT AND PLAN OF REORGANIZATION THIS AGREEMENT AND PLAN OF REORGANIZATION (this "AGREEMENT") is made and entered into as of April 10, 2000 (the "AGREEMENT DATE") by and among HNC SOFTWARE INC., a Delaware corporation ("HNC"), CTI MERGER CORP., a Delaware corporation that is a wholly-owned subsidiary of HNC ("SUB"), CELERITY TECHNOLOGIES, INC., an Ohio corporation ("CTI") and, solely for purposes of Sections 3, 5, 7.2, 11 and 12 of this Agreement, THE FRANK GATES COMPANIES, INC., an Ohio corporation ("FGC"). RECITALS A. The parties intend that, subject to the terms and conditions of this Agreement, Sub will be merged with and into CTI in a merger, with CTI to be the surviving corporation of such merger, pursuant to the terms and conditions of this Agreement and the applicable laws of the States of Ohio and Delaware. B. Upon the effectiveness of such merger (a) CTI will become a wholly-owned subsidiary of HNC and (b) all the common stock of CTI that is outstanding immediately prior to the effectiveness of the merger will be converted into the right to receive shares of the common stock of HNC and cash, all subject to the terms and conditions of this Agreement. C. The parties also intend for such merger to be treated as a "reorganization" under Section 368(a) of the Internal Revenue Code of 1986, as amended (the "CODE"). NOW, THEREFORE, in consideration of the above-recited facts and the mutual promises, covenants and conditions contained herein, the parties hereby agree as follows: ARTICLE 1 CERTAIN DEFINITIONS As used in this Agreement and its exhibits, the following terms will have the respective meanings set forth below: "CASH AMOUNT PER SHARE" means the quotient obtained by dividing (a) Two Million Four Hundred Thousand Dollars ($2,400,000) by (b) the CTI Fully Diluted Number (as defined below). "CTI ANCILLARY AGREEMENTS" means, collectively, each agreement or certificate (other than this Agreement) which CTI is to enter into as a party thereto, or otherwise is to execute and deliver, pursuant to this Agreement. "CTI COMMON STOCK" means CTI's Common Stock, no par value per share. "CTI DERIVATIVE SECURITIES" means, collectively: (a) any warrant, option, right or other security that entitles the holder thereof to purchase or otherwise acquire any shares of the capital stock of CTI of any class or series (collectively, "CTI STOCK RIGHTS"); (b) any note, evidence of indebtedness, stock (including without limitation convertible preferred stock) or other security of CTI that is convertible into or exchangeable for any shares of the capital stock of CTI of any class or series or for any CTI Stock Rights ("CTI CONVERTIBLE SECURITY"); and (c) any warrant, option, 2 right, note, evidence of indebtedness, stock or other security that entitles the holder thereof to purchase or otherwise acquire any CTI Stock Right or any CTI Convertible Security. "CTI FULLY DILUTED NUMBER" means that number of shares of the capital stock of CTI that is equal to the sum of: (a) the total number of shares of the capital stock of CTI that are issued and outstanding immediately prior to the Effective Time; plus (b) the total number of shares of the capital stock of CTI that, immediately prior to the Effective Time, are, directly or indirectly, potentially issuable by CTI upon the exercise, conversion or exchange in full of all CTI Derivative Securities (if any) that are issued and outstanding (or issuable) immediately prior to the Effective Time (determined as if all such CTI Derivative Securities were then fully vested and exercisable in full). "CTI STOCKHOLDERS" means those persons or entities (each being individually referred to herein as a "CTI STOCKHOLDER") who, as of immediately prior to the Effective Time, hold the shares of CTI Common Stock that are issued and outstanding immediately prior to the Effective Time. "CTI STOCKHOLDERS' VOTE" means, as applicable, (a) the written consent of CTI stockholders in lieu of a meeting effected in accordance with Section 1701.54 of the OGCL or (b) the special meeting of CTI stockholders to be called and held by CTI, in order to seek the CTI stockholders' approval of the Merger, this Agreement and the transactions contemplated thereby. "CTI WEBSITE" means all websites or other sites accessed via the internet or any other electronic network (including without limitation any cable-based network or private network), that are, in whole or in part, owned or operated by CTI including without limitation that certain website currently accessible at the URL address "http://www. celeritytech.com" (the "HOME CTI WEBSITE"). "CONVERSION NUMBER" means the quotient obtained by dividing (a) the number of shares of HNC Common Stock constituting the HNC Merger Shares by (b) the CTI Fully Diluted Number. "DGCL" means the Delaware General Corporation Law, as amended. "EFFECTIVE TIME" means the time and date on which the Merger first becomes legally effective under the laws of the States of Delaware and Ohio as a result of: (a) the filing with the Delaware Secretary of State of a Certificate of Merger in substantially the form of Exhibit A hereto (the "DELAWARE CERTIFICATE OF MERGER") in accordance with, and conforming to, the provisions of this Agreement and the requirements of Section 252 of the DGCL, and (b) the filing with the Ohio Secretary of State of a Certificate of Merger in the form of Exhibit B hereto (the "OHIO CERTIFICATE OF MERGER") conforming to the provisions of this Agreement and the applicable requirements of Section 1701.81 of the OGCL (the Delaware Certificate of Merger and the Ohio Certificate of Merger are collectively referred to herein as the "CERTIFICATES OF MERGER"). "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder. "FGC ANCILLARY AGREEMENTS" means, collectively, the Escrow Agreement, the Non-Competition Agreement and each other agreement or certificate (other than this Agreement) which FGC is to enter into as a party thereto, or otherwise is to execute and deliver, pursuant to this Agreement. 2 3 "HNC ANCILLARY AGREEMENTS" means, collectively, each agreement or certificate (other than this Agreement) which HNC is to enter into as a party thereto, or otherwise is to execute and deliver, pursuant to this Agreement. "HNC CLOSING PRICE PER SHARE" means the average of the closing prices per share of HNC Common Stock as quoted on the Nasdaq National Market and reported in The Wall Street Journal for the ten (10) trading days immediately preceding (but not including) the Closing Date. "HNC COMMON STOCK" means HNC's Common Stock, $0.001 par value per share. "HNC MERGER SHARES" means Two Hundred Twenty Thousand (220,000) shares of HNC Common Stock, as constituted on the Agreement Date. "HSR ACT" means the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the rules and regulations promulgated thereunder. "KNOWLEDGE" (a) when used with reference to CTI, means the collective actual knowledge of any person who, at the Agreement Date, was an officer of CTI or a member of CTI's Board of Directors; and (b) when used with reference to HNC, means the collective actual knowledge of the persons who, at the Agreement Date, are HNC's officers (within the meaning of Section 16 of the Exchange Act and the regulations promulgated thereunder). "LOSS" means, collectively, any and all claims, demands, suits, actions, causes of action, losses, damages, debts, liabilities, judgments, fines, penalties, costs and expenses including, without limitation, reasonable attorneys' fees, accountants' fees, tax preparers' fees, other professionals' and experts' reasonable fees and court or arbitration costs. "MATERIAL ADVERSE EFFECT" when used with reference to any entity or group of entities, means any event, change or effect that is (or will with the passage of time be) materially adverse to the financial condition, properties, assets, liabilities, business, operations, or results of operations of such entity and its subsidiaries, taken as a whole. "MATERIAL ADVERSE CHANGE" when used with reference to any entity or group of entities, means a material adverse change to the financial condition, properties, assets, liabilities, business, operations or results of operations of such entity and its consolidated subsidiaries, taken as a whole; provided however, that none of the following shall constitute a Material Adverse Change: (a) a change to the extent it arises or results, directly or indirectly, from general industry, economic or stock market conditions; or (b) a change that is proximately caused by the public announcement of, and the response or reaction of customers, vendors, licensors, investors, employees of such entity or group of entities to, this Agreement, the Merger or any of the transactions contemplated by this Agreement; or (c) solely with respect to HNC, a reduction in the market price of the capital stock of HNC and/or any of HNC's subsidiaries; or (d) solely with respect to HNC (i) any investment by third parties or any sale of stock or other equity security (including any public offering) in any subsidiary, business unit or asset of HNC, (ii) the grant by HNC of licenses or other rights in Intellectual Property or products to a business or entity of which HNC is not the sole owner; (iii) any distribution by HNC to its stockholders (or any distribution by a subsidiary of HNC to such subsidiary's stockholders) of stock or equity interests in a business unit or subsidiary of HNC. 3 4 The "MERGER" means the statutory merger of Sub with and into CTI to be effected pursuant to the terms and conditions of this Agreement. "OGCL" means the Ohio General Corporation Law, as amended. "SEC" means the U.S. Securities and Exchange Commission. "SECURITIES ACT" means the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. "SUB ANCILLARY AGREEMENTS" means, collectively, each agreement or certificate (other than this Agreement) which Sub is to enter into as a party thereto, or otherwise is to execute and deliver, pursuant to this Agreement. "TERMINATION DATE" means May 15, 2000. Other capitalized terms defined elsewhere in this Agreement and not defined in this Article 1 will have the meanings assigned to such terms in this Agreement. ARTICLE 2 PLAN OF REORGANIZATION 2.1 Conversion of Shares Upon Effectiveness of Merger. 2.1.1 Conversion of Sub Common Stock. At the Effective Time, each share of the Common Stock of Sub that is issued and outstanding immediately prior to the Effective Time will, by virtue of the Merger and without the need for any further action on the part of the holder thereof, be converted into and become one (1) share of CTI Common Stock that is issued and outstanding immediately after the Effective Time, and the shares of CTI Common Stock into which the shares of Sub Common Stock are so converted in the Merger will be the only shares of capital stock of CTI that are issued and outstanding immediately after the Effective Time. 2.1.2 Conversion of CTI Common Stock. Subject to the terms and conditions of this Agreement, at the Effective Time each share of CTI Common Stock that is issued and outstanding immediately prior to the Effective Time will, by virtue of the Merger, and without the need for any further action on the part of the holder thereof, be converted into: (a) the right to receive a number of shares of HNC Common Stock that is equal to the Conversion Number, subject to the provisions of Section 2.2 regarding the elimination of fractional shares; and (b) the right to receive an amount of cash equal to the Cash Amount Per Share. 2.2 Fractional Shares. No fractional shares of HNC Common Stock will be issued in connection with the Merger. In lieu thereof, each CTI Stockholder who would otherwise be entitled to receive a fraction of a share of HNC Common Stock pursuant to Section 2.1.2 (where the amount of such fraction will be determined in each case after aggregating all shares of HNC Common Stock to be received by such holder pursuant to Section 2.1.2), will instead receive from HNC, in lieu of any fractional share that would otherwise issuable to such holder under Section 2.1.2, a payment of cash in an amount equal to the fraction of a share of HNC Common Stock 4 5 that such holder would otherwise be entitled to receive (determined as provided above) multiplied by the HNC Closing Price Per Share, which amount shall be paid when such person is entitled, under the terms of Article 7, to receive a stock certificate for shares of HNC Common Stock issued to such holder in the Merger under Section 2.1.2 (and the amount of such cash payment will be rounded down to the nearest whole number of cents). 2.3 Tax-Free Reorganization. 2.3.1 The parties intend that this Agreement be a plan of reorganization, and that the Merger qualify as a reorganization within the meaning of Section 368(a) of the Code. The shares of HNC Common Stock issued in the Merger pursuant to Section 2.1.2 and the cash consideration to be paid in the Merger pursuant to Section 2.1.2, will be issued or paid solely for the issued and outstanding shares of CTI Common Stock pursuant to this Agreement. In addition, HNC represents that it presently intends, and that at the Effective Time it will intend, to continue CTI's historic business or use a significant portion of CTI's business assets in a business. 2.3.2 Notwithstanding anything herein, HNC makes no representations or warranty to CTI or to any stockholder of CTI regarding the tax treatment of the Merger or whether the Merger will qualify as a reorganization within the meaning of Section 368(a) of the Code or any other law or statute regarding taxation. CTI hereby acknowledges and agrees that CTI has not relied, and that no CTI stockholder is entitled to rely, on HNC or HNC's legal counsel, accountants or tax advisers, for any advice or counsel with respect to the tax treatment of the Merger, including without limitation its status as a reorganization under the Code. 2.4 Adjustments for Capital Changes. Notwithstanding the provisions of this Article 2, if at any time after the Agreement Date and prior to the Effective Time, HNC (a) recapitalizes, either through a subdivision (or stock split) of the outstanding shares of HNC Common Stock into a greater number of shares of HNC Common Stock, or a combination (or reverse stock split) of the outstanding shares of HNC Common Stock into a lesser number of shares of HNC Common Stock, or (b) declares a dividend or distribution on the outstanding shares of HNC Common Stock payable in shares of HNC Common Stock or in other securities, cash or property, or (c) reorganizes, reclassifies, exchanges or otherwise changes the outstanding shares of HNC Common Stock into other securities, cash or property through, without limitation, a merger, consolidation, reorganization, or recapitalization (other than through a subdivision or combination of shares provided for in clause (a) above or through a dividend or distribution provided for in clause (b) above), or (d) sets a record date that is prior to the Effective Time, for determining which holders of outstanding HNC Common Stock will be entitled to receive a dividend of the type described in clause (b) above, or to have their shares of HNC Common Stock reorganized, reclassified, exchanged or changed into other securities, cash or property as described in clause (c) above (each, a "CAPITAL CHANGE"), then the HNC Closing Price Per Share, the number of shares of HNC Common Stock constituting the HNC Merger Shares and the Conversion Number will each, if and to the extent necessary, be appropriately adjusted, the number of shares of HNC Common Stock constituting the HNC Merger Shares so as to equitably maintain the proportionate interests of the stockholders of HNC and CTI intended by this Agreement (but, in the case of stockholders of CTI, only with respect to their interests in the equity of HNC represented by those shares of HNC Common Stock that are issued or issuable pursuant to the Merger and this Agreement and, in the case of stockholders of HNC, only with respect to their interests in the equity of HNC as of the Effective Time); provided, however, that there shall only be a single such adjustment to reflect any event constituting a Capital Change, and there shall not be multiple adjustments with respect to any event due to the fact that such event may be described under more than one of the clauses (a) through (d) in this Section 2.4. 5 6 2.5 Escrow Agreement. 2.5.1 Escrow; Escrow Shares. HNC will be entitled to withhold from the CTI Stockholders, and to place in escrow as provided herein, fifteen percent (15%) of the shares of HNC Common Stock that are issuable to the CTI Stockholders at the Effective Time pursuant to Section 2.1.2 (such number of shares of HNC Common Stock to be so withheld and placed in escrow pursuant to this Section 2.5.1 are hereinafter collectively referred to as the "ESCROW SHARES"). HNC will deliver (i) certificates representing the Escrow Shares to State Street Bank and Trust Co., N.A. or a similar institution mutually agreed upon by the parties (the "ESCROW AGENT"), to be held by the Escrow Agent in escrow as security for CTI Stockholders' indemnification obligations under Article 11 hereof pursuant to the provisions of an Escrow Agreement in substantially the form of Exhibit C to be entered into at the Closing by HNC, the Escrow Agent, the Representative (as defined below) and each CTI Stockholder (the "ESCROW AGREEMENT"). The number of the Escrow Shares to be withheld from the shares of HNC Common Stock issued to each CTI Stockholder pursuant to Section 2.1.2 and placed in escrow under the Escrow Agreement (such CTI Stockholder's "ESCROW PRO RATA") will be fifteen percent (15%) of the number of shares of HNC Common Stock issuable to such CTI Stockholder at the Effective Time in the Merger pursuant to Section 2.1.2. The Escrow Shares will be represented by certificates issued and registered in the name of the Escrow Agent, but will be beneficially owned by the CTI Stockholders in proportion to their respective Escrow Pro Rata interests in the Escrow Shares and will be held in escrow by the Escrow Agent during the Escrow Period (as that term is defined in the Escrow Agreement) pursuant to the provisions of the Escrow Agreement. 2.5.2 Additional Provisions; Terms Binding on CTI Stockholders; Representative's Authority. By their approval of the Merger, each of the CTI Stockholders will be conclusively deemed to have consented to, approved and agreed to be personally bound by: (i) the provisions of Article 11, including without limitation all indemnification obligations of the CTI Stockholders thereunder; (ii) the Escrow Agreement and the terms and conditions thereof; (iii) the appointment of Niles C. Overly (in his capacity as the Chief Executive Officer of FGC) as the representative of the CTI Stockholders (together with each of his successor(s) appointed pursuant to this Agreement and the Escrow Agreement (the "REPRESENTATIVE")) and as the attorney-in-fact and agent for and on behalf of each CTI Stockholder as provided in this Agreement and the Escrow Agreement; and (iv) the taking by the Representative of any and all actions and the making of any decisions required or permitted to be taken by the Representative under this Agreement and/or under the Escrow Agreement, including without limitation the exercise by the Representative of the power to: (1) authorize delivery to HNC of Escrow Shares (or, if elected by a CTI Stockholder, the payment of cash in lieu thereof, in accordance with the provisions of the Escrow Agreement) in satisfaction of indemnity claims by HNC or any other Indemnified Person (as defined herein) pursuant to Article 11 and/or the Escrow Agreement; (2) agree to, negotiate, enter into settlements and compromises of, demand arbitration of, and comply with orders of courts and awards of arbitrators with respect to, any claim for indemnification made pursuant to Article 11; (3) arbitrate, contest, defend, resolve, settle or compromise any claim for indemnification made pursuant to Article 11 or any other dispute arising under this Agreement or the Escrow Agreement; and (4) take all actions necessary in the good faith judgment of the Representative for the accomplishment of the foregoing. The Representative will have the full right, power and authority to act on behalf of each CTI Stockholder with respect to all matters arising under or relating to Article 11 of this Agreement and/or the Escrow Agreement, including but not limited to the disposition, settlement or other handling of all indemnity claims, and any other matters, arising under Article 11 of this 6 7 Agreement and/or the Escrow so long as all CTI Stockholders are treated under the Escrow Agreement in the same manner on a pro rata basis in proportion to their respective Escrow Pro Rata interests in the Escrow Shares (except as an adversely affected CTI Stockholder may otherwise consent in writing). Each CTI Stockholder will be irrevocably bound by all actions taken by the Representative in connection with all matters arising under or relating to Article 11 of this Agreement and/or the Escrow Agreement, and HNC will be entitled to rely on any action or decision of the Representative in connection therewith. In performing the functions specified in this Agreement and the Escrow Agreement, the Representative will not be liable to any CTI Stockholder in the absence of gross negligence or willful misconduct on the part of the Representative. Any fees and expenses of the Escrow Agent will be paid by HNC except to the extent otherwise expressly provided in the Escrow Agreement. 2.6 Effects of the Merger. At and upon the Effective Time of the Merger: (a) the separate existence of Sub will cease, Sub will be merged with and into CTI and CTI will be the surviving corporation of the Merger (the "SURVIVING CORPORATION") pursuant to the terms of this Agreement and the Certificates of Merger; (b) each share of Sub Common Stock that is outstanding immediately prior to the Effective Time will be converted into one (1) share of CTI Common Stock as provided in Section 2.1.1; (c) each share of CTI Common Stock that is issued and outstanding immediately prior to the Effective Time will be converted into HNC Common Stock as provided in Section 2.1.2 and the applicable provisions of this Article 2; (d) the officers of the Surviving Corporation (and the respective offices they will hold) will be Earl Malit -- President and Chief Executive Officer, and John Falliers -- Chief Financial Officer and Secretary; (e) the directors of the Surviving Corporation will be Earl Malit and John Falliers (unless any such person declines to serve as a director of the Surviving Corporation, in which case HNC shall be authorized to appoint a substitute for such director); and (f) the Merger will, from and after the Effective Time, have all of the effects provided by applicable law. 2.7 Securities Laws Compliance - Private Placement Exemption. Subject to the terms and conditions of this Agreement, HNC will issue the shares of HNC Common Stock to be issued in the Merger pursuant to Section 2.1.2 pursuant to the exemption(s) from registration provided under Section 4(2) and/or Regulation D promulgated under the Securities Act, the exemption from qualification under Section 25120 of the California Corporate Securities Law of 1968, as amended (the "CALIFORNIA LAW") provided by Section 25100(o) of the California Law and applicable exemptions under applicable state securities laws. Accordingly, as a condition to consummation of the Merger, each CTI Stockholder must execute and deliver to HNC an Investment Representation Letter in the form of Exhibit D attached hereto (the "INVESTMENT REPRESENTATION LETTER"). 2.8 Further Assurances. If, at any time before or after the Effective Time, HNC believes or is advised that any further instruments, deeds, assignments or assurances are reasonably necessary or desirable to consummate the Merger or to carry out the purposes and 7 8 intent of this Agreement at or after the Effective Time, then HNC, the Surviving Corporation and their respective officers and directors may, execute and deliver all such proper deeds, assignments, instruments and assurances and do all other things necessary or desirable to consummate the Merger and to carry out the purposes of this Agreement, in the name of CTI or otherwise. ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF CTI AND FGC CTI and FGC jointly and severally represent and warrant to HNC that, except as set forth in the letter addressed to HNC from CTI that is executed by the President of CTI and dated as of the Agreement Date (including all schedules thereto) which has been delivered by CTI to HNC concurrently with the parties' execution of this Agreement (the "CTI DISCLOSURE LETTER"), each of the representations, warranties and statements contained in the following sections of this Article 3 is true and correct as of the Agreement Date and will be true and correct on and as of the Closing Date. For all purposes of this Agreement (including without limitation Articles 8 and 9 hereof), the statements contained in the CTI Disclosure Letter and its schedules shall also be deemed to be representations and warranties made and given by CTI and FGC under Article 3 of this Agreement. 3.1 Organization and Good Standing. CTI is a corporation duly organized, validly existing and in good standing under the laws of the State of Ohio. CTI has the corporate power and authority to own, operate and lease its properties and to carry on its business as now conducted and as proposed to be conducted, and is qualified to transact business, and is in good standing, as a foreign corporation in each jurisdiction in which its failure to be so qualified would have a Material Adverse Effect on CTI. CTI has delivered to HNC and to HNC's counsel, Fenwick & West LLP, true and correct copies of the currently effective Articles of Incorporation and Code of Regulations or other charter documents, as applicable, of CTI, each as amended to date. CTI is not in violation of its Articles of Incorporation, Code of Regulations or any other charter documents. All of the members of CTI's Board of Directors have been validly and lawfully elected to CTI's Board of Directors in compliance with CTI's Articles of Incorporation and Code of Regulations and applicable law (including without limitation the OGCL). 3.2 Subsidiaries. CTI does not have any subsidiary or any equity or ownership interest, whether direct or indirect, in any corporation, partnership, limited liability company, joint venture or other business entity. 3.3 Power, Authorization and Validity. 3.3.1 Power and Authority. CTI has all requisite corporate power and authority to enter into, execute, deliver, and perform its obligations under, this Agreement and each of the CTI Ancillary Agreements, and to consummate the Merger. The execution, delivery and performance by CTI of this Agreement and each of the CTI Ancillary Agreements have been duly and validly approved and authorized by CTI's Board of Directors and CTI's stockholders in full compliance with applicable law (including without limitation the OGCL) and CTI's Articles of Incorporation and Code of Regulations, each as amended. 3.3.2 No Consents. No consent, approval, order or authorization of, or registration, declaration or filing with, any court, administrative agency, commission or other governmental authority (each, a "GOVERNMENTAL AUTHORITY") is necessary or required to be made or obtained by CTI to enable CTI to lawfully execute and deliver, enter into, and to perform its 8 9 obligations under, this Agreement and each of the CTI Ancillary Agreements, or to consummate the Merger, except for: (a) the filing of the Delaware Certificate of Merger with the Delaware Secretary of State as required under the DGCL to effect the Merger; (b) the filing of the Ohio Certificate of Merger with the Ohio Secretary of State as required under the OGCL to effect the Merger; (c) such filings and notifications as may be necessary under the HSR Act with respect to the Merger and the other transactions contemplated by this Agreement and the expiration or early termination of any applicable waiting periods thereunder; and (d) any filings required to be made by CTI under applicable securities laws. 3.3.3 Enforceability. This Agreement and each of the CTI Ancillary Agreements are, or when executed by CTI will be, valid and binding obligations of CTI, enforceable against CTI in accordance with their respective terms, subject to the effect of (a) applicable bankruptcy and other similar laws affecting the rights of creditors generally and (b) rules of law and equity governing specific performance, injunctive relief and other equitable remedies. This Agreement, the Escrow Agreement and any agreement entered into by FGC pursuant to this Agreement are, or when executed by FGC will be, valid and binding obligations of FGC, enforceable against FGC in accordance with their respective terms, subject to the effect of (a) applicable bankruptcy and other similar laws affecting the rights of creditors generally and (b) rules of law and equity governing specific performance, injunctive relief and other equitable remedies. 3.4 Capitalization of CTI. 3.4.1 Capital Stock. (a) Authorized and Outstanding Shares. The authorized capital stock of CTI consists entirely of 850 shares of Common Stock, no par value per share, of which a total of 100 shares are issued and outstanding as of the Agreement Date. No fractional shares of CTI Common Stock are issued or outstanding and CTI holds no treasury shares. No shares of any preferred stock of CTI are, or ever have been, authorized, issued or outstanding. (b) Status of Shares. All of the issued and outstanding shares of CTI's capital stock have been duly authorized and validly issued, are fully paid and nonassessable, are not subject to any claim, lien, encumbrance, preemptive right, right of first refusal, right of first offer or right of rescission. All of the issued and outstanding shares of CTI's capital stock issued prior to the Effective Time have been offered, issued, sold and delivered by CTI in compliance with all registration or qualification requirements (or applicable exemptions therefrom) of all applicable federal and state securities laws. No stockholder of CTI owes CTI any money or other consideration representing any part of the purchase price of any outstanding shares of CTI's capital stock, including without limitation any money due under a promissory note payable to CTI. CTI has no liability (or potential liability) to any stockholder (or former stockholder) for any dividends that have been declared or accrued or for any portion of any repurchase or redemption price payable to such stockholder (or former stockholder) to repurchase or redeem any of the stockholder's shares of CTI capital stock. (c) Stockholders. FGC is the sole stockholder of CTI and owns all 100 outstanding shares of CTI Common Stock free and clear of any claims, liens, pledges, security interests, encumbrances and other impairments or imperfections of title. FGC's principal offices are located in the State of Ohio. FGC lawfully, validly and effectively acquired all of the issued and outstanding shares of CTI's stock as a dividend and distribution from The Frank Gates Service Company, an Ohio corporation that is an affiliate of FGC ("FGSC"). 9 10 3.4.2 No Options, Warrants or Rights. There are no options, warrants, convertible securities or other securities, calls, commitments, conversion privileges, preemptive rights, rights of first refusal, rights of first offer or other rights or agreements outstanding to purchase or otherwise acquire (whether directly or indirectly) any shares of CTI's authorized but unissued capital stock or any securities convertible into or exchangeable for any shares of CTI's capital stock or obligating CTI to grant, issue, extend, or enter into any such option, warrant, convertible security or other security, call, commitment, conversion privilege, preemptive right, right of first refusal, right of first offer or other right or agreement. There are no options, warrants, convertible debentures, or any other securities of CTI, or any rights to acquire shares of CTI stock or any warrants or other securities of CTI, that will become an option, warrant, convertible debenture, security or other right to purchase or otherwise acquire any capital stock or other securities of HNC by reason of the Merger or this Agreement. No person or entity holds, or has any option, warrant or other right to acquire, any issued and outstanding shares of the capital stock of CTI from any holder of shares of the capital stock of CTI or any other security holder of CTI. 3.4.3 No Voting Arrangements, Registration Rights. Except as set forth in Schedule 3.4.3 to the CTI Disclosure Letter, there are no voting agreements, voting trusts, proxies, preemptive rights, rights of first refusal, rights of first offer, rights of co-sale or tag-along rights, or any put option arrangements, buy-sell agreements or redemption agreements obligating CTI to redeem or repurchase any shares of its capital stock under any conditions or other restrictions applicable to any shares of CTI's outstanding stock or other securities or to the conversion of any shares of CTI's capital stock in the Merger pursuant to any agreement or obligation to which CTI is a party or, to CTI's knowledge, pursuant to any other agreement or obligation. CTI is not under any obligation to register under the Securities Act any of its presently outstanding shares of stock or other securities or any stock or other securities that may subsequently be issued by CTI. 3.5 No Conflict. Neither the execution and delivery of this Agreement nor any of the CTI Ancillary Agreements by CTI or FGC, nor the consummation of the Merger or any of the other transactions contemplated hereby or thereby, will conflict with, or (with or without notice or lapse of time, or both) result in: (a) a termination, or a breach, impairment or violation by CTI or FGC of (i) any provision of the Articles of Incorporation or Code of Regulations or other charter documents of CTI or FGC as currently in effect or (ii) any federal, state, local or foreign law, statute, rule, regulation, judgment, writ, decree or order, applicable to CTI or FGC or to any of their assets or properties; or (b) a termination, or a material breach, impairment or violation by CTI or FGC of (i) any Material CTI Agreement (as defined in Section 3.11) or (ii) any material agreement, instrument, commitment or obligation of FGC. Neither CTI's nor FGC's entering into this Agreement nor the consummation of the Merger will give rise to, or trigger the application of, any rights of any third party under any agreement, instrument, commitment or obligation of CTI or FGC that would come into effect upon the effectiveness of the Merger. The consummation of the Merger or any other transaction contemplated by this Agreement by CTI will not require the consent, release, waiver or approval of any third party other than the required approval of CTI's stockholders under the OGCL. Except as set forth in Schedule 3.5 to the CTI Disclosure Letter, no consent or approval of any third party is required to ensure that, following the Effective Time, any CTI Material Agreement will continue to be in full force and effect without any breach, default or violation thereof caused by virtue of this Agreement, the consummation of the Merger or by any other transaction called for by this Agreement or by any CTI Ancillary Agreement or any agreement entered into by FGC pursuant to this Agreement. 10 11 3.6 Litigation. There is no action, claim, suit, arbitration, mediation, proceeding, claim or investigation pending against CTI (or, to CTI's and FGC's knowledge, against any officer, director, stockholder, employee, key consultant or agent of CTI in their capacity as such or relating to their employment, services, stock holdings or relationship with CTI) before any court, administrative agency or arbitrator, nor, to CTI's knowledge, has any such action, suit, proceeding, arbitration, mediation, claim or investigation been threatened. There is no judgment, decree, injunction, rule or order of any governmental entity or agency, court or arbitrator outstanding against CTI or, to CTI's and FGC's knowledge, against any officer, director, stockholder, employee, key consultant or agent of CTI in their capacity as such. To CTI's and FGC's knowledge, there is no basis for any person, firm, corporation or other entity to assert a claim against CTI or FGC based upon: (a) CTI's or FGC's entering into this Agreement, any CTI Ancillary Agreement or consummating the Merger or any of the transactions contemplated by this Agreement or any CTI Ancillary Agreement or any agreement entered into by FGC pursuant to this Agreement; or (b) a disputed claim of ownership of any CTI capital stock or options, warrants or other rights to acquire ownership of, any shares of the capital stock of CTI or any rights as a CTI stockholder, including any option, warrant or preemptive rights, right of refusal, rights of co-sale or tag-along rights or rights to notice or to vote. 3.7 Taxes. 3.7.1 CTI has timely filed all federal, state, local and foreign tax returns required to be filed by it, has timely paid all taxes required to be paid by it for which payment is due, has established an adequate accrual or reserve for the payment of all taxes payable in respect of the periods subsequent to the periods covered by its most recent applicable tax returns (which accrual or reserve as of the Balance Sheet Date (as defined in Section 3.8) is fully reflected on the Balance Sheet (as defined in Section 3.8) and in any more recent balance sheet of CTI provided by CTI to HNC on or before the Agreement Date), has made all necessary estimated tax payments, and has no material liability for taxes in excess of the amount so paid or accruals or reserves so established except for taxes arising in the ordinary course of CTI's business since the Balance Sheet Date (as defined in Section 3.8). CTI is not delinquent in the payment of any tax or in the filing of any tax return, and no deficiencies for any tax have been threatened, claimed, proposed or assessed against CTI or any of the officers, employees or agents of CTI in their capacity as such. CTI has not received any notification from the Internal Revenue Service or any other taxing authority (including but not limited to any sales or use tax authority) that any material issues have been raised by (or are currently pending) before the Internal Revenue Service or such tax authority regarding CTI and no tax return of CTI has ever been audited by the Internal Revenue Service or any state or local taxing agency or authority. No tax liens have been filed or exist against any assets of CTI. CTI is not, and since its inception has not been, (a) an "S corporation" within the meaning of the Code or (b) a "personal holding company" within the meaning of the Code. CTI has not filed any election under Section 341(f) of the Code. CTI is not, and has never been, a "qualified subchapter S subsidiary" within the meaning of the Code. CTI has withheld with respect to each of its employees and independent contractors all taxes, including but not limited to federal and state income taxes, FICA, Medicare, FUTA and other taxes, required to be withheld, and paid such withheld amounts to the appropriate tax authority within the time prescribed by law. CTI has not made any payments, nor is it obligated to make any payments, nor is it a party to any agreement that under certain circumstances could obligate it to make any payments, that will not be deductible under Section 280G of the Code. CTI is not, and has not been at any time, a United States real property holding corporation within the meaning of Section 897(c)(2) of the Code. CTI is not a party to any tax allocation, tax indemnity or tax sharing agreement nor does CTI owe any amount under any such agreement. CTI has no liability for the taxes of any person (other than CTI) under Treasury Regulation 1.1502-6 (or any 11 12 similar provision of state, local or foreign law) or as a transferee or successor or by contract or otherwise. CTI has not distributed the stock of any corporation in a transaction satisfying the requirements of Section 355 of the Code nor has the stock of CTI been distributed by any other corporation in a transaction satisfying the requirements of Section 355 of the Code. Prior to January 1, 2000, CTI had during its entire existence been a member of an affiliated group filing a consolidated federal income tax return, the common parent of which is FGC (and which was formerly FGSC, an affiliate of FGC). 3.7.2 As used herein, the term "FGC AFFILIATED GROUP" means an affiliated group, the common parent of which is or was FGC. The FGC Affiliated Group has timely filed all federal, state, local and foreign tax returns required to be filed by it, has timely paid all taxes required to be paid by it for which payment is due, has established an adequate accrual or reserve for the payment of all taxes payable in respect of the periods subsequent to the periods covered by its most recent applicable tax returns, has made all necessary estimated tax payments, and has no material liability for taxes in excess of the amount so paid or accruals or reserves so established except for taxes arising in the ordinary course of the FGC Affiliated Group's business since the Balance Sheet Date (as defined in Section 3.8). Neither the FGC Affiliated Group nor any member thereof is delinquent in the payment of any tax or in the filing of any tax return, and no deficiencies for any tax have been threatened, claimed, proposed or assessed against the FGC Affiliated Group, any member thereof or any of the officers, employees or agents of FGC or any other member of the FGC Affiliated Group in their capacity as such. Neither FGC nor any other member of the FGC Affiliated Group has received any notification from the Internal Revenue Service or any other taxing authority (including but not limited to any sales or use tax authority) that any material issues have been raised by (or are currently pending) before the Internal Revenue Service or such tax authority regarding the FGC Affiliated Group, FGC or any other member of the FGC Affiliated Group and no tax return of the FGC Affiliated Group has ever been audited by the Internal Revenue Service or any state or local taxing agency or authority. No tax liens have been filed or exist against any assets of the FGC Affiliated Group. FGC made a valid election to be treated as an "S" corporation within the meaning of the Code effective January 1, 2000 and such election has not been terminated. Neither FGC nor any other member of the FGC Affiliated Group is or has ever been a "personal holding company" within the meaning of the Code. Neither the FGC Affiliated Group, FGC nor any other member of the FGC Affiliated Group has filed any election under Section 341(f) of the Code. The FGC Affiliated Group has withheld with respect to each of its employees and independent contractors all taxes, including but not limited to federal and state income taxes, FICA, Medicare, FUTA and other taxes, required to be withheld, and paid such withheld amounts to the appropriate tax authority within the time prescribed by law. 3.7.3 Any tax sharing, tax allocation and/or tax indemnity agreement ever made or entered into by and between FGC and CTI (if any) shall be terminated effective no later than immediately prior to the Effective Time and will have no further force or effect for any taxable year, whether the current year, a future year or a past year. 3.7.4 For the purposes of this Section, the terms "TAX" and "TAXES" include all federal, state, local and foreign income, alternative or add-on minimum income, gains, franchise, excise, property, property transfer, sales, use, employment, license, payroll, ad valorem, documentary, stamp, withholding, occupation, recording, value added or transfer taxes, governmental charges, fees, customs duties, levies or assessments (whether payable directly or by withholding), and, with respect to any such taxes, any estimated tax, interest, fines and penalties or additions to tax and interest on such fines, penalties and additions to tax. 12 13 3.8 CTI Financial Statements. (a) CTI has delivered to HNC, as Schedule 3.8 to the CTI Disclosure Letter, (a) the audited consolidating balance sheets of CTI as of December 31, 1997, 1998 and 1999 and CTI's audited consolidating income statements for each of its three full fiscal years ended December 31, 1997, 1998 and 1999 and (b) the unaudited consolidated balance sheets of CTI as of January 31, 2000 and February 29, 2000 and CTI's unaudited statements of profit and loss for the month ended January 31, 2000 and for the month ended February 29, 2000 (all such audited and unaudited financial statements of CTI and any notes thereto are hereinafter collectively referred to as the "CTI FINANCIAL STATEMENTS"). The CTI Financial Statements (a) are derived from and in accordance with the books and records of CTI, (b) fairly present the financial condition of CTI at the dates therein indicated and the results of operations for the periods therein specified and (c) have been prepared in accordance with generally accepted accounting principles applied on a basis consistent with prior periods (except, solely in the case of any of the CTI Financial Statements that are unaudited, for any absence of notes thereto and the absence of year-end audit adjustments). CTI has no material debt, liability or obligation of any nature, whether accrued, absolute, contingent or otherwise, and whether due or to become due, except for (i) those shown on CTI's unaudited balance sheet as of February 29, 2000 included in the CTI Financial Statements (the "BALANCE SHEET"), and (ii) those that may have been incurred after February 29, 2000 (the "BALANCE SHEET DATE") in the ordinary course of CTI's business consistent with its past practices, and that are not material in amount, either individually or collectively, and are not required to be set forth in the Balance Sheet under generally accepted accounting principles. All reserves established by CTI that are set forth in or reflected in the Balance Sheet (including but not limited to bad debt and warranty reserves and reserves for taxes) are reasonably adequate. At the Balance Sheet Date, there were no material loss contingencies (as such term is used in Statement of Financial Accounting Standards No. 5 issued by the Financial Accounting Standards Board in March 1975) which are not adequately provided for in the Balance Sheet as required by said Statement No. 5. CTI and FGC acknowledge that the number of shares of HNC Common Stock to be issued to the stockholders of CTI in the Merger was computed based on the amounts set forth in the CTI Financial Statements (including but not limited to the stated amounts of CTI's assets, liabilities, net revenues, expenses and net income (or loss) set forth in the Financial Statements). (b) The Closing Balance Sheet (as defined in Section 5.19 hereof): (i) will be derived from and in accordance with the books and records of CTI as such exist on and through the date of the Closing Balance Sheet; (ii) will fairly present the assets and liabilities and stockholders' equity of CTI as of the date of the Closing Balance Sheet; and (iii) will be prepared in accordance with generally accepted accounting principles (except for the absence of notes thereto and the absence of year-end audit adjustments) applied on a basis consistent with prior periods. The accounts receivable of CTI reflected on the Closing Balance Sheet will (i) be stated net of an adequate reserve for doubtful accounts, which reserve shall not exceed fifteen percent (15%) of the gross amount of CTI's accounts receivable as of the close of business on the date of the Closing Balance Sheet (less any intercompany receivables that are to be eliminated pursuant to the provisions of Section 9.17), and (b) be collectible in full in the amount of such accounts receivable as set forth in the Closing Balance Sheet, without offset or deduction. (c) The total outstanding balance of unpaid principal and accrued interest payable by CTI to Fifth Third Bank, Central Ohio ("FIFTH THIRD BANK") under that certain loan made by Fifth Third Bank to CTI and evidenced by that certain Term Note (Note No. 901951848-00018) of CTI dated August 1, 1999 in the initial principal amount of $550,000 made payable to the order of Fifth Third Bank (the "FIFTH THIRD BANK LOAN") shall not, as of the Effective Time, 13 14 exceed a total of $490,300, and no prepayment penalties or similar additional payments will arise or become payable in connection with the Fifth Third Bank Loan as a result of the repayment of the Fifth Third Bank Loan by HNC as contemplated by Section 6.9. 3.9 Title to Properties. Except as set forth in Schedule 3.9 to the CTI Disclosure Letter, CTI has good and marketable title to all of its respective assets and properties (including but not limited to those shown on the Balance Sheet), free and clear of all mortgages, deeds of trust, security interests, pledges, liens, title retention devices, collateral assignments, claims, charges, restrictions or other encumbrances of any kind (other than liens for current taxes that are not yet due and payable) except for liens of Taxes not yet due and payable. All machinery, vehicles, equipment and other tangible personal property owned or leased by CTI or used in its business are in reasonably good condition and repair, normal wear and tear excepted, and all leases of real or personal property to which CTI is a party are in full force and effect and afford CTI a valid leasehold interest in, and the right to peaceful and undisturbed leasehold possession of, the real or personal property that is the subject of the lease. CTI is not in violation in any material respect of any zoning, building or safety ordinance, regulation or requirement or other law or regulation applicable to the operation of its owned or leased properties, nor has CTI received any notice of violation of law with which it has not complied. CTI does not own any real property. 3.10 Absence of Certain Changes. Except as set forth in Schedule 3.10 to the CTI Disclosure Letter, since the Balance Sheet Date, there has not been with respect to CTI any: (a) Material Adverse Change; (b) amendment or change in the Articles of Incorporation or Code of Regulations of CTI; (c) incurrence, creation or assumption by CTI of (i) any mortgage, deed of trust, security interest, pledge, lien, title retention device, collateral assignment, claim, charge, restriction or other encumbrance of any kind on any of the assets or properties of CTI; or (ii) any obligation, liability or indebtedness for borrowed money; (d) payment or discharge by CTI of any security interest, lien, claim, or encumbrance of any kind on any asset or property of CTI, or the payment or discharge of any liability that was not shown on the Balance Sheet or was not incurred in the ordinary course of CTI's business after the Balance Sheet Date; (e) purchase, license, sale, assignment or other disposition or transfer, or any agreement or other arrangement binding on CTI for the purchase, license, sale, assignment or other disposition or transfer, of any assets, properties or goodwill of CTI other than in the ordinary course of CTI's business, consistent with its past practices; (f) damage, destruction, theft or loss of any property or asset of CTI, whether or not covered by insurance, having (or likely with the passage of time to have) a Material Adverse Effect on CTI; (g) declaration, setting aside or payment of any dividend on, or the making of any other distribution in respect of, any shares of the capital stock of CTI, or any direct or indirect redemption, repurchase or other acquisition by CTI of any shares of its capital stock or 14 15 other securities or any change in any rights, preferences, privileges or restrictions of any outstanding security of CTI; (h) change or increase in the compensation payable or to become payable to any of the officers, directors, employees or key consultants of CTI; (i) payment of cash, property or other consideration by CTI, or commitment, agreement or understanding that would require any payment of cash or other consideration by CTI to any of officer, director, employee, consultant or independent contractor of CTI, FGC or any of their respective affiliates in connection with, upon the consummation of, or by reason of, the Merger, this Agreement or any transaction contemplated by this Agreement; (j) change in any bonus or pension, insurance or other benefit payment, plan or arrangement (including without limitation stock awards, stock option grants, stock appreciation rights or stock option grants) made to or with any of such officers, employees, key consultants or agents except in connection with normal employee salary or performance reviews or otherwise in the ordinary course of CTI's business, consistent with its past practices and not in conflict with any of the provisions of this Agreement or any of the conditions contained in Article 8 or Article 9 of this Agreement); (k) the entering into, amendment of, relinquishment, termination or non-renewal by CTI of any CTI Material Agreement, other than in the ordinary course of CTI's business consistent with its past practices or as may be expressly required by the terms of this Agreement; (l) entering into by CTI of any transaction, contract or agreement that by its terms requires or contemplates a current and/or future financial commitment, expense (inclusive of overhead expense) or obligation on the part of CTI involving in excess of $50,000 that is not entered into in the ordinary course of CTI's business, or the conduct of any business or operations other than in the ordinary course of CTI's business; or (m) any license, transfer or grant by CTI of any CTI IP Rights (as defined in Section 3.13) or any rights thereunder, other than any such license, transfer or grant made in the ordinary course of CTI's business consistent with its past practices. 3.11 Contracts and Commitments/Licenses and Permits. Schedule 3.11 to the CTI Disclosure Letter sets forth a list of (i) each of the written or oral contracts, agreements, commitments or other instruments to which CTI is a party or to which CTI or any of its assets or properties is bound that are described below in this Section 3.11 and (ii) each of the licenses and permits held by CTI that are described below in this Section 3.11: (a) any distribution, marketing, sales representative or similar agreement under which any third party is authorized to sell, sublicense, lease, distribute, market or take orders for, any product, service or technology owned, marketed, licensed or provided by CTI; (b) any continuing contract for the future purchase, sale, license, provision or manufacture of products, material, supplies, equipment or services requiring payment to or from CTI in an amount in excess of $50,000 per annum which is not terminable on ninety (90) or fewer days' notice without cost or other liability to CTI; 15 16 (c) any contract or commitment in which CTI has granted or received most favored customer pricing provisions, exclusive sales, distribution, marketing or on-line distribution rights, rights of refusal, rights of first negotiation or similar rights with respect to any product, service, technology or Intellectual Property (as defined in Section 3.13) that is now or hereafter owned by, provided to, or provided by, CTI; (d) any grant, authorization, contract or agreement between CTI and any Governmental Authority; (e) any contract or arrangement providing for the development of any software, content (including without limitation textual content and visual or graphics content), technology or Intellectual Property by or for (or for the benefit or use of) CTI; (f) any agreement, contract or arrangement (including without limitation any agreement, contract or arrangement described in Section 3.13.7 hereof) providing for the purchase, lease or license of any software, content (including without limitation textual content and visual or graphics content), data (including but not limited to electronically stored data), technology or Intellectual Property to (or for the benefit or use of) CTI (indicating under which of such agreements, contracts or arrangements CTI pays royalties or similar payments to any third party); but excluding licenses for software that is generally available to the public at retail stores or which is generally available on standard, non-negotiable license terms at a per copy license fee of less than $2,000 per copy); (g) any agreement, contract or arrangement pursuant to which CTI has sold, leased or licensed any rights in or to any software, content (including without limitation textual content and visual or graphics content), data (including electronically stored data), technology or Intellectual Property to any third party, including but not limited to any agreement, contract or arrangement regarding CTI Source Code described in Section 3.13.8, if such agreement, contract or arrangement (i) involves or involved a payment to or from CTI of $25,000 or more, (ii) grants any exclusive rights, including but not limited to any exclusivity with respect to any product, market, industry, field of use or geographic territory; (iii) requires the ongoing payment of any royalties or periodic fees or payments by or to CTI; (iv) is material to CTI's business, Intellectual Property or technology; or (v) grants any third party any rights or licenses (whether currently effective or contingent) with respect to any CTI Source Code; (h) any joint venture or partnership contract or agreement, any agreement relating to a limited liability company, or any other agreement which has involved, or is reasonably expected to involve, a sharing of revenues, profits, cash flows, expenses or losses by CTI with any other party; (i) any contract or commitment for or relating to the employment or hiring for services of any officer, director, employee, consultant or independent contractor of CTI or any other type of contract or understanding with any director, officer, employee or consultant of CTI that is not immediately terminable by CTI without cost or other liability, including but not limited to any contract or agreement requiring CTI to make a payment to any officer, director, employee, consultant or independent contractor on account of the Merger or any transaction contemplated by this Agreement or agreement that is an exhibit to this Agreement; (j) any indenture, mortgage or trust deed encumbering any asset or property of CTI, any promissory note of CTI, any credit line, credit facility, loan agreement or other agreement or commitment for the borrowing of money pursuant to which CTI may borrow or 16 17 loan funds, any security agreement encumbering any asset or property of CTI, any security agreement encumbering any asset or property of a third party for the benefit of CTI, any guarantee by CTI of any obligation or indebtedness of another party or any guarantee of any obligation or indebtedness of CTI, and any agreement or commitment for a leasing transaction of a type required to be capitalized in accordance with Statement of Financial Accounting Standards No. 13 of the Financial Accounting Standards Board; (k) any lease or other agreement under which CTI is lessee of or holds or operates any items of tangible personal property or real property owned by any third party and under which payments to such third party exceed $20,000 per annum, and any agreement for the sale, purchase or disposition of any real property; (l) any agreement or arrangement for the sale, licensing or leasing by or to CTI of any assets, properties, products, services (including network access or network services) or rights having a value in excess of $50,000 or which is material to CTI's business as currently conducted; (m) any agreement that restricts CTI from engaging in any aspect of its business, from engaging, participating or competing in any line of business or market or that restricts CTI from engaging in any business in any market, with any customer(s) or in any geographic area; (n) any CTI IP Rights Agreement (as defined in Section 3.13) if such CTI IP Rights Agreement (i) involves or involved a payment to or from CTI of $25,000 or more, (ii) grants any exclusive rights, including but not limited to any exclusivity with respect to any product, service, market, industry, field of use or geographic territory; (iii) requires the ongoing payment of any royalties or periodic fees or payments by CTI; or (iv) is material to CTI's business, to CTI's Intellectual Property or technology or to any of CTI's current or proposed products or services; (o) any website hosting, website linking, consent or data sharing, data feed, information exchange, advertising, fee sharing, lead or customer referral, commerce, co-branding, framing, service, order or transaction processing or similar agreement relating to any aspect or element of any of the CTI Websites or any other website; (p) any agreement or plan (including but not limited to any stock option, stock purchase and/or stock bonus plan) relating to the sale, issuance, grant, exercise, award, purchase, repurchase or redemption of any shares of capital stock or any other securities of CTI or any options, warrants, convertible notes or other rights to purchase or otherwise acquire any such shares of stock, other securities or options, warrants or other rights therefore; (q) consulting or similar agreement under which CTI provides any advice or services to a third party (i) for an annual compensation to CTI of $25,000 per year or more or (ii) which by its terms is not terminable by CTI within six (6) months of the Effective Time; (r) any contract with or commitment to any labor union or any collective bargaining agreement or similar agreement with employees of CTI; (s) any agreement pursuant to which CTI has acquired a business or entity, or assets of a business or entity, whether by way of merger, consolidation, purchase of stock, purchase of assets, license or otherwise; 17 18 (t) any other instrument, agreement, contract, undertaking, understanding, understanding or commitment (whether verbal or in writing) to which CTI is a party or by which CTI or any of its assets or properties are bound that is (i) material to CTI's business, operations, assets, properties, operating results or financial condition or (ii) that involves a future financial commitment by CTI in excess of $100,000; and (u) any Governmental Permit (as defined in Section 3.14.4). A true and complete copy of each agreement or document required by subsections (a) through (t) of this Section to be listed on Schedule 3.11 to the CTI Disclosure Letter (such agreements and documents being collectively referred to in this Agreement as the "CTI MATERIAL AGREEMENTS") and a copy of each Governmental Permit required by subparagraph (u) of this Section to be listed on Schedule 3.11 to the CTI Disclosure Letter, has been delivered to HNC's counsel, Fenwick & West LLP. All CTI Material Agreements are in full force and effect. With respect to each CTI Material Agreement required to be described pursuant to subparagraph (a), (b), (c), (e), (f), (g) or (l) of this Section 3.11, Schedule 3.11 to the CTI Disclosure Letter shall set forth, as part of the description of such CTI Material Agreement, a true and complete listing of each product or service of CTI that is licensed (whether for end-use, distribution, resale or otherwise) under such agreement or that is subject to such agreement. 3.12 No Default; No Restrictions. (a) No Default. CTI is not in breach, default or violation of any CTI Material Agreement or of any representations or warranties made by CTI under any CTI Material Agreement. No event has occurred, and no circumstance or condition exists, that (with or without notice or lapse of time) will, or would reasonably be expected to: (i) result in a breach, default or violation of any of the provisions of any CTI Material Agreement; or (ii) give any third party (A) the right to declare a default or exercise any remedy under any CTI Material Agreement, (B) the right to a rebate, repurchase, charge back, penalty or change in delivery schedule under any CTI Material Agreement, (C) the right to accelerate the maturity or performance of any obligation of CTI under any CTI Material Agreement, or (D) the right to cancel, terminate, rescind, modify or refuse to renew any CTI Material Agreement. CTI has not received any notice or other communication (i) regarding any actual or asserted breach, default or violation of any CTI Material Agreement by CTI or by any other party to any CTI Material Agreement, or (ii) that any party to an CTI Material Agreement that is renewable by its terms does not intend or expect to renew any such CTI Material Agreement. (b) No Restrictions. CTI is not a party to any contract, agreement or arrangement which has had, or could reasonably be expected to have, a Material Adverse Effect on CTI, its business or financial condition. CTI has incurred no material liability for renegotiation of government contracts or subcontracts, if any. CTI is not a party to, and no asset or property of CTI is bound or affected by, any judgment, injunction, order, decree, contract, covenant or agreement (non-compete or otherwise) that restricts or prohibits (or purports to restrict or prohibit) CTI from freely engaging in any business now conducted by CTI or from competing anywhere in the world (including without limitation any contracts, covenants or agreements restricting the geographic area or markets in which CTI may sell, license, market, distribute, provide or support any product, technology or service, or restricting the markets, customers or industries that CTI may address in operating its businesses), or includes any grants by CTI of any exclusive license or distribution rights. 3.13 Intellectual Property. 18 19 3.13.1 CTI IP Rights; Intellectual Property. CTI owns, or has the valid right or license to use, possess, sell or license, all Intellectual Property (as defined below) necessary or required for the conduct of CTI's business as presently conducted and as presently proposed to be conducted (such Intellectual Property being hereinafter collectively referred to as the "CTI IP RIGHTS"), and such rights to use, possess, sell or license are sufficient for the conduct of such business. CTI owns all right, title and interest in and to, and all Intellectual Property associated with, all of the products or services developed and/or marketed by CTI, including but not limited to each of the following products: Employer-Connect; Admin-Connect; Provider-Connect; State-Connect and Trans-Connect; all Synapse network software not provided by AT&T; and all software developed for and used in the CTI Website. Except as may be set forth in Schedule 3.13 to the CTI Disclosure Letter, no Governmental Authority owns or holds any rights in any of the CTI IP Rights. On July 6, 1994, CTI duly and validly acquired sole ownership of, and currently owns, all right, title and interest in and to all of the Intellectual Property, other assets and agreements that were used by FGSC, an affiliate of FGC, in conducting the Employer-Connect, Medical First and Network Services businesses of FGSC as of July 6, 1994. As used herein, the term "INTELLECTUAL PROPERTY" means, collectively, all worldwide industrial and intellectual property rights, including, without limitation, patents, patent applications, patent rights, trademarks, trademark registrations and applications therefor, trade dress rights, trade names, service marks, service mark registrations and applications therefor, logos, Internet domain names, Internet and World Wide Web URLs or addresses, copyrights, copyright registrations and applications therefor, moral rights, mask work rights, mask work registrations and applications therefor, franchises, licenses, inventions, trade secrets, know-how, customer lists, supplier lists, proprietary processes and formulae, software source code and object code, algorithms, net lists, architectures, structures, screen displays, layouts, inventions, development tools, designs, blueprints, specifications, technical drawings (or similar information in electronic format) and all documentation and media constituting, describing or relating to the foregoing, including, without limitation, manuals, programmers' notes, memoranda and records. 3.13.2 No Default. Neither the execution, delivery and performance of this Agreement, the Certificates of Merger, or the consummation of the Merger and the other agreements and transactions contemplated hereby and/or by CTI Ancillary Agreements will: (a) constitute a material breach, violation or default of any instrument, contract, license or other agreement governing any CTI IP Right to which CTI or any of its subsidiaries is a party (collectively, the "CTI IP RIGHTS AGREEMENTS"); (b) cause the forfeiture or termination of, or give rise to a right of forfeiture or termination of, any CTI IP Right held or owned by CTI; or (c) materially impair the right of CTI or the Surviving Corporation or their affiliates to use, possess, sell or license any CTI IP Right or any portion thereof. There are no royalties, honoraria, fees or other payments payable by CTI or any of its subsidiaries to any third person by reason of the ownership, use, possession, license, sale, marketing, advertising or disposition of any CTI IP Rights by CTI or any of its subsidiaries. 3.13.3 No Infringement. Neither the manufacture, marketing, license, sale, furnishing, provision or intended use of any product or service (including without limitation any of the CTI Websites) currently licensed, utilized, sold, distributed, provided or furnished by CTI or currently under development by CTI violates any license or agreement between CTI and any third party or any law or infringes or misappropriates any Intellectual Property Right of any other party; and there is no pending or, to the knowledge of CTI, threatened, claim or litigation contesting the validity, ownership or right of CTI or any of its subsidiaries to use, possess, sell, market, distribute, advertise, license, or dispose of any CTI IP Right nor, to the knowledge of CTI, is there any basis for any such claim, nor has CTI received any notice asserting that any CTI IP Right or the proposed use, sale, distribution, license or disposition thereof conflicts or will 19 20 conflict with the rights of any other party, nor, to the knowledge of CTI, is there any reasonable basis for any such assertion. 3.13.4 No Breach by Employees or Consultants. No employee, consultant or independent contractor of CTI: (a) is in material violation of any term or covenant of any employment contract, patent disclosure agreement, invention assignment agreement, non-disclosure agreement, non-competition agreement or any other contract or agreement with any other party by virtue of such employee's, consultant's, or independent contractor's being employed by, or performing services for, CTI or using trade secrets or proprietary information of others; or (b) has developed any technology, software or other copyrightable, patentable, or otherwise proprietary work for CTI that is subject to any agreement under which such employee, consultant or independent contractor has assigned or otherwise granted to any third party any rights (including without limitation Intellectual Property) in or to such technology, software or other copyrightable, patentable or otherwise proprietary work or any Intellectual Property related thereto. To CTI's knowledge, the employment of any employee of CTI or the use by CTI or any subsidiary of CTI of the services of any consultant or independent contractor does not subject CTI to any liability to any third party. 3.13.5 Protection of Proprietary Information. CTI has taken all necessary steps to protect, preserve and maintain the secrecy and confidentiality of the CTI IP Rights and all CTI's ownership interests and proprietary rights therein. All officers, employees, consultants and contractors of CTI having access to proprietary information of CTI, its customers or business partners, or who have developed for CTI, or have access to, any software, proprietary information or inventions used or possessed by CTI, have executed and delivered to CTI an agreement whereby they have agreed to hold such software, proprietary information and inventions in confidence, and copies of the form of all such agreements have been delivered to HNC's counsel. CTI has secured from all consultants, contractors and employees who were involved in, or who contributed to, the creation or development of any CTI IP Rights, valid written assignments of all rights to such contributions that may be owned by such persons or that CTI does not already own by operation of law. No current or former employee, officer, director, consultant or independent contractor of CTI has any right, license, claim or interest whatsoever in or with respect to any CTI IP Rights. 3.13.6 Registered and Unregistered Intellectual Property. Schedule 3.13.6 to the CTI Disclosure Letter contains a complete list of (i) all worldwide registrations (if any) of any patents, copyrights, mask works, trademarks, service marks, Internet domain names or Internet or World Wide Web URLs or addresses with any governmental or quasi-governmental authority; (ii) all applications, registrations, filings and other formal actions made or taken by CTI pursuant to federal, state and foreign laws to secure, perfect or protect its interest in CTI IP Rights, including, without limitation, all patent applications, copyright applications, and applications for registration of trademarks and service marks, (iii) all CTI's unregistered copyrights, trademarks and service marks that have been used in CTI's business. All patents, and all registered trademarks, service marks, Internet domain names, Internet or World Wide Web URLs or addresses and copyrights held by CTI are valid and enforceable. 3.13.7 Licenses. Schedule 3.13.7 to the CTI Disclosure Letter contains a complete list of (i) all licenses, sublicenses and other agreements as to which CTI or any of its subsidiaries is a party and pursuant to which any person or entity is authorized to use any CTI IP Rights, and (ii) all licenses, sublicenses and other agreements to which CTI is a party and pursuant to which CTI is authorized to use any third party patents, trademarks, Internet domain names, Internet or World Wide Web URLs or addresses, or copyrights, including but not limited 20 21 to software ("THIRD PARTY IP RIGHTS") which would be infringed by, or are incorporated in, or form a part of, any product or service sold, licensed, distributed, provided or marketed by CTI, but excluding licenses held by CTI to use software that is generally available to the public at retail stores or which is generally available on standard, non-negotiable license terms at a per copy license fee of less than $2,000 per copy. Each end-user of any software that has been marketed, distributed, provided or licensed, whether directly or indirectly, by CTI (collectively, "CTI SOFTWARE") is bound by a written license agreement enforceable by CTI pursuant to which such end-user is prohibited from reverse engineering, disassembling, disclosing or transferring any code of such CTI Software and is not entitled to modify, or make derivative works from, any CTI Software (a "RESTRICTED USE LICENSE AGREEMENT"). CTI has not granted to any party any license or other right to: (a) make, prepare, create, develop or have made, prepared, created or developed, any modifications to, or any derivative works of, any CTI Software (any such modifications to or derivative works of any CTI Software being hereinafter referred to as "CTI SOFTWARE DERIVATIVES"); (b) market, distribute, provide or license any CTI Software or any CTI Software Derivative to any end-user who has not executed and delivered a restricted use license agreement , or (c) market, distribute, provide or license any CTI Software or any CTI Software Derivative in source code form. Continental Casualty Company ("CNA") has not exercised its rights under that certain Electronic Data Interchange Purchase for Distribution Agreement between CNA and CTI (the "CNA AGREEMENT") to receive a fully-paid license to distribute the CTI Software that is subject to such CNA Agreement, and the only CTI Software that is subject to the CNA Agreement are CTI's Employer-Connect and Admin-Connect products. 3.13.8 Source Code. Except as set forth on Schedule 3.13.8 of the CTI Disclosure Letter, neither CTI nor any other party acting on its or their behalf, has disclosed or delivered to any party, or permitted the disclosure or delivery to any escrow agent or other party, of any CTI Source Code (as defined below). No event has occurred, and no circumstance or condition exists, that (with or without notice or lapse of time) will, or would reasonably be expected to, result in the disclosure or delivery to any party of any CTI Source Code (as defined below). Schedule 3.13.8 of the CTI Disclosure Letter identifies each contract, agreement and instrument (whether written or oral) pursuant to which CTI has deposited, or is or may be required to deposit, with an escrowholder or any other party, any CTI Source Code and further describes whether the execution of this Agreement or the consummation of the Merger or any of the other transactions contemplated hereby, in and of itself, would reasonably be expected to result in the release from escrow of any CTI Source Code. As used herein, "CTI SOURCE CODE" means, collectively, any software source code (or portion thereof) of any software that is (a) included in the definition of CTI IP Rights; (b) incorporated or embodied in any product marketed by CTI; or (c) used by CTI to provide a service. 3.13.9 Infringement of CTI Rights. To CTI's knowledge, there is no unauthorized use, disclosure, infringement or misappropriation of any CTI IP Rights or any Intellectual Property Right of CTI by any third party, including any employee or former employee of CTI. CTI has not agreed to indemnify any person for any infringement of any Intellectual Property of any third party by any product or service that has been sold, licensed, leased, supplied, marketed, distributed, or provided by CTI. 3.13.10 Conformity to Warranty. All software developed by CTI and licensed by CTI to customers, all other products manufactured, sold, licensed, leased or delivered by CTI to customers and all services provided by CTI to customers on or prior to the Closing Date, conforms in all material respects to applicable contractual commitments, express and implied warranties, product specifications and product documentation and to any representations provided to CTI's customers and CTI does not have any material liability (and, to CTI's knowledge, there 21 22 is no reasonable basis for any present or future action, suit, proceeding, hearing, investigation, charge, complaint, claim or demand against CTI or any of its subsidiaries giving rise to any material liability or any liability in excess of $100,000 in the aggregate) for replacement or repair thereof or other damages in connection therewith in excess of any reserves therefor reflected on the Balance Sheet. 3.13.11 Year 2000 Compliance. The CTI Websites, and all services, products and software developed, owned, licensed and/or marketed or distributed by CTI or utilized by CTI in connection with any of the CTI Websites or otherwise, both individually and when operating in conjunction with all other systems and products with which they are designed to work or interface, are Year 2000 Compliant (as defined below). All internal computer systems of CTI are, both individually and in conjunction with all other systems with which they work or interface, Year 2000 Compliant. CTI has made inquiries of the manufacturers, suppliers, vendors and customers and, to CTI's knowledge, is not relying on any third party whose systems are not Year 2000 Compliant. CTI has no material expenses or other material liabilities associated with securing Year 2000 Compliance, or making contingency arrangements to address Year 2000 Compliance issues, with respect to the CTI Websites, the services or products of CTI, the internal computer systems of CTI and its subsidiaries or the computer systems or products or services of manufacturers, suppliers, vendors or customers of CTI. "YEAR 2000 COMPLIANT" or "YEAR 2000 COMPLIANCE" means, as applied to hardware and software, that: (i) such hardware and software will operate and correctly store, represent and process (including sort) all dates (including single and multi-century formulas and leap year calculations), such that errors will not occur when the date being used is in the Year 2000, or in a year preceding or following the Year 2000; (ii) such hardware and software has been written, developed and tested to support numeric and date transitions from the twentieth century to the twenty-first century, and back (including without limitation all calculations, aging, reporting, printing, displays, reversals, disaster and vital records recoveries) without error, corruption or impact to current and/or future operations; and (iii) such hardware and software will function without error or interruption related to any date information, specifically including errors or interruptions from functions which may involve date information from more than one century. 3.14 Compliance with Laws. 3.14.1 Compliance with Applicable Law. CTI has complied, and is now and at the Closing Date will be in compliance with, all applicable federal, state, local or foreign laws, ordinances, regulations, and rules, and all orders, writs, injunctions, awards, judgments, and decrees applicable to it or to its assets, properties, and business (collectively, "APPLICABLE LAW"). 3.14.2 Disclosures. None of the disclosures made or contained in any CTI Website have been inaccurate, misleading or deceptive or in violation of Applicable Law in any material respect. 3.14.3 No Audit. To CTI's knowledge, CTI has not been the subject of any audit by any governmental agency or authority for the purpose of determining whether CTI has complied with any Applicable Law. 3.14.4 Governmental Permits. CTI holds all permits, licenses and approvals from, and has made all filings with, government (and quasi-governmental) agencies and authorities, that are necessary for CTI to conduct its present business without any violation of Applicable Law ("GOVERNMENTAL PERMITS") and all such Governmental Permits are in full force and effect. CTI has not received any written notice from any Governmental Authority (or quasi- 22 23 governmental authority) regarding (a) any actual or possible violation of law or any Governmental Permit or any failure to comply with any term or requirement of any Governmental Permit, or (b) any actual or possible revocation, withdrawal, suspension, cancellation, termination or modification of any Governmental Permit. 3.14.5 Improper Payments. Neither CTI nor any director, officer, agent or employee of CTI has, for or on behalf of CTI, (a) used any funds for unlawful contributions, gifts, entertainment or other unlawful expenses relating to political activity, (b) made any unlawful payment to foreign or domestic government officials or employees or to foreign or domestic political parties or campaigns or violated any provision of the Foreign Corrupt Practices Act of 1977, as amended, or (c) made any other unlawful payment. 3.15 Certain Transactions and Agreements. To CTI's knowledge, none of the stockholders, officers, directors or key employees of CTI nor any member of their immediate families, has any direct or indirect ownership interest in any firm or corporation that competes with, or does business with, or has any contractual arrangement with, CTI (except with respect to any interest in less than one percent (1%) of the stock of any corporation whose stock is publicly traded). To CTI's knowledge, none of said stockholders, officers, directors or key employees or any member of their immediate families, is a party to, or otherwise directly or indirectly interested in, any contract or informal arrangement with CTI, except for normal compensation for services as an officer, director, employee or consultant of CTI that have been disclosed to HNC. To CTI's knowledge, none of said stockholders, officers, directors or key employees, or any of their family members has any interest in any property, real or personal, tangible or intangible (including but not limited to any CTI IP Rights or any other Intellectual Property) that is used in, or that pertains to, the business of CTI, except for the normal rights of a stockholder. 3.16 Employees, ERISA and Other Compliance. 3.16.1 Employment Compliance. CTI is in compliance in all material respects with all applicable laws, agreements and contracts relating to employment, employment practices, immigration, wages, hours, and terms and conditions of employment, including, but not limited to, employee compensation matters. A list of all current employees, officers and consultants of CTI and their current title and/or job description and compensation is set forth on Schedule 3.16.1 to the CTI Disclosure Letter. CTI does not have any employment contracts or consulting agreements currently in effect that are not terminable at will (other than agreements with the sole purpose of providing for the confidentiality of proprietary information or assignment of inventions). CTI has no liability to any employee, officer or director of CTI, FGC or any affiliate of FGC for the payment of any bonus or other compensatory payment that will be triggered by or become payable as a result of, the execution or delivery of this Agreement or the consummation of the Merger or any of the other transactions contemplated by this Agreement or any of the agreements which are exhibits hereto. 3.16.2 Labor Relations. Neither CTI nor any of its subsidiaries (i) now is, nor has ever been, subject to a union organizing effort, (ii) is subject to any collective bargaining agreement with respect to any of its employees, (iii) is subject to any other contract, written or oral, with any trade or labor union, employees' association or similar organization or (iv) has any current labor disputes. To its knowledge, CTI has generally good labor relations with its employees, and CTI has no knowledge of any facts indicating that the consummation of the Merger or any of the other transactions contemplated hereby will have a Material Adverse Effect on such labor relations, and have no knowledge that any of their key employees intends to leave 23 24 their employ. All of the employees of CTI are legally permitted to be employed by CTI in the United States of America in their current job capacities. 3.16.3 ERISA. Neither CTI nor any other employer that is under common control with CTI, within the meaning of Code Section 414(b), (c), (m) or (o) and the regulations promulgated thereunder (each such employer an "ERISA AFFILIATE") has any pension plan which constitutes, or has since the enactment of the Employee Retirement Income Security Act of 1974, as amended ("ERISA") constituted, a "multiemployer plan" as defined in Section 3(37) of ERISA. No pension plan of CTI is subject to Title IV of ERISA. 3.16.4 Employment Benefit Arrangements. (a) CTI Benefit Arrangements. Schedule 3.16.4 to the CTI Disclosure Letter lists each employment, severance or other similar contract, arrangement or policy, each "employee benefit plan" as defined in Section 3(3) of ERISA and each plan or arrangement (written or oral) providing for insurance coverage (including any self-insured arrangements), workers' benefits, vacation benefits, severance benefits, disability benefits, death benefits, hospitalization benefits, retirement benefits, deferred compensation, profit-sharing, bonuses, stock options, stock purchase, phantom stock, stock appreciation or other forms of incentive compensation or post-retirement insurance, compensation or benefits for employees, consultants or directors which is entered into, maintained or contributed to by CTI or which is sponsored by FGC or any other ERISA Affiliate and covers any employee or former employee of CTI. Such contracts, plans and arrangements as are described in this Section 3.16.4(a) are hereinafter collectively referred to as "CTI BENEFIT ARRANGEMENTS." CTI has delivered to HNC or its counsel a complete and correct copy of each CTI Benefit Arrangement or, if no such document exists, a written description of such CTI Benefit Arrangement. (b) Compliance. Each CTI Benefit Arrangement has been maintained in compliance in all material respects with its terms and with the requirements prescribed by any and all statutes, orders, rules and regulations that are applicable to such CTI Benefit Arrangement, and each such CTI Benefit Arrangement that is an "employee pension benefit plan" as defined in Section 3(2) of ERISA which is intended to qualify under Section 401(a) of the Code has received a favorable determination letter that such plan satisfies the requirements of the Tax Reform Act of 1986 (a copy of which letter(s) have been delivered to HNC and its counsel). CTI (and/or FGC, if applicable) has timely filed and delivered to HNC and its counsel the most recent annual report (Form Series 5500) for each CTI Benefit Arrangement that is an "employee benefit plan" as defined under ERISA and for which such report is required. CTI has not been a participant in any "prohibited transaction", within the meaning of Section 406 of ERISA with respect to any employee pension benefit plan (as defined in Section 3(2) of ERISA) which CTI sponsors as employer or in which CTI participates as an employer, which was not otherwise exempt pursuant to Section 408 of ERISA (including any individual exemption granted under Section 408(a) of ERISA), Code Section 4975, or which could result in an excise tax under the Code. (c) Contributions. All contributions due from CTI with respect to any CTI Benefit Arrangements have been made or have been accrued on CTI's financial statements (including without limitation the CTI Financial Statements). All contributions with respect to any CTI Benefit Arrangements have been timely made in accordance with the terms of the CTI Benefit Arrangement and applicable law. CTI shall not have any liability for contributions attributable to or benefits payable under any CTI Benefit Arrangement to employees of any other ERISA Affiliates. 24 25 (d) Participation. All individuals who, pursuant to the terms of any CTI Benefit Arrangement, are entitled to participate in any such CTI Benefit Arrangement, are currently participating in such CTI Benefit Arrangement or have been offered an opportunity to do so. CTI shall have no liability for benefits accrued or claims attributable to service of CTI employees following the effective date of its withdrawal from any CTI Benefit Arrangement. CTI shall have no liability under the CTI Benefit Arrangements for benefits accrued or claims attributable to the employees of any other ERISA Affiliates at any time. 3.16.5 No Increase in Expense. There has been no amendment to, written interpretation or announcement (whether or not written) by CT, FGC or any ERISA Affiliate relating to, or change in employee participation or coverage under, any CTI Benefit Arrangement that would materially increase the expense of maintaining such CTI Benefit Arrangement above the level of the expense incurred in respect thereof for CTI's fiscal year ended December 31, 1999. The termination of, or the termination of CTI's participation in, any of the employee pension benefit plans which CTI sponsors as employer or in which CTI participates as an employer and the distribution of the assets thereunder shall not trigger any surrender fee, reverse load or other cost that would reduce a participant's account or benefit. Furthermore any such termination would not trigger a fee payable by HNC or CTI which would exceed $1,000 per employee pension benefit plan in connection with the termination of such a plan. 3.16.6 Continuation of Coverage; COBRA. The group health plans (as defined in Section 4980B(g) of the Code) that benefit employees of CTI are in compliance, in all material respects, with the continuation coverage requirements of Section 4980B of the Code as such requirements affect CTI employees. As of the Closing Date, there will be no material outstanding, uncorrected violations under the Consolidation Omnibus Budget Reconciliation Act of 1985, as amended ("COBRA"), with respect to any of CTI Benefit Arrangements, covered employees, or qualified beneficiaries that could result in a Material Adverse Effect on CTI, or in a Material Adverse Effect on HNC after the Effective Time. 3.16.7 Parachute Payments. No benefit payable or which may become payable by CTI pursuant to any CTI Benefit Arrangement or as a result of or arising under this Agreement or the Merger will constitute an "excess parachute payment" (as defined in Section 280G(b)(1) of the Code) which is subject to the imposition of an excise Tax under Section 4999 of the Code or which would not be deductible by reason of Section 280G of the Code. Neither CTI nor any subsidiary of CTI is a party to any: (a) agreement with any executive officer or other key employee thereof (i) the benefits of which are contingent, or the terms of which are materially altered, upon the occurrence of a transaction involving CTI or such CTI subsidiary in the nature of the Merger or any of the other transactions contemplated by this Agreement or any CTI Ancillary Agreement, (ii) providing any term of employment or compensation guarantee, or (iii) providing severance benefits or other benefits after the termination of employment of such employee regardless of the reason for such termination of employment; or (b) agreement or plan, including, without limitation, any stock option plan, stock appreciation rights plan or stock purchase plan, any of the benefits of which will be increased, or the vesting of benefits of which will be accelerated, by the occurrence of the Merger or any of the other transactions contemplated by this Agreement or any CTI Ancillary Agreement, or the value of any of the benefits of which will be calculated on the basis of any of the transactions contemplated by this Agreement or any CTI Ancillary Agreement. 3.17 Corporate Documents. CTI has made available to HNC for examination all documents and information listed in the CTI Disclosure Letter or in any schedule thereto or in any other exhibit or schedule called for by this Agreement which have been requested by HNC's 25 26 legal counsel, including, without limitation, the following: (a) copies of CTI's Articles of Incorporation and Code of Regulations, each as amended and currently in effect; (b) CTI's Minute Book containing all records of all proceedings, consents, actions, and meetings of CTI's stockholders, board of directors and any committees thereof; (c) CTI's stock ledger and journal reflecting all stock issuances and transfers; (d) all permits, orders, and consents issued by, and filings by CTI with, any regulatory agency with respect to CTI, or any securities of CTI, and all applications for such permits, orders, and consents; and (e) all the CTI Material Agreements. 3.18 No Brokers. Neither CTI, nor any affiliate of CTI is obligated for the payment of any fees or expenses of any investment banker, broker, finder or similar party in connection with the origin, negotiation or execution of this Agreement or in connection with the Merger or any other transaction contemplated by this Agreement, and HNC will not incur any liability, either directly or indirectly, to any such investment banker, broker, finder or similar party as a result of, this Agreement, the Merger or any act or omission of CTI, any of its employees, officers, directors, stockholders, agents, subsidiaries or affiliates. 3.19 Books and Records. 3.19.1 Records. The books, records and accounts of CTI (a) are in all material respects true, complete and correct, (b) have been maintained in accordance with good business practices on a basis consistent with prior years, (c) are stated in reasonable detail and accurately and fairly reflect the transactions and dispositions of the assets of CTI, and (d) accurately and fairly reflect the basis for the CTI Financial Statements. 3.19.2 Accounting Controls. CTI has devised and maintains a system of internal accounting controls sufficient to provide reasonable assurances that: (a) transactions are executed in accordance with management's general or specific authorization; (b) transactions are recorded as necessary (i) to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and (ii) to maintain accountability for assets; and (c) the amount recorded for assets on the books and records of CTI is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. 3.20 Insurance. During the prior two years, CTI has maintained, and now maintains, policies of insurance and bonds of the type and in amounts customarily carried by persons conducting businesses or owning assets similar in type and size to those of CTI, including without limitation errors and omissions, casualty, fire and general liability insurance and all legally required workers' compensation insurance. There is no material claim pending under any of such policies or bonds as to which coverage has been questioned, denied or disputed by the underwriters of such policies or bonds. All premiums due and payable under all such policies and bonds have been timely paid and CTI are otherwise in compliance with the terms of such policies and bonds. CTI has no knowledge of any threatened termination of, or material premium increase with respect to, any of such policies. All policies of insurance now held by CTI are set forth in Schedule 3.20 to the CTI Disclosure Letter, together with the name of the insurer under each policy, the type of policy, the policy coverage amount and any applicable deductible. 3.21 Environmental Matters. 3.21.1 Compliance. CTI is in compliance with all applicable Environmental Laws (as defined below), which compliance includes the possession by CTI and its subsidiaries of all permits and other governmental authorizations required under applicable Environmental 26 27 Laws, and compliance with the terms and conditions thereof. CTI has not received any written notice, whether from a governmental body, citizens' group, employee or otherwise, that alleges that CTI is not in compliance with any Environmental Law, and there are no circumstances that may prevent or interfere with CTI's compliance with any current Environmental Law in the future. To CTI's and FGC's knowledge, no current or prior owner of any property leased, possessed or ever owned by CTI has received any written notice or communication, whether from a government body, citizens' group, employee or otherwise, that alleges that such current or prior owner or CTI is not in compliance with any Environmental Law. All governmental authorizations currently held by CTI pursuant to any Environmental Law (if any) are identified in Schedule 3.21 of CTI Disclosure Letter. To CTI's and FGC's knowledge, (a) the real estate and improvements thereon comprising the premises on which CTI's offices, buildings and facilities are located (the "CTI PREMISES") have not been tainted or polluted by any Material of Environmental Concern and (b) no Materials of Environmental Concern are present on the CTI Premises. 3.21.2 Defined Terms. For purposes of this Section 3.21: (i) "ENVIRONMENTAL LAW" means any federal, state, local or foreign statute, law regulation or other legal requirement relating to pollution or protection of human health or the environment (including ambient air, surface water, ground water, land surface or subsurface strata), including any law or regulation relating to emissions, discharges, releases or threatened releases of Materials of Environmental Concern, or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of Materials of Environmental Concern; and (ii) "MATERIAL OF ENVIRONMENTAL CONCERN" include chemicals, pollutants, contaminants, wastes, toxic substances, radioactive substances, petroleum and petroleum products and any other substance that is currently regulated by an Environmental Law or that is otherwise a danger to health, reproduction or the environment. 3.22 Vote Required. The affirmative vote of the holders of: (a) more than 50% of the shares of CTI Common Stock that are issued and outstanding on the Record Date (as defined below) is the only vote of the holders of any of the shares of CTI's capital stock that is necessary to approve this Agreement, the Merger, the Certificates of Merger, the Escrow Agreement and the other transactions contemplated by this Agreement under applicable law (including but not limited to the OGCL), CTI's Articles of Incorporation, Code of Regulations and any other charter documents of CTI, and under any agreement or contract regarding the voting of shares of CTI's capital stock. As used in this Section, the term "RECORD DATE" means the record date for determining those stockholders of CTI who are entitled to vote at the CTI Stockholders' Vote, whether such vote is taken at a stockholders' meeting or by written consent without a meeting. 3.23 Board Approval. The Board of Directors of CTI has unanimously (a) approved this Agreement and the Merger, the CTI Ancillary Agreements and all the agreements, transactions and actions contemplated by this Agreement, (b) determined that the Merger is in the best interests of the stockholders of CTI and is on terms that are fair to such stockholders and (c) voted to submit this Agreement, the Merger, the Merger and the transactions and agreements contemplated by this Agreement to the vote and approval of CTI's stockholders and to recommend approval of this Agreement and the Merger to the stockholders of CTI. 3.24 No Existing Discussions. Neither CTI nor any director, officer or agent of CTI is engaged, directly or indirectly, in any discussions or negotiations with any third party relating to any transaction that would be inconsistent with the accomplishment of the Merger, such as, without limitation, any merger, consolidation, sale of assets or similar business combination transaction with a third party involving CTI. 27 28 3.25 Disclosure. (a) Neither the representations and warranties of CTI contained in Article 3 of this Agreement and the CTI Disclosure Letter, nor any of the certificates to be delivered by CTI to HNC under Article 9 of this Agreement, taken together, contains any untrue statement of a material fact or omits to state any material fact necessary in order to make the statements contained herein and therein, in light of the circumstances under which such statements were made, not misleading. (b) None of the information supplied or to be supplied by or on behalf of CTI for inclusion in any information statement to be provided to the stockholders of CTI in connection with the CTI Stockholders' Vote (the "INFORMATION STATEMENT") will, as of the date such Information Statement is first sent to the stockholders of CTI, contain any untrue statement of a material fact or omit to state any material fact regarding CTI that is required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they are made, not misleading. ARTICLE 4 REPRESENTATIONS AND WARRANTIES OF HNC AND SUB HNC and Sub hereby represent and warrant that, except as set forth in the letter addressed to CTI from HNC executed by the Chief Executive Officer or the Chief Financial Officer of HNC and dated as of the Agreement Date which has been delivered by HNC to CTI concurrently herewith (the "HNC DISCLOSURE LETTER"), each of the following representations, warranties and statements in the following sections of this Article 4 is true and correct as of the Agreement Date and will be true and correct on and as of the Closing Date. For all purposes of this Agreement (including without limitation Articles 8 and 9 hereof), the statements contained in the HNC Disclosure Letter and its schedules shall also be deemed to be representations and warranties made and given by HNC under Article 4 of this Agreement. 4.1 Organization and Good Standing. HNC is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, and has the corporate power and authority to own, operate and lease its properties and to carry on its business as now conducted and as proposed to be conducted, and is qualified to transact business, and is in good standing, as a foreign corporation in each jurisdiction in which its failure to be so qualified would have a Material Adverse Effect on HNC. Sub is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, and has the corporate power and authority to own, operate and lease its properties and to carry on its business as now conducted, and is in good standing, as a foreign corporation in each jurisdiction in which its failure to be so qualified would have a Material Adverse Effect on HNC. Neither HNC nor Sub is in violation of its Certificate of Incorporation, Bylaws or other charter documents. 4.2 Power, Authorization and Validity. 4.2.1 HNC has the requisite corporate power and authority to enter into, execute, deliver and perform its obligations under this Agreement and each of the HNC Ancillary Agreements. The execution, delivery and performance by HNC of this Agreement and the HNC Ancillary Agreements have been duly and validly approved and authorized by HNC's Board of Directors in compliance with applicable law (including without limitation the DGCL) and HNC's Certificate of Incorporation and Bylaws, each as amended. The issuance by HNC of the shares of 28 29 HNC Common Stock to be issued in the Merger does not require the approval of HNC's stockholders. Sub has the requisite corporate power and authority to enter into, execute, deliver and perform its obligations under this Agreement, and each of the Sub Ancillary Agreements. The execution, delivery and performance of this Agreement and all other Sub Ancillary Agreements by Sub have been duly and validly approved and authorized by Sub's Board of Directors and by HNC as the sole stockholder of Sub in compliance with applicable law (including without limitation the DGCL) and Sub's Certificate of Incorporation and Bylaws, each as amended. 4.2.2 No consent, approval, order or authorization of, or registration, declaration or filing with, any Governmental Authority is necessary or required to be made or obtained by HNC or Sub to enable them to lawfully execute and deliver enter into, and to perform their respective obligations under, this Agreement, and each of the HNC Ancillary Agreements and the Sub Ancillary Agreements, as applicable, or to consummate the Merger, except for: (a) the filing by HNC of such reports and information with the SEC under the Exchange Act as may be required in connection with this Agreement, the Merger and the transactions contemplated hereby; (b) the filing with the SEC of a Form D relating to the issuance of HNC securities in the Merger, if so elected by HNC; (c) the filing of the Certificates of Merger with the Delaware Secretary of State and the Ohio Secretary of State and any such further documents as may be required under the DGCL or the OGCL to effect the Merger; (d) such filings and notifications as may be necessary under the HSR Act with respect to the Merger and the other transactions contemplated by this Agreement and the expiration or early termination of any applicable waiting periods thereunder; (e) such other filings as may be required by the Nasdaq National Market System with respect to the Merger; and (f) such other filings, if any, as may be required to comply with federal and state securities laws. 4.2.3 Enforceability. This Agreement and each of the HNC Ancillary Agreements are, or when executed by HNC will be, valid and binding obligations of HNC, enforceable against HNC in accordance with their respective terms, subject to the effect, if any, of (a) applicable bankruptcy and other similar laws affecting the rights of creditors generally and (b) rules of law and equity governing specific performance, injunctive relief and other equitable remedies. This Agreement and each of the Sub Ancillary Agreements are, or when executed by Sub will be, valid and binding obligations of Sub, enforceable against Sub in accordance with their respective terms, subject to the effect, if any, of (a) applicable bankruptcy and other similar laws affecting the rights of creditors generally and (b) rules of law and equity governing specific performance, injunctive relief and other equitable remedies. 4.3 Capitalization of HNC. 4.3.1 Stock. The authorized capital stock of HNC consists entirely of 50,000,000 shares of HNC Common Stock, $0.001 par value per share, and 4,000,000 shares of Preferred Stock, $0.001 par value per share (the "HNC PREFERRED STOCK"). At the close of business on February 29, 2000, 24,950,840 shares of HNC Common Stock were issued and outstanding. No shares of HNC Preferred Stock are issued or outstanding at the Agreement Date. All issued and outstanding shares of HNC Common Stock have been duly authorized and validly issued, are fully paid and nonassessable and not subject to preemptive rights. As of the date hereof, the authorized capital stock of Sub consists of 100 shares of Common Stock, $0.001 par value per share, of which 100 shares have been duly authorized and validly issued, are fully paid and nonassessable, all of which are owned by HNC. 29 30 4.3.2 Options; Convertible Notes. As of February 29, 2000: (a) options to purchase an aggregate total of 6,238,298 shares of HNC Common Stock were outstanding (the "OUTSTANDING HNC OPTIONS"). As of the Agreement Date, there are outstanding $100,000,000 in principal face amount of 4.75% Convertible Subordinated Notes due 2003 of HNC, which, as of the Agreement Date, are convertible into shares of HNC Common Stock at the price of $44.85 per share of HNC Common Stock, as presently constituted, which price is subject to adjustment as provided in such notes (the "CONVERTIBLE NOTES"). 4.3.3 No Other Options, Etc. Except for the Outstanding HNC Options described in Section 4.3.2 above, options to purchase HNC Common Stock granted after February 29, 2000, the rights to convert Convertible Notes into HNC Common Stock, and rights of HNC employees to subscribe for shares of HNC Common Stock under the HNC 1995 Employee Stock Purchase Plan, as of February 29, 2000, there were no outstanding options, warrants, convertible or other securities of HNC entitling any party to purchase or acquire shares of HNC Common Stock or any other stock or security of HNC. 4.4 No Violation of Material Agreements. Neither the execution and delivery of this Agreement nor any HNC Ancillary Agreement, nor the consummation of the transactions contemplated by this Agreement or any HNC Ancillary Agreement, will conflict with, or (with or without notice or lapse of time, or both) result in: (a) a material breach, impairment or violation of (i) any provision of the Certificate of Incorporation or Bylaws of HNC, as currently in effect or (ii) any federal, state, local or foreign judgment, writ, decree, order, statute, rule or regulation to which HNC or its assets or properties is subject that would have a Material Adverse Effect on HNC; or (b) a termination, or a material breach, impairment or violation, of any material instrument or contract to which HNC is a party or by which HNC or its properties are bound which is listed as a material agreement in the exhibit list to (a) HNC's annual report on Form 10-K for its fiscal year ended December 31, 1999, as amended by the annual report on Form 10-K/A filed on March 27, 2000 (the "1999 10-K") or (b) any report on Form 10-Q or Form 8-K filed by HNC since the date on which HNC filed the 1999 10-K with the SEC or (c) any registration statement that HNC has filed with the SEC pursuant to the Securities Act or the Exchange Act since the date on which HNC filed the 1999 10-K. 4.5 SEC Documents; HNC Financial Statements. HNC has furnished or made available to CTI: (a) the 1999 10-K and true and complete copies of all reports, proxy statements or registration statements filed by HNC with the SEC under the Securities Act or the Exchange Act subsequent to March 27, 2000 and prior to the Agreement Date, including HNC's report on Form 8-K filed on March 27, 2000 (all of the foregoing reports, proxy statements or registration statements of HNC being collectively referred to as the "HNC SEC DOCUMENTS"); (b) a Prospectus dated February 27, 1998 forming part of HNC's registration statement on Form S-3 relating to the offering of the Convertible Notes; (c) a Prospectus of Retek Inc. ("RETEK"), a subsidiary of HNC, dated November 17, 1999 forming part of Retek's registration statement on Form S-1 relating to the initial public offering of Retek's common stock; and (d) Retek's annual report on Form 10-K for its fiscal year ended December 31, 1999. As of their respective filing dates, the HNC SEC Documents complied in all material respects with the requirements of the Securities Act or the Exchange Act, as applicable, and no HNC SEC Documents contained, as of its respective filing date, any untrue statement of a material fact or omitted to state any material fact necessary in order to make the statements contained therein, in light of the circumstances under which such statements were made, not misleading in any material respect, except to the extent corrected by a document subsequently filed with the SEC. The HNC SEC Documents constitute all reports and documents that HNC was required to file with the SEC under applicable law during the period beginning on March 27, 2000 and ending on the Agreement Date. The 30 31 financial statements of HNC, including the notes thereto, included in the HNC SEC Documents (the "HNC FINANCIAL STATEMENTS") were prepared in accordance with generally accepted accounting principles consistently applied (except as may be indicated in the notes thereto) and, as of their filing dates, presented fairly the consolidated financial position of HNC at the dates thereof and of its operations and cash flows for the periods then ended (subject, in the case of unaudited statements, to normal, recurring audit adjustments), and except to the extent modified or corrected by financial statements subsequently filed with the SEC. Since January 1, 2000, there has been no change in HNC's accounting policies except as described in the notes to the HNC Financial Statements. 4.6 Validity of Shares. The shares of HNC Common Stock to be issued pursuant to the Merger will, when issued: (a) be duly authorized, validly issued, fully paid and nonassessable and free of liens and encumbrances created by HNC, (b) will be subject to applicable securities law restrictions on transfer, including those imposed by Regulation D or Section 4(2) of the Securities Act and Rule 144 promulgated under the Securities Act, and under applicable "blue sky" state securities laws, and (c) will be authorized for listing on the Nasdaq National Market subject to notice of issuance. 4.7 No Brokers; Accredited Status. HNC is not obligated for the payment of any fees or expenses of any investment banker, broker, finder or similar party in connection with the origin, negotiation or execution of this Agreement or the HNC Ancillary Agreements or in connection with any transaction contemplated hereby or thereby for which CTI or any of the CTI Stockholders will incur any personal liability. HNC is an "accredited investor" within the meaning of Regulation D promulgated under the Securities Act. 4.8 Litigation. There is no action, claim, suit, arbitration, proceeding, claim or investigation pending (or, to HNC's knowledge, threatened) against HNC before any court, administrative agency or arbitrator that, if determined adversely to HNC, is likely to have a Material Adverse Effect on HNC's financial condition or results of operation. 4.9 No Material Adverse Change. Since December 31, 1999, there has not occurred: (a) any Material Adverse Change to HNC (excluding for purposes of this Section any fact or event that has been publicly disclosed by HNC prior to the Agreement Date, by a press release or filing with the SEC or otherwise) or (b) any amendment or change in the Certificate of Incorporation or Bylaws of HNC that adversely affects the rights of the HNC Common Stock. 4.10 Disclosure. (a) Neither the representations and warranties contained in Article 4 of this Agreement and the HNC Disclosure Letter, nor any of the certificates to be delivered by HNC to CTI under Article 8 of this Agreement, taken together, contains any untrue statement of a material fact or omits to state any material fact necessary in order to make the statements contained herein and therein, in light of the circumstances under which such statements were made, not misleading. (b) None of the information regarding HNC supplied or to be supplied by or on behalf of HNC for inclusion in the Information Statement will, as of the date such Information Statement is first sent to the stockholders of CTI, contain any untrue statement of a material fact or omit to state any material fact regarding HNC that is required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they are made, not misleading. 31 32 ARTICLE 5 COVENANTS OF CTI AND FGC CTI and, solely with respect to Sections 5.1, 5.2, 5.6, 5.7, 5.8, 5.9, 5.17 and 5.18, FGC covenant and agree with HNC and Sub as follows: 5.1 Advice of Changes. During the time period from the Agreement Date until the earlier to occur of (i) the Effective Time or (ii) the termination of this Agreement in accordance with Article 10, CTI will promptly advise HNC in writing (a) of any event occurring subsequent to the Agreement Date of which CTI or FGC has knowledge that would render any representation or warranty of CTI and FGC contained in Article 3 of this Agreement (as qualified by the CTI Disclosure Letter), if made on or as of the date of such event or the Closing Date, untrue or inaccurate in any material respect and (b) of any Material Adverse Change in CTI. 5.2 Maintenance of Business. During the time period from the Agreement Date until the earlier to occur of (i) the Effective Time or (ii) the termination of this Agreement in accordance with Article 10, (a) CTI will use its good faith diligent efforts to carry on and preserve its business and its relationships with customers, suppliers, employees and others in substantially the same manner as it has prior to the Agreement Date, and (b) if CTI or FGC becomes aware of a material deterioration in the relationship between CTI and any key customer, key supplier or key employee of CTI, it will promptly bring such information to the attention of HNC in writing. 5.3 Conduct of Business. During the time period from the Agreement Date until the earlier to occur of (i) the Effective Time or (ii) the termination of this Agreement in accordance with Article 10, CTI will continue to conduct its business and maintain its business relationships in the ordinary and usual course and CTI shall not, without the prior written consent and approval of the President or Chief Financial Officer of HNC: (a) borrow or lend any money, other than reasonable and customary advances to employees for bona fide travel and expenses that are incurred in the ordinary course of CTI's business consistent with CTI's past practices; (b) enter into any material transaction or agreement that is not in the ordinary course of CTI's business; (c) grant any lien, security interest, other encumbrance on any of CTI's assets or guarantee or act as a surety for any obligation of any third party; (d) sell, transfer or dispose of any of its assets except in the ordinary course of CTI's business consistent with CTI's past practices; (e) enter into any material lease or any contract for the purchase or sale of any property, whether real or personal, tangible or intangible; (f) pay any bonus, increased salary or special remuneration to any officer, director, employee or consultant (except for normal salary increases and bonus payments that are consistent with CTI's past practices and, in each case, not to exceed 5% of such officer's, employee's or consultant's base annual compensation), enter into any new employment or consulting agreement with any such person or enter into any indemnification agreement or agreement to advance expenses of defending any claim, suit or proceeding with any such person; 32 33 (g) declare, set aside or pay any cash or stock dividend or other distribution in respect of its capital stock, redeem, repurchase or otherwise acquire any of its capital stock or other securities, pay or distribute any cash or property to any stockholder or securityholder of CTI or make any other cash payment to any stockholder or securityholder of CTI that is unusual, extraordinary, or not made in the ordinary course of CTI's business consistent with its past practices; (h) amend or terminate any contract, agreement or license to which CTI or any of its subsidiaries is a party except for (i) those amended or terminated in the ordinary course of CTI's business, consistent with its past practices, or (ii) those amended to enable CTI to satisfy any condition to the consummation of the Merger set forth in Article 8 or 9 which shall not have any material impact on CTI's business or financial condition; (i) waive or release any material right or claim except in the ordinary course of CTI's business, consistent with CTI's past practice; (j) issue, sell, create or authorize any shares of its capital stock of any class or series or any other of its securities, or issue, grant or create any options, warrants, rights, obligations, subscriptions, convertible securities, or other commitments to issue shares of its capital stock or securities ultimately exchangeable for, or convertible into, shares of its capital stock; (k) subdivide, split, combine or reverse split the outstanding shares of its capital stock of any class or series or enter into any recapitalization affecting the number of outstanding shares of its capital stock of any class or series or affecting any other of its securities; (l) merge, consolidate or reorganize with, or acquire, or enter into any other business combination with, any corporation, partnership, limited liability company or any other entity or enter into any negotiations, discussions or agreement for such purpose; (m) amend its Articles of Incorporation or Code of Regulations; (n) license any of its technology or Intellectual Property except for licenses of products made in the ordinary course of CTI's business on terms consistent with CTI's past practices, or acquire any Intellectual Property (or any license thereto) from any third party except for any such license obtained in the ordinary course of CTI's business consistent with its past practices; (o) materially change any insurance coverage or issue any certificates of insurance; (p) agree to any audit assessment proposed by any tax authority or file without HNC's prior written consent (which will not be unreasonably withheld or delayed) any federal or state income or franchise tax return unless copies of such returns have first been delivered to HNC for its review prior to filing; (q) modify or change the terms or rights of any CTI stock or other CTI securities; 33 34 (r) agree to do any of the things described in the preceding clauses 5.3(a) through 5.3(q). 5.4 Approval of CTI's Stockholders. CTI shall take the actions necessary to conduct and obtain the CTI Stockholders' Vote (as defined in Article 1) at the earliest practicable date on or after the Agreement Date (consistent with, and subject to, the requirements of Section 4(2) and/or Regulation D under the Securities Act and CTI's performance of its obligations under Section 5.12). In connection therewith CTI's Board of Directors shall recommend to CTI's stockholders that they approve the Merger, this Agreement and the transactions contemplated thereby. The CTI Stockholders' Vote shall be called, held and conducted, and any proxies or written consents shall be solicited, in compliance with CTI's Articles of Incorporation and Code of Regulations, both as amended, and in compliance with applicable law (including without limitation the OGCL). CTI will not put any proposal up for the vote of its stockholders (as part of the CTI Stockholders' Vote or otherwise) other than the proposal to approve this Agreement and the Merger, without obtaining HNC's prior written consent to do so, which consent will not be unreasonably withheld, consistent with the provisions, purposes and intent of this Agreement. 5.5 Information Statement; Cooperation. CTI will be solely responsible for any statement, information or omission in the Information Statement relating to CTI or its affiliates that is provided to CTI's Stockholders in connection with the CTI Stockholders' Vote. CTI will in good faith comply with its obligations under Section 5.12 (including without limitation its obligations to cooperate with HNC in connection with the Information Statement) and CTI will use its good faith diligent efforts to assist HNC in all reasonable ways in complying with the requirements of the exemptions provided by Section 4(2) and/or Regulation D under the Securities Act with respect to the issuance of HNC securities in the Merger. 5.6 Regulatory Approvals. CTI and FGC will promptly execute and file, or join in the execution and filing, of any application, notification or any other document that may be necessary in order to obtain the authorization, approval or consent of any Governmental Authority, whether federal, state, local or foreign, which may be reasonably required, or which HNC may reasonably request, in connection with the consummation of the Merger or any other transactions contemplated by this Agreement or any CTI Ancillary Agreement, including but not limited to any filings required to be made by CTI or FGC under the HSR Act. CTI and FGC will each use its diligent efforts to obtain, and to cooperate with HNC to promptly obtain, all such authorizations, approvals and consents. 5.7 Necessary Consents. CTI and FGC will each use its diligent efforts to obtain such consents and authorizations of third parties, give notices to third parties and take such other actions as may be necessary or appropriate in addition to those set forth in the foregoing Sections of this Article 5 in order to effect the consummation of the Merger and the other transactions contemplated by this Agreement and to enable CTI to carry on its business after the Effective Time substantially as such business was conducted by CTI prior to the Effective Time. 5.8 Litigation. During the time period from the Agreement Date until the earlier to occur of (i) the Effective Time or (ii) the termination of this Agreement in accordance with Article 10, CTI and/or FGC will notify HNC in writing promptly after learning of any claim, demand, action, suit, arbitration, mediation, proceeding or investigation by or before any court, arbitrator or arbitration panel, tribunal, board or governmental agency, initiated by or against CTI, or known by CTI or FGC to be threatened against CTI or against any of its stockholders, officers, directors, employees or stockholders in their capacity as such. 34 35 5.9 No Other Negotiations. During the time period commencing on the Agreement Date and ending on the earlier to occur of (a) termination of this Agreement in accordance with the provisions of Article 10, or (b) consummation of the Merger at the Effective Time, neither CTI nor FGC will, and neither CTI nor FGC will authorize, encourage or permit any officer, director, employee, stockholder or agent of CTI or any other person on CTI's behalf to, directly or indirectly: (i) solicit, initiate, encourage or induce the making, submission or announcement of, any offer or proposal from any party concerning any Alternative Transaction (as defined below) or take any other action that could reasonably be expected to lead to an Alternative Transaction or a proposal therefore; (ii) consider any inquiry, offer or proposal received from any party concerning any Alternative Transaction; (iii) furnish any information regarding CTI to any person or entity in connection with or in response to any inquiry, offer or proposal for or regarding any Alternative Transaction; (iv) participate in any discussions or negotiations with any person or entity with respect to any Alternative Transaction; (v) otherwise cooperate with, facilitate or encourage any effort or attempt by any person or entity (other than HNC) to effect any Alternative Transaction; or (vi) execute, enter into or become bound by any letter of intent, agreement, commitment or understanding between CTI or FGC and any third party that is related to, provides for or concerns any Alternative Transaction. During the foregoing time period identified in the preceding sentence, each of CTI and FGC will promptly disclose to HNC any inquiries or proposals for Alternative Transactions received by it from any third parties, which disclosure shall include the identity of the party making the inquiry or proposal and the terms of any proposal that are received. As used herein, the term "ALTERNATIVE TRANSACTION" means (i) any commitment, agreement or transaction involving or providing for the possible disposition of all or any substantial portion of CTI's business, assets or capital stock, whether by way of merger, consolidation, sale of assets, sale of stock, tender offer, license and/or any other form of business combination or (ii) any initial public offering of capital stock or other securities of CTI pursuant to a registration statement filed under the Securities Act or otherwise. 5.10 Access to Information. During the time period commencing on the Agreement Date and ending on the earlier to occur of (a) termination of this Agreement in accordance with the provisions of Article 10, or (b) consummation of the Merger at the Effective Time, CTI will allow HNC and its agents, during normal business hours and on reasonable advance notice (which may be given orally), access to the files, books, records, personnel and offices of CTI, including, without limitation, any and all information relating to CTI's taxes, commitments, contracts, leases, licenses, and real, personal and intangible property and financial condition, subject to the terms of any written nondisclosure or confidentiality Agreement between CTI and HNC. CTI will cause its accountants to cooperate with HNC and its agents in making available all financial information reasonably requested by HNC, including without limitation the right to examine all working papers pertaining to all financial statements prepared or audited by such accountants. 5.11 Satisfaction of Conditions Precedent. During the time period from the Agreement Date until the earlier to occur of (i) the Effective Time or (ii) the termination of this Agreement in accordance with Article 10, CTI will use its diligent efforts to satisfy or cause to be satisfied all the conditions precedent which are set forth in Articles 8 and 9, and CTI will use its diligent efforts to cause the Merger and the other transactions contemplated by this Agreement to be consummated in accordance with the terms of this Agreement by the Termination Date. 5.12 Securities Law Compliance. CTI will use its diligent good faith efforts: (a) to cause each CTI Stockholder to execute and deliver to HNC, at or prior to the Closing, an Investment Representation Letter and (b) to deliver to each CTI Stockholder (i) all disclosure 35 36 documents regarding HNC and the Merger that HNC requests CTI to deliver to each CTI Stockholder for the purposes of making disclosures to such stockholders regarding HNC. 5.13 Blue Sky Laws. CTI will use its diligent efforts to assist HNC to the extent necessary to comply with the securities and Blue Sky laws of all jurisdictions which are applicable in connection with the Merger. 5.14 CTI Employee Plans and Benefit Arrangements. CTI shall terminate its participation in any CTI Benefit Arrangement at, immediately prior to or as soon as administratively feasible following, the Effective Time upon the request of HNC. In the event that the distribution or rollover of assets from the trust of a Code Section 401(k) plan in which CTI was a participating employer prior to the Effective Time will trigger liquidation, surrender or other fees which will be imposed on the account of any participant or beneficiary of such terminated plan, CTI and FGC shall take such actions as are necessary to reasonably estimate the amount of such fees and provide such reasonable estimate in writing to HNC prior to the Effective Time. 5.15 Closing of Merger. CTI will not refuse to effect the Merger if, on or before the Closing Date, all the conditions precedent to CTI's obligations to effect the Merger under Article 8 have been satisfied or waived by CTI and HNC elects to consummate the Merger. 5.16 Tax-Free Reorganization. CTI and FGC will not take any action that it knows would cause the Merger not to qualify as a tax-free reorganization under Section 368(a) of the Code. 5.17 No Transfer. During the time period from the Agreement Date until the earlier to occur of (i) the Effective Time or (ii) the termination of this Agreement in accordance with Article 10, FGC shall not sell, pledge, encumber, transfer or dispose of any shares of CTI stock it owns as of the Agreement Date. 5.18 Tax Matters. FGC covenants and agrees with HNC and CTI that, from and after the Effective Time: (a) FGC will include the income of CTI (including any deferred income triggered into income by Treasury Regulation Section 1.1502-13 and Section 1.1502-14 and any excess loss accounts taken into income under Treasury Regulation Section 1.1502-19) on the FGC consolidated federal income tax returns for all periods through December 31, 1999 and FGC will be responsible for and will pay any federal income taxes attributable to such income. (b) HNC shall prepare or cause to be prepared and file or cause to be filed all tax returns for CTI for all periods ending on or prior to the Effective Time which are filed after the Effective Time other than income tax returns with respect to periods for which a consolidated, unitary or combined income tax return of FGC will include the operations of CTI. HNC shall permit FGC to review and comment on each such tax return prepared and filed or caused to be filed by HNC and described in the preceding sentence prior to filing but the ultimate decision as to the contents of any such tax return shall be made by HNC; provided, however, that HNC shall not unreasonably withhold its consent to changes requested by FGC. HNC or the Surviving Corporation shall prepare or cause to be prepared and file or cause to be filed all tax returns for the Surviving Corporation for all periods ending after the Effective Time which are filed after the Effective Time. HNC, FGC and the Surviving Corporation shall cooperate fully, as and to the extent reasonably requested by each other, in connection with the filing of tax returns pursuant to 36 37 this Section 5.18(b) and any audit, litigation or other proceeding with respect to taxes relating to such tax returns. Such cooperation shall include the retention and (upon request) the provision of records and information which are reasonably relevant to any such audit, litigation, or other proceeding and making employees available on a mutually convenient basis to provide additional information and explanation of any material provided hereunder. FGC agrees, and HNC agrees to cause the Surviving Corporation: (A) to retain all books and records with respect to tax matters pertinent to CTI or the Surviving Corporation relating to any taxable period beginning before the Effective Time until the expiration of the statute of limitations (and, to the extent notified by FGC or HNC, any extensions thereof) of the respective taxable periods, and (B) to give the other party reasonable written notice prior to transferring, destroying or discarding any such books and records and, if the other party so requests, FGC or the Surviving Corporation, as the case may be, shall allow the other to take possession of such books and records as are to be transferred, destroyed or discarded. HNC and FGC further agree, upon request, to use diligent efforts to obtain any certificate or other document from any governmental authority or any other person or entity as may be necessary to mitigate, reduce or eliminate any tax that could be imposed (including, but not limited to, with respect to the transactions contemplated hereby). FGC will allow CTI and its counsel to participate in any audits of FGC consolidated federal income tax returns to the extent that such returns relate to CTI. FGC will not settle any such audit in a manner which would adversely affect CTI after the Effective Time without the prior written consent of HNC, which consent shall not be unreasonably withheld. 5.19 Delivery of Closing Balance Sheet. FGC covenants and agrees with HNC that, promptly following the Effective Time, FGC shall promptly prepare a balance sheet of CTI as of the close of business on the date immediately prior to the date on which the Effective Time occurs (the "CLOSING BALANCE SHEET") in accordance with, and conforming to, all the requirements for such Closing Balance Sheet set forth in Section 3.8(b). The Closing Balance Sheet shall not reflect any intercompany receivables or payables required to be eliminated by the provisions of Section 9.17. FGC shall prepare and deliver the Closing Balance Sheet to HNC promptly following the Effective Time, but in no event later than ten (10) days following the Effective Time. HNC will afford FGC access to CTI's accounting books and other records as reasonably necessary to enable FGC to prepare the Closing Balance Sheet within the time required by this Section 5.19. ARTICLE 6 HNC COVENANTS 6.1 Advice of Changes. During the time period from the Agreement Date until the earlier to occur of (i) the Effective Time or (ii) the termination of this Agreement in accordance with Article 10, HNC will promptly advise CTI (a) of any event occurring subsequent to the Agreement Date of which HNC has knowledge that would render any representation or warranty of HNC contained in Article 4 of this Agreement (as qualified by the HNC Disclosure Letter), if made on or as of the date of such event or the Closing Date, untrue or inaccurate in any material respect and (b) of any Material Adverse Change in HNC arising after the Agreement Date. 6.2 Regulatory Approvals. HNC will promptly execute and file, or join in the execution and filing, of any application, notification or any other document that may be necessary in order to obtain the authorization, approval or consent of any Governmental Authority, whether federal, state, local or foreign, which may be reasonably required, in connection with the consummation of the Merger and the other transactions contemplated by this Agreement and the HNC Ancillary Agreements and Sub Ancillary Agreements in accordance with the terms of this 37 38 Agreement, including but not limited to any filings required to be made by HNC under the HSR Act. HNC will use diligent efforts to obtain all such authorizations, approvals and consents. 6.3 Satisfaction of Conditions Precedent. HNC will use its diligent efforts to satisfy or cause to be satisfied all of the conditions precedent which are set forth in Article 8, and HNC will use its diligent efforts to cause the Merger and the other transactions contemplated by this Agreement to be consummated in accordance with the terms of this Agreement by the Termination Date. 6.4 Nasdaq Listing. Prior to the Effective Time, HNC will take all actions necessary to authorize for listing on the Nasdaq Stock Market (or on whatever other securities exchange HNC Common Stock is issuable), the shares of HNC Common Stock to be issued upon consummation of the Merger pursuant to Section 2.1.2 (including the Escrow Shares). 6.5 Closing of Merger. HNC will not refuse to effect the Merger if, on or before the Closing Date, all the conditions precedent to HNC's obligations to effect the Merger under Article 9 have been satisfied or waived by HNC and CTI elects to consummate the Merger. 6.6 Tax-Free Reorganization. HNC will not take any action that it knows would cause the Merger not to qualify as a tax-free reorganization under Section 368(a) of the Code. 6.7 Blue Sky Laws. HNC will use its diligent efforts, subject to CTI's good faith cooperation, to the extent necessary to comply with the securities and Blue Sky laws of all jurisdictions which are applicable to the issuance of securities of HNC in connection with the Merger. 6.8 Tax Matters. HNC agrees to the provisions of Section 5.18(b) hereof. 6.9 Post-Closing Payment of Fifth Third Bank Loan. HNC agrees with FGC that, within one (1) week after the Effective Time, HNC or CTI shall pay in full to Fifth Third Bank the entire amount of unpaid principal and accrued interest under the Fifth Third Bank Loan (as defined in Section 3.8(c)); provided, however, that notwithstanding the foregoing, the maximum amount that HNC and/or CTI shall be obligated to pay under this Section 6.9 shall not exceed the total sum of $490,300; and provided further, that such payment by HNC shall be contingent on Fifth Third Bank releasing CTI from any potential liability or indebtedness associated with any loans, other credit arrangements or agreements between Fifth Third Bank, on the one hand, and/or FGC, any direct or indirect subsidiary of FGC or any direct or indirect affiliate of FGC. 6.10 Replacement of Guarantees. FGC has guaranteed CTI's obligation to pay amounts under several equipment leases now held by Fifth Third Bank, Central Ohio. HNC agrees with FGC that, promptly after the Effective Time, HNC will cooperate with FGC for the purpose of convincing the holders of such equipment leases to release FGC from such guaranty obligations for such leases, and, if necessary, HNC will provide such holders replacement guarantees of such equipment leases provide that the aggregate amount of indebtedness of CTI that HNC must so guarantee under such equipment leases does not exceed the amounts guaranteed by FGC and does not exceed $98,637.00 in the aggregate. 38 39 ARTICLE 7 CLOSING MATTERS 7.1 The Closing. Subject to termination of this Agreement as provided in Article 10, the closing of the transactions to consummate the Merger (the "CLOSING") will take place at the offices of Fenwick & West LLP, Two Palo Alto Square, Palo Alto, California 94306 at 10:00 a.m., Pacific Standard Time on the first business day after all of the conditions to Closing set forth in Articles 8 and 9 have been satisfied and/or waived in accordance with this Agreement, or on such later day as HNC and CTI may mutually agree on (the "CLOSING DATE"). Concurrently with the Closing, the Delaware Certificate of Merger will be filed with the Delaware Secretary of State and the Ohio Certificate of Merger will be filed with the Ohio Secretary of State. 7.2 Surrender and Exchange of Stock Certificates. 7.2.1 Surrender by CTI Stockholders. At or after the Closing, each holder of shares of CTI Stock will surrender the certificate(s) for all such shares of CTI Common Stock (each a "CTI CERTIFICATE"), duly endorsed to CTI (or accompanied by a stock power duly endorsed and executed by such holder), with the holder's signature notarized or signature guaranteed, for cancellation as of the Effective Time, together with an Investment Representation Letter executed by such holder. 7.2.2 Delivery by HNC. Promptly after the surrender by a CTI Stockholder to HNC of (i) such CTI Stockholder's CTI Certificate(s) duly endorsed as required in Section 7.2.1 above, and (ii) the delivery to HNC of an Investment Representation Letter executed by such CTI Stockholder, HNC or its transfer agent will issue and pay to each CTI Stockholder who has tendered to HNC CTI Certificate(s) representing all of the shares of CTI Common Stock held by such CTI Stockholder immediately prior to the Effective Time in accordance with the foregoing provisions of Section 7.2.1 and an Investment Representation Letter executed by such CTI Stockholder, (a) a certificate for the number of shares of HNC Common Stock that such holder is entitled to receive upon the conversion of such holder's shares of CTI Common Stock pursuant to Section 2.1.2(a) (less the number of such shares that represent such holder's Escrow Pro Rata of the Escrow Shares, which shall be withheld and placed in escrow pursuant to the provisions of Section 2.5 and the Escrow Agreement) plus (b) the amount of cash that such holder is entitled to receive upon the conversion of such holder's shares of CTI Common Stock pursuant to Section 2.1.2(b) plus (c) the amount of cash in lieu of fractional shares in the amount payable to such holder in accordance with Section 2.2, payable by check or wire transfer, at HNC's option. Within ten (10) business days after the execution by HNC, FGC, Overly and the Escrow Agent, HNC will also deliver the certificates representing the Escrow Shares to the Escrow Agent pursuant to the Escrow Agreement. 7.2.3 No payments of certificates of HNC Common Stock or cash described in Section 7.2.2 and no dividends or distributions payable to holders of record of HNC Common Stock after the Effective Time, will be paid to the holder of any unsurrendered CTI Certificate with respect to the shares of HNC Common Stock into which the shares of CTI Common Stock represented by such CTI certificate have been converted in the Merger until the holder of such unsurrendered CTI Certificate surrenders such CTI Certificate to HNC as provided in Sections 7.2.1 and 7.2.2 above, together with an executed Investment Representation Letter as provided in Section 7.2.2 above. Subject to the effect, if any, of applicable escheat and other laws, following the surrender of any CTI Certificate, there will be delivered to the person entitled thereto, without interest, the amount of any such dividends and distributions theretofore paid with respect to HNC 39 40 Common Stock so withheld as of any date subsequent to the Effective Time and prior to such date of delivery. 7.2.4 After the Effective Time there will be no further registration of transfers on the stock transfer books of CTI or its transfer agent of any shares of CTI capital stock that were outstanding immediately prior to the Effective Time. If, after the Effective Time, CTI Certificates are presented for any reason, they will be canceled and exchanged as provided in this Section 7.2. 7.2.5 Until CTI Certificates representing shares of CTI Common Stock outstanding immediately prior to the Effective Time are surrendered pursuant to Section 7.2.1 above, such CTI Certificates will be deemed, for all purposes, to evidence ownership of the right to receive the number of shares of HNC Common Stock and cash (plus cash for fractional shares as provided in Section 2.2) into which such shares of CTI Common Stock will have been converted pursuant to Section 2.1.2 in the Merger, subject to all the provisions of this Agreement, including but not limited to the provisions of Section 2.5 regarding the escrow, and the Escrow Agreement. 7.2.6. Each stock certificate representing shares of HNC Common Stock issued pursuant to this Agreement shall bear the following legend (in addition to any legends required by applicable state laws): THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE U.S. SECURITIES ACT OF 1933, AS AMENDED (THE "1933 ACT"). THESE SECURITIES MAY NOT BE OFFERED, SOLD, PLEDGED, OR TRANSFERRED UNLESS (1) A REGISTRATION STATEMENT UNDER THE 1933 ACT (AND A CURRENT PROSPECTUS) IS IN EFFECT AS TO THE SECURITIES, (2) AN EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THE 1933 ACT IS AVAILABLE, OR (3) THE SECURITIES ARE SOLD PURSUANT TO RULE 144 OF THE 1933 ACT. THE ISSUER OF THESE SECURITIES MAY REQUIRE AN OPINION OF COUNSEL IN FORM AND SUBSTANCE SATISFACTORY TO THE ISSUER TO THE EFFECT THAT ANY PROPOSED TRANSFER OR RESALE IS IN COMPLIANCE WITH THE 1933 ACT AND ANY APPLICABLE STATE SECURITIES LAWS. 7.2.7 HNC may issue appropriate "stop transfer" instructions to its transfer agent. HNC shall not be required (a) to transfer or have transferred on its books any shares of HNC Common Stock issued pursuant to this Agreement that have been sold or otherwise transferred in violation of any of the provisions of (i) the legend set forth in Section 7.2.6, (ii) any other provisions of this Agreement, (iii) any applicable law or (iv) the Investment Representation Letter, or (b) to treat as owner of such shares or to accord the right to vote or pay dividends to any purchaser or other transferee to whom such shares shall have been so transferred in violation of any law or of any provision of this Agreement or the Investment Representation Letter. 40 41 ARTICLE 8 CONDITIONS TO OBLIGATIONS OF CTI CTI's obligations to consummate the Merger hereunder are subject to the fulfillment or satisfaction, on and as of the Closing, of each of the following conditions (any one or more of which may be waived by CTI, but only in a writing signed by CTI): 8.1 Accuracy of Representations and Warranties. The representations and warranties of HNC and Sub set forth in Article 4 (as qualified by the HNC Disclosure Letter) will be true and correct in all material respects on and as of the Closing with the same force and effect as if they had been made at the Closing (except for those representations and warranties which address matters only as of a particular date or dates, which need be true and correct only as of such date or dates), except for such breaches, inaccuracies or omissions of such representations and warranties that neither have, nor reasonably would be expected to have, a Material Adverse Effect on HNC; and CTI will have received a certificate to such effect executed by HNC's President or Chief Financial Officer. 8.2 Agreements and Covenants. HNC and Sub shall have performed or complied in all material respects with all agreements and covenants required by this Agreement to be performed or complied with by them on or prior to the Effective Time, and CTI shall have received a certificate to such effect executed by HNC's President or Chief Financial Officer. 8.3 No Material Adverse Change to HNC. There shall not have occurred any Material Adverse Change to HNC since December 31, 1999 (excluding for purposes of this Section any fact or event that has been publicly disclosed by HNC prior to the Agreement Date, by a press release or filing with the SEC or otherwise), and CTI shall have received a certificate to such effect executed by HNC's President or Chief Financial Officer. 8.4 Compliance with Law; No Legal Restraints; No Litigation. No litigation or proceeding (other than any litigation or proceeding initiated by CTI or any of its affiliates) will be pending (a) for the purpose or with the probable effect of enjoining or preventing the consummation of the Merger or any of the other material transactions contemplated by this Agreement, or (b) which could be reasonably expected to have a Material Adverse Effect on (i) CTI or (ii) following the Merger, HNC and its consolidated subsidiaries, considered together as a whole. There will not be any outstanding, or enacted or adopted, any order, decree, temporary, preliminary or permanent injunction, legislative enactment, statute, regulation or any judgment or ruling by any court, arbitrator, governmental agency or authority, that, directly or indirectly, challenges, prohibits, enjoins, restrains, suspends, delays, conditions or renders illegal or imposes limitations on the Merger or any other material transaction contemplated by this Agreement. 8.5 Government Consents; HSR Act Compliance. There will have been obtained at or prior to the Closing Date such permits or authorizations, and there will have been taken all such other actions by any regulatory authority having jurisdiction over the parties and the actions herein proposed to be taken, as may be required to lawfully consummate the Merger, including but not limited to (a) the completion of all filings required to be made by HNC, CTI and FGC under the HSR Act regarding the Merger and the other transactions contemplated hereby and the expiration (or early termination) of all waiting periods with respect to such transactions under the HSR Act and (b) requirements under applicable federal and state securities laws 41 42 8.6 Opinion of HNC's Counsel. CTI will have received from Fenwick & West LLP, counsel to HNC, a favorable opinion regarding the matters set forth in Exhibit E. 8.7 Stockholder Approval. This Agreement and the Merger shall have been approved and adopted by the CTI Stockholders by the requisite vote required under the OGCL and the Articles of Incorporation, Code of Regulations and any other charter documents of CTI. 8.8 Nasdaq Listing. The shares of HNC Common Stock issuable to CTI Stockholders pursuant to this Agreement and such other shares required to be reserved for issuance in connection with the Merger shall have been authorized for listing on the Nasdaq Stock Market upon official notice of issuance in accordance with the provisions of Section 6.4. ARTICLE 9 CONDITIONS TO OBLIGATIONS OF HNC AND SUB The obligations of HNC and Sub hereunder are subject to the fulfillment or satisfaction on, and as of the Closing, of each of the following conditions (any one or more of which may be waived by HNC, but only in a writing signed by HNC): 9.1 Accuracy of Representations and Warranties. The representations and warranties of CTI and FGC set forth in Article 3 (as qualified by CTI Disclosure Letter) will be true and correct in all material respects on and as of the Closing with the same force and effect as if they had been made at the Closing (except for those representations and warranties which address matters only as of a particular date or dates, which need be true and correct only as of such date or dates), and except for such breaches, inaccuracies or omissions of such representations and warranties that neither have, nor reasonably would be expected to have, a Material Adverse Effect on CTI; and HNC will have received a certificate to such effect executed by CTI's Chief Executive Officer and Chief Financial Officer and FGC's Chief Executive Officer or Chief Financial Officer. 9.2 Agreements and Covenants. CTI and FGC shall have performed or complied in all material respects with all agreements and covenants required by this Agreement to be performed or complied with by CTI or FGC (as applicable) on or prior to the Effective Time, and HNC shall have received a certificate to such effect executed by CTI's Chief Executive Officer and Chief Financial Officer and by FGC's Chief Executive Officer or Chief Financial Officer. 9.3 No Material Adverse Change to CTI. There shall not have occurred any Material Adverse Change to CTI since the Balance Sheet Date, and HNC shall have received a certificate to such effect executed by CTI's Chief Executive Officer and Chief Financial Officer. 9.4 Compliance with Law; No Legal Restraints; No Litigation. No litigation or proceeding (other than any litigation or proceeding initiated by HNC or any of its affiliates) will be pending (a) for the purpose or with the probable effect of enjoining or preventing the consummation of the Merger or any of the other material transactions contemplated by this Agreement, or (b) which could be reasonably expected to have a Material Adverse Effect on (i) CTI or (ii) following the Merger, HNC and its consolidated subsidiaries, taken as a whole. There will not be any outstanding or enacted or adopted, any order, decree, temporary, preliminary or permanent injunction, legislative enactment, statute, regulation or any judgment or ruling by any court, arbitrator, governmental agency or authority, that, directly or indirectly, 42 43 challenges, prohibits, enjoins, restrains, suspends, delays, conditions or renders illegal or imposes limitations on the Merger or any other material transaction contemplated by this Agreement. 9.5 Government Consents. There will have been obtained at or prior to the Closing Date such permits or authorizations, and there will have been taken all such other actions, as may be required to consummate the Merger by any governmental or regulatory authority having jurisdiction over the parties and the actions herein proposed to be taken, including but not limited to (a) the completion of all filings required to be made by HNC, CTI and FGC under the HSR Act regarding the Merger and the other transactions contemplated hereby and the expiration (or early termination) of all waiting periods with respect to such transactions under the HSR Act and (b) the requirements under applicable federal and state securities laws. 9.6 Opinion of CTI's Counsel. HNC will have received from Schottenstein, Zox & Dunn, Co., L.P.A. counsel to CTI, a favorable opinion regarding the matters set forth in the form of Exhibit F. 9.7 Consents Obtained. HNC will have received duly executed copies of all material third-party consents, approvals, assignments, waivers, authorizations or other certificates necessary for CTI to consummate the Merger set forth in Schedule 3.5 to the CTI Disclosure Letter in form and substance reasonably satisfactory to HNC. 9.8 Requisite Approvals; No Dissenters. This Agreement, the Merger and the CTI Ancillary Agreements will have been duly and validly approved and adopted, as required by applicable law and CTI's Articles of Incorporation and Code of Regulations, by (a) CTI's Board of Directors and (b) the valid and affirmative vote of not less than one hundred percent (100%) of the outstanding shares of CTI Common Stock entitled to vote thereon. Immediately prior to the Closing no holder of any outstanding shares of CTI's capital stock shall be eligible to exercise any dissenting stockholders' appraisal rights under the OGCL or any other law with respect to the Merger. 9.9 Escrow Agreement. HNC will have received a fully executed copy of the Escrow Agreement in the form of Exhibit C executed by the Escrow Agent, the Representative and FGC. 9.10 Non-Competition Agreement. HNC will have received a copy of a Non-Competition Agreement in substantially the form of Exhibit H, duly executed by CTI and FGC. 9.11 Resignation of Directors. The directors of CTI in office immediately prior to the Effective Time of the Merger (other than any such director who is designated in Section 2.6(e) to be a director of CTI immediately after the Effective Time) will have resigned as directors of the Surviving Corporation effective as of the Effective Time. 9.12 Investment Representation Letter. Each holder of outstanding shares of CTI Common Stock shall have executed and delivered an Investment Representation Letter to HNC. 9.13 Securities Compliance. HNC shall be reasonably satisfied that the issuance of its shares of HNC Common Stock and other securities in the Merger shall: (a) be exempt from the registration requirements of the Securities Act by reason of the exemption(s) provided by Section 4(2) of the Securities Act and/or Regulation D promulgated under the Securities Act and (b) be exempt from the registration and/or qualification requirements of all applicable state "blue sky" securities laws. 43 44 9.14 Assignment of EDICT Agreement. FGC shall, pursuant to a written agreement executed by CTI and FGC that is reasonably satisfactory to HNC and its counsel, have validly assigned and transferred to CTI all right, title and interest in and to all of the assets and properties and licenses (including but not limited to Intellectual Property and licenses thereto) acquired by FGC pursuant to that certain Asset Purchase Agreement dated as of February 26, 1996 between FGC and EDICT Systems, Inc. ("EDICT"), free and clear of all claims, demands, liens and encumbrances whatsoever. 9.15 Confirmation of Ownership. FGC and FGSC shall have confirmed, in a writing executed by them that is reasonably satisfactory to HNC and its counsel, that each of FGC and FGSC have assigned and transferred to CTI all right, title and interest in and to all products, software, technology, Intellectual Property and other properties and assets that are used or marketed in CTI's business, including but not limited to all right, title and interest in and to all of the Intellectual Property, other assets and agreements that were used by FGSC in conducting the Employee-Connect, Medical First Aid Network Services businesses of FGSC as of July 6, 1994. 9.16 Termination of Employment Agreement. That certain Employment Agreement dated as of December 21, 1995 between Shawn Maloney ("MALONEY") and FGSC, as such may have been amended (the "MALONEY EMPLOYMENT AGREEMENT") and that certain letter agreement dated February 24, 2000 between Maloney and FGC relating to the Merger (the "MALONEY ADDENDUM") shall each have been validly terminated by each of the parties thereto and CTI shall have been released of any obligation or liability to Maloney or any of his heirs, successors or assigns under the Maloney Employment Agreement and the Maloney Addendum. 9.17 Elimination of Certain Intercompany Accounts. All intercompany debts and payables that are owed by CTI to FGC and/or to any subsidiary or direct or indirect affiliate of FGC (other than ordinary trade payables owed by CTI to such persons), and all intercompany debts and receivables that are payable to CTI by FGC and/or by any direct or indirect subsidiary or direct or indirect affiliate of FGC (other than ordinary trade payables owed to CTI by such persons), shall have been eliminated and cancelled, and HNC shall have received a written instrument to that effect executed by FGC and in form and substance reasonably satisfactory to HNC and its counsel. For purposes of clarification, the parties agree that satisfaction of the condition set forth in this Section 9.17 shall not, without limitation, require the cancellation or release of (a) any trade receivable payable to CTI by FGC, FGSC, CareWorks (as defined below), and/or by any direct or indirect subsidiary of FGC or any direct or indirect affiliate of FGC, or (b) any non-pecuniary performance obligation of CTI (such as license, maintenance or support obligations) to CareWorks of Ohio Ltd. ("CAREWORKS") under that certain Synapse Network Services Agreement dated as of April 8, 1997 between CTI and CareWorks, and under that certain Synapse Network Services Agreement between CTI and FGSC, as such agreements may be amended pursuant to Section 9.19 below. 9.18 AT&T Agreement in Effect. That certain AT&T Easycommerce Services Reseller Agreement dated as of September 5, 1996 between CTI and AT&T Corp. ("AT&T") and that certain AT&T Easycommerce Services Messaging and Software License Agreement between CTI and AT&T shall each be in full force and effect and CTI shall not be in breach, violation or default of either of such agreements. 9.19 Amendment of CareWorks and FGC Agreement. That certain Synapse Network Services Agreement between CTI and CareWorks dated as of April 8, 1997 shall have been amended to extend the term of such agreement for an additional two (2) year term effective April 44 45 1,2000 (with the potential for automatic renewal of such term) by a writing executed and delivered by CareWorks and CTI that is in form and substance reasonably acceptable to HNC and its counsel, and that certain Synapse Network Services Agreement between CTI and FGSC shall have been amended to extend the term of such agreement for an additional two (2) year term effective April 1, 2000 (with the potential for automatic renewal of such term) by a writing executed by FGSC and CTI that is in form and substance reasonably acceptable to HNC and its counsel. ARTICLE 10 TERMINATION OF AGREEMENT 10.1 By Consent. This Agreement may be terminated at any time prior to the Effective Time by the mutual written consent of HNC and CTI. 10.2 Governmental Order. Either HNC or CTI, by giving written notice to the other, may terminate this Agreement if a court of competent jurisdiction or other Governmental Authority shall have issued a non-appealable final order, decree or ruling or taken any other action, in each case having the effect of permanently restraining, enjoining or otherwise prohibiting the Merger. 10.3 At Termination Date. Either HNC or CTI, by giving written notice to the other, may terminate this Agreement if the Merger shall not have been consummated and the Effective Time has not occurred on or before the Termination Date; provided, however, that notwithstanding the foregoing, a party may not terminate this Agreement pursuant to this Section 10.3 if: (a) the failure of such party to perform any of its obligations or covenants under this Agreement in any material respect, or the material breach of a representation or warranty made by such party in this Agreement (or its applicable Disclosure Letter), results in the failure of any condition set forth in Article 8 or Article 9 that has not been waived by the other party; and (b) the other party has performed its obligations under this Agreement in all material respects and the representations and warranties of such other party under Article 3 or Article 4 of this Agreement (as applicable) are true and correct in all material respects as of the Termination Date. 10.4 Termination for Material Breach. HNC or CTI may terminate this Agreement at any time prior to the Closing if the other party ("BREACHING PARTY") has committed a material breach of any of the breaching party's representations and warranties under Article 3 or Article 4 of this Agreement, as applicable, or a material breach of any of the breaching party's covenants or obligations under this Agreement, and the breaching party has not cured such material breach or breaches within thirty (30) days after the party seeking to terminate this Agreement has given the breaching party written notice of its intention to terminate this Agreement pursuant to this Section 10.4; provided, that if the material breach of any of a party's representations and warranties or covenants or obligations cannot by its nature be substantially cured, then this Agreement shall terminate immediately upon the giving by the party seeking to terminate this Agreement to the breaching party of written notice of termination of this Agreement pursuant to this Section 10.4, but only if such notice states that this Agreement will be immediately terminated because the breach cannot by its nature be cured. For purposes of this Section 10.4, HNC and Sub shall be considered to be one party, and CTI and FGC shall be considered to be one party; provided that neither Sub nor FGC may terminate this Agreement. 10.5 No Liability. No party who terminates this Agreement in accordance with the provisions of this Article 10 shall incur any obligation or liability to any other party on account of 45 46 such termination. However, nothing herein will limit or modify the obligations of CTI and HNC under Sections 5.11 and 6.3, respectively. ARTICLE 11 SURVIVAL OF REPRESENTATIONS, INDEMNIFICATION AND REMEDIES, CONTINUING COVENANTS 11.1 Survival of Representations. Subject to the provisions of Section 11.3, all representations, warranties and covenants of CTI and FGC contained in Article 3 of this Agreement or in the CTI Disclosure Letter will remain operative and in full force and effect, regardless of any investigation made by or on behalf of HNC, until that date (the "ESCROW RELEASE DATE") which is the first (1st) anniversary of the Effective Time. 11.2 Indemnification. (a) Agreement to Indemnify; Indemnifiable Loss. Subject to the terms and conditions of this Article 11, FGC and the other CTI Stockholders (if any) shall jointly and severally indemnify and hold harmless HNC and the Surviving Corporation and their respective officers, directors, agents and employees, and each person, if any, who, controls or may hereafter control HNC or the Surviving Corporation within the meaning of the Securities Act or the Exchange Act (HNC, the Surviving Corporation and each such other person being hereinafter referred to individually as an "INDEMNIFIED PERSON" and collectively as "INDEMNIFIED PERSONS") from and against any and all Loss (as defined in Article 1) incurred with respect to, and/or arising out of, any inaccuracy, misrepresentation, breach or violation of, or default in, any of the representations, warranties or covenants given or made by CTI in this Agreement, in the CTI Disclosure Letter or in any certificate delivered by or on behalf of CTI to HNC pursuant to this Agreement, if such inaccuracy, misrepresentation, breach or default existed at the Closing Date (all such Loss being hereinafter called "INDEMNIFIABLE LOSS"). Without limitation, any and all fees (including without limitation reasonable attorneys' fees, accountants' fees and tax preparers' fees) relating to the investigation, defense, remedy, settlement or satisfaction of any Indemnifiable Loss shall be deemed to be Indemnifiable Loss. (b) Timing. Except with respect to a claim for Special Loss (as defined in Section 11.3), any claim for indemnification for Indemnifiable Loss made by or on behalf of any Indemnified Person under this Section 11.2 against any CTI Stockholder (an "INDEMNITY CLAIM") must be raised in a writing delivered to the Escrow Agent by no later than the Escrow Release Date, but any such Indemnity Claim, if so raised prior to the Escrow Release Date, may continue to be prosecuted and resolved after the Escrow Release Date in accordance with the provisions of this Article 11 and the provisions of the Escrow Agreement, as applicable. (c) Limitations. Except as otherwise provided in Section 11.3 or as otherwise provided in this Article 11 with respect to Special Loss and claims by HNC or other persons to recover Special Loss (which shall not be subject to any of the following limitations set forth in this Section 11.2(c)): (i) in seeking indemnification for Indemnifiable Loss that is not Special Loss under Section 11.2, the Indemnified Persons will exercise their remedies solely with respect to the Escrow Shares and any other assets deposited in escrow pursuant to the Escrow Agreement (collectively, the "ESCROW PROPERTY") and neither FGC nor any CTI Stockholder will have any liability to an Indemnified Person under Section 11.2 of this Agreement for 46 47 Indemnifiable Loss that is not Special Loss except to the extent of such CTI Stockholder's interest in the Escrow Property; and (ii) the remedies set forth in this Section 11.2 and the Escrow Agreement will be the exclusive remedies of HNC and the other Indemnified Persons under Section 11.2 of this Agreement against FGC or any CTI Stockholder for their indemnification obligations under Section 11.2 with respect to Indemnifiable Loss that is not Special Loss. (iii) the indemnification obligations of FGC and the CTI Stockholders under this Section 11.2 for Indemnifiable Loss that is not Special Loss shall not apply unless and until the aggregate amount of Indemnifiable Loss for which one or more Indemnified Persons seeks or has sought indemnification under Section 11.2 exceeds a cumulative aggregate of One Hundred Thousand Dollars ($100,000) (the "BASKET"), in which event the CTI Stockholders shall, subject to the foregoing limitations, be liable to indemnify the Indemnified Persons for all Indemnifiable Loss. (d) Special Loss Claims Against Escrow Property. Claims for Special Loss that is also Indemnifiable Loss that are raised by HNC or any other Indemnified Person prior to the Escrow Release Date may, at HNC's or an Indemnified Person's sole option and discretion, be prosecuted (i) under the arbitration and other provisions of the Escrow Agreement so that HNC can recover such Special Loss from the Escrow Property (except that HNC's remedy will not be restricted to the recovery of Escrow Property) and/or (ii) before any court of competent jurisdiction having jurisdiction of the parties against whom HNC or an Indemnified Person seeks recovery for such Special Loss; provided, however, that (x) HNC shall have no obligation to prosecute claims for Special Loss (A) pursuant to the Escrow Agreement or (B) prior to the Escrow Release Date, and, in addition to prosecuting any such claim for Special Loss that is Indemnifiable Loss under the arbitration and other provisions of the Escrow Agreement as provided in clause (i) above, at its option, HNC and/or an Indemnified Person may prosecute such claim to recover Special Loss in or before any court of competent jurisdiction having jurisdiction of the parties against whom HNC or an Indemnified Person seeks recovery of such Special Loss at any time prior to expiration of the applicable statute of limitations. Nothing herein will require HNC or any other Indemnified Person to first exercise any rights or remedies with respect to the Escrow Property with respect to any claim for Special Loss. 11.3 Claims for Special Loss. (a) Special Loss. As used herein, "SPECIAL LOSS" means Misconduct Loss, Tax Loss, Compensation Loss, Title Loss and/or D&O Indemnity Loss, collectively and individually, and "SPECIAL LOSS CLAIM" means a Misconduct Loss Claim, a Tax Loss Claim, a Compensation Loss Claim, a Title Loss Claim and/or a D&O Indemnity Claim, collectively and individually. (b) Misconduct Loss. As used herein, "MISCONDUCT LOSS" means, collectively, any Loss suffered or incurred by HNC and/or any other Indemnified Person that arises or results from (i) the fraudulent conduct of FGC or any other CTI Stockholder, or (ii) from conduct of FGC or any other CTI Stockholder that constitutes a willful and intentional effort to cause CTI to commit a material breach of any of its covenants, obligations, representations or warranties under this Agreement. As used herein, "MISCONDUCT LOSS CLAIM" means any claim, suit, arbitration, action or other proceeding brought by HNC and/or any other Indemnified Person to recover Misconduct Loss from any CTI Stockholder whose conduct described in clause (i) and/or clause (ii) of this Section 11.3(b), gave rise to or resulted in such Misconduct Loss. 47 48 (c) Tax Loss. As used herein "TAX LOSS" means any Loss suffered or incurred by HNC and/or any Indemnified Person arising or resulting from: (i) any breach or violation of the representations and warranties of CTI set forth in Section 3.7 of this Agreement; and/or (ii) any liability of CTI for taxes of any person or entity other than CTI (A) under Treasury Regulation Section 1.1502-6 (or any similar provision of state, local or foreign law), (B) as a transferee or successor, (C) by contract or agreement, or (D) otherwise. As used herein, "TAX LOSS CLAIM" means any claim, suit, arbitration, action or other proceeding brought by HNC and/or any other Indemnified Person to recover Tax Loss from FGC, any FGC Affiliate (other than CTI) and/or any other CTI Stockholder (if any). (d) Compensation Loss. As used herein "COMPENSATION LOSS" means any Loss suffered or incurred by HNC and/or any Indemnified Person arising or resulting from any claim, demand, suit, action or proceeding by any employee, officer, director, consultant, independent contractor or other service provider of CTI, FGC or any subsidiary or affiliate of FGC: (i) for any payment of cash, property (including but not limited to stock, options, securities or derivatives thereof) or any compensation in connection with, payable upon the consummation of, or payable by reason of, the Merger, this Agreement or any transaction contemplated by this Agreement or any agreement that is an exhibit to this Agreement; or (ii) arising in any manner under the Maloney Agreement or the Maloney Addendum or any modification, termination, release or rescission thereof. As used herein, "COMPENSATION LOSS CLAIM" means any claim, suit, arbitration, action or other proceeding brought by HNC, CTI and/or any other Indemnified Person to recover Compensation Loss from FGC, any FGC Affiliate (other than CTI) and/or any other CTI Stockholder (if any). (e) Title Loss. As used herein "TITLE LOSS" means any Loss suffered or incurred by HNC and/or any Indemnified Person arising or resulting from (i) any failure by FGC or any other CTI Stockholder to hold good, valid and marketable title to the number of shares of CTI Common Stock that such CTI Stockholder is represented to own under this Agreement and/or the CTI Disclosure Letter or any schedule thereto, free and clear of all claims, liens, pledges and encumbrances and/or (ii) the existence (or claim asserting the existence) of any option, warrant or other right to purchase or otherwise acquire any CTI Common Stock or other securities of CTI, from CTI or from any CTI Stockholder. As used herein, "TITLE LOSS CLAIM" means any claim, suit, arbitration, action or other proceeding brought by HNC and/or any other Indemnified Person against a CTI Stockholder to recover Title Loss from such CTI Stockholder based on the failure of such CTI Stockholder, to hold good, valid and marketable title to the full number of shares of CTI Common Stock that such CTI Stockholder is represented to own under this Agreement and/or the CTI Disclosure Letter or any schedule thereto, free and clear of all claims, liens, pledges and encumbrances. (f) D&O Indemnity Loss. As used herein, "D&O INDEMNITY LOSS" means any Loss suffered or incurred by HNC and/or any Indemnified Person arising or resulting from any claim, demand, suit, action, arbitration or other proceeding brought by any person who served as a director or officer of CTI prior to the Effective Time for indemnification or advancement or reimbursement of expenses or similar compensation pursuant to any provisions of CTI's Articles of Incorporation or Code of Regulations, each as amended, or under an agreement or applicable law to the extent such claim arises from any facts or events occurring prior to the Effective Time. As used herein, "D&O INDEMNITY CLAIM" means any claim, suit, action, arbitration or other proceeding brought by HNC and/or any other Indemnified Person against a CTI Stockholder to recover D&O Indemnity Loss. 48 49 (g) Special Treatment of Special Loss Claims. Notwithstanding anything in the foregoing provisions of this Article 11 to the contrary, none of the limitations on the indemnification obligations and liabilities of the CTI Stockholders set forth in the foregoing provisions of this Article 11 (including but not limited to those limitations set forth in Section 11.2) shall be applicable to, or otherwise in any manner limit, the right or ability of HNC and/or any other Indemnified Person to recover, or seek recovery for, any Special Loss with respect to any Special Loss Claim. Accordingly, without limitation: (i) there shall be no limitation on the liability of a CTI Stockholder for the amount of Special Loss arising from the fraudulent conduct of such CTI Stockholder and/or from conduct of such CTI Stockholder described in clause (ii) of Section 11.3(b); (ii) there shall be no limitation on the liability of any CTI Stockholder for any Tax Loss arising from any Tax Loss Claim; (iii) there shall be no limitation on the liability of a CTI Stockholder for any Title Loss arising from a Title Loss Claim; (iv) there shall be no limitation on the liability of any CTI Stockholder for any D&O Indemnity Loss arising from any D&O Indemnity Loss Claim; (v) Special Loss Claims need not be made, brought or raised prior to the Escrow Release Date and any Special Loss Claim may be made, brought or raised by HNC and/or any other Indemnified Person at any time prior to expiration of the statute of limitations applicable to such Special Loss Claim under applicable law; and (vi) the Basket limitation described in Section 11.2(c) shall not apply to any Special Loss Claim. In addition, claims for Special Loss not required to be prosecuted under the Escrow Agreement under the terms of Section 11.2, or Special Loss Claims that are first made, brought or raised after the Escrow Release Date, need not be prosecuted pursuant to the Escrow Agreement and may be prosecuted by HNC, at its election, (A) pursuant to the arbitration process described in Section 3 of the Escrow Agreement (except that HNC's remedy will not be restricted to the recovery of Escrow Shares) and/or (B) before any court having jurisdiction of the parties. (h) Third-Party Claims. As used in this Section 11.3, a "THIRD-PARTY Claim" means a claim, demand, suit, arbitration, investigation, inquiry or proceeding brought by a third party against HNC or any Indemnified Person that, if successful, would result in HNC and/or an Indemnified Person suffering or incurring Special Loss of any kind. (i) After an executive officer of HNC becomes aware of the bringing of a Third-Party Claim against HNC or any Indemnified Person, HNC will, within a reasonable time thereafter, give FGC notice of such Third-Party Claim; provided that any failure by HNC to give FGC notice of a Third-Party Claim shall not release FGC of any liability or obligations it has to HNC with respect to such Third-Party Claim under this Article 11 unless (A) HNC's failure to notify FGC of such Third-Party Claim materially prejudices the ability to defend such Third-Party Claim, (B) FGC is entitled to defend such Third-Party Claim under the provisions of this Section 11.3(h) and (C) HNC does not take reasonable efforts to defend such Third-Party Claim, but in no event will FGC be released of any liability that FGC may have to HNC and/or any Indemnified Person otherwise than under Section 11.2 hereof. (ii) Subject to the provisions of Section 11.3(h)(iii) below, HNC shall defend any Third-Party Claim, and the costs and expenses incurred by HNC in connection with such defense (including but not limited to reasonable attorneys' fees, other professionals' and experts' fees and court or arbitration costs) shall be deemed to be Special Loss included in the Special Loss for which HNC is entitled to indemnification pursuant to such Third-Party Claim. (iii) Notwithstanding the provisions of Section 11.3(h)(ii) above, subject to the terms and conditions of this Section 11.3(h), FGC will have the right, at its sole option, and at its sole cost and expense, to assume and control the defense of HNC and all other Indemnified Persons against a Third-Party Claim with reputable legal counsel of FGC's choice 49 50 that is reasonably satisfactory to HNC and all the other affected Indemnified Person(s) ("ACCEPTABLE COUNSEL") so long as: (A) FGC notifies HNC and each affected Indemnified Person in writing within ten (10) days after HNC or the Indemnified Person has given notice of the Third-Party Claim for which FGC intends to undertake such defense; (B) FGC provides HNC and each Indemnified Person with reasonably acceptable evidence that FGC has, and will have, the financial resources necessary to provide Acceptable Counsel to defend HNC and the Indemnified Persons against the Third-Party Claim and fulfill the CTI Stockholders' defense and indemnification obligations; (C) the Third-Party Claim involves only money damages and does not seek an injunction or other equitable relief (unless HNC and all affected Indemnified Persons agree in writing that FGC may nevertheless control the defense of such action for an injunction or other equitable relief); (D) settlement of, or an adverse judgment with respect to, the Third-Party Claim is not, in the good faith judgment of HNC, likely to establish a precedent, custom or practice adverse to the continuing business interests of HNC; (E) FGC conducts the defense of the Third-Party Claim actively and diligently; and (F) the Acceptable Counsel chosen by FGC does not have any conflict of interest in representing the interests of HNC or any of the affected Indemnified Person(s). (iv) So long as FGC is conducting the defense of the Third-Party Claim in accordance with Section 11.3(h)(iii) above: (A) HNC and each Indemnified Person may retain separate co-counsel and participate in the defense of the Third-Party Claim at its own cost and expense and shall have the right to receive copies of all pleadings, notices and communications with respect to the Third-Party Claim to the extent no privilege of FGC is thereby waived; (B) HNC and each Indemnified Person may participate in all settlement negotiations with respect to the Third-Party Claim; and (C) FGC will not consent to the entry of any judgment or enter into any settlement with respect to the Third-Party Claim unless (1) HNC and each of the affected Indemnified Persons consent thereto in writing (which consent will not unreasonably be withheld) or (2) the settlement, compromise or consent includes an unconditional release from all liability with respect to the Third-Party Claim in favor of HNC and each Indemnified Person. (v) If FGC does not elect to assume control of or otherwise participate in the defense or settlement of any Third-Party Claim, or if FGC does so elect but any of the conditions to FGC's being entitled to defend such Third-Party Claim set forth in Section 11.3(h)(iii) above are not satisfied or later cease to be unsatisfied, or if FGC ceases at any time to actively and diligently defend the Third-Party Claim, then: (A) HNC and the affected Indemnified Person(s) may assume control of the defense of and consent to the entry of any judgment or enter into any settlement with respect to the Third-Party Claim; provided, however, that (1) FGC shall have the right to receive copies of all pleadings, notices and communications with respect to the Third-Party Claim so long as the receipt of such documents by FGC does not adversely affect any privilege relating to HNC or any Indemnified Person, and (2) FGC may participate in settlement negotiations with respect to the Third-Party Claim; (B) HNC and the Indemnified Person(s) shall not enter into any settlement of such Third-Party Claim without the prior written consent of FGC (which consent shall not be unreasonably withheld); and (C) FGC will remain responsible to indemnify HNC and all Indemnified Person(s) for all Loss they may incur arising out of, resulting from or caused by the Third-Party Claim to the fullest extent provided in Sections 11.2 and 11.3. 50 51 ARTICLE 12 MISCELLANEOUS 12.1 Governing Law. The internal laws of the State of California (irrespective of its choice of law principles) will govern the validity of this Agreement, the construction of its terms, and the interpretation and enforcement of the rights and duties of the parties hereto. 12.2 Assignment; Binding Upon Successors and Assigns. No party hereto may assign any of its rights or obligations hereunder without the prior written consent of each other party hereto. This Agreement will be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns. 12.3 Severability. If any provision of this Agreement, or the application thereof, will for any reason and to any extent be invalid or unenforceable, then the remainder of this Agreement and the application of such provision to other persons or circumstances will be interpreted so as reasonably to give effect to the intent of the parties hereto. The parties further agree to replace such void or unenforceable provision of this Agreement with a valid and enforceable provision that will achieve, to the maximum extent legally permissible, the economic, business and other purposes of the void or unenforceable provision. 12.4 Counterparts. This Agreement may be executed in any number of counterparts, each of which will be an original as regards any party whose signature appears thereon and all of which together will constitute one and the same instrument. This Agreement will become binding when one or more counterparts hereof, individually or taken together, bear the signatures of all the parties reflected hereon as signatories and have been delivered by each party to each other party (whether in facsimile or original form). 12.5 Other Remedies. Except as otherwise provided herein, any and all remedies herein expressly conferred upon a party will be deemed cumulative with, and not exclusive of, any other remedy conferred hereby or by law on such party, and the exercise of any one right or remedy will not preclude the exercise of any other right or remedy. 12.6 Amendment and Waivers. This Agreement may be amended by the parties hereto at any time but only by a writing signed solely by HNC and CTI. Any such amendment may be made at any time before or after approval of this Agreement by the stockholders of CTI, but, after such approval, no amendment will be made which by applicable law requires the further approval of the stockholders of CTI without obtaining such further approval. The observance of any term or provision of this Agreement may be waived (either generally or in a particular instance and either retroactively or prospectively) only by a writing signed by the party to be bound by such waiver. The waiver by a party of any breach hereof or default in the performance hereof will not be deemed to constitute a waiver of any other default or any succeeding breach or default. At any time prior to the Effective Time, each of CTI and HNC, by action taken by its Board of Directors, may, to the extent legally allowed, (a) extend the time for the performance of any of the obligations or other acts of the other; (b) waive any inaccuracies in the representations and warranties made to it contained herein or in any document delivered pursuant hereto; and (c) waive compliance with any of the agreements or conditions for its benefit contained herein. No such waiver or extension will be effective unless signed in writing by the party against whom such waiver or extension is asserted. The failure of any party to enforce any of the provisions 51 52 hereof will not be construed to be a waiver of the right of such party thereafter to enforce such provisions. 12.7 Expenses. HNC and Sub will bear their own expenses and legal fees incurred with respect to this Agreement, and the transactions contemplated hereby. All legal fees and other expenses, including without limitation accounting fees, brokers' fees, investment banking or financial advisors' fees incurred by CTI or any CTI Stockholder prior to the Effective Time with respect to this Agreement and the transactions contemplated hereby shall be paid solely by the CTI Stockholders. 12.8 Attorneys' Fees. Should suit be brought to enforce or interpret any part of this Agreement, including the provisions of Article 11, the prevailing party will be entitled to recover, as an element of the costs of suit and not as damages, reasonable attorneys' fees and arbitration or court costs to be fixed by the arbitrator, arbitral panel or court, as applicable (including without limitation, costs, expenses and fees on any appeal). The prevailing party will be entitled to recover its costs of suit, regardless of whether such suit proceeds to final judgment. Notwithstanding anything to the contrary in the preceding provisions of this Section, the preceding sentence of this Section 12.8 shall not apply to arbitrations of claims for indemnification under Article 11 of this Agreement that are arbitrated pursuant to the terms of Article 11 of this Agreement and the Escrow Agreement, and the award of attorneys' fees and costs of arbitration to the prevailing party in any such arbitration shall instead be determined in accordance with the provisions of the Escrow Agreement. 12.9 Notices. All notices and other communications required or permitted under this Agreement will be in writing and will be either hand delivered in person, sent by telecopier, sent by certified or registered first class mail, postage pre-paid, or sent by a nationally recognized express courier service. Such notices and other communications will be effective upon receipt if hand delivered or sent by telecopier, (b) five (5) days after mailing if sent by mail, and (c) one (l) day after dispatch if sent by express courier, to the following addresses, or such other addresses as any party may notify the other parties in accordance with the notice provisions of this Section: If to HNC or Sub: If to CTI or FGC: HNC Software Inc. The Frank Gates Companies, Inc. 5935 Cornerstone Court West 5000 Bradenton Avenue San Diego, CA 92121 Dublin, Ohio 43017 Attention: President Attention: Chief Executive Officer Fax Number: (858) 452-3220 Fax Number: (614) 791-7650 with a copy to: with a copy to: Fenwick & West, LLP Schottenstein, Zox & Dunn Co., L.P.A. Two Palo Alto Square, Suite 800 41 South High Street, Suite 2600 Palo Alto, CA 94306 Columbus, Ohio 43215 Attention: Kenneth A. Linhares, Esq. Attention: Bill Zox, Esq. Fax Number: (650) 494-1417 Fax Number: (614) 462-5135 or to such other address as a party may have furnished to the other parties in writing pursuant to this Section 12.9. 52 53 12.10 Construction of Agreement. This Agreement has been negotiated by the respective parties hereto and their attorneys and the language hereof will not be construed for or against either party. A reference to a Section or an exhibit will mean a Section in, or exhibit to, this Agreement unless otherwise explicitly set forth. The titles and headings herein are for reference purposes only and will not in any manner limit the construction of this Agreement which will be considered as a whole. 12.11 Further Assurances. Each party agrees to cooperate fully with the other parties and to execute such further instruments, documents and agreements and to give such further written assurances as may be reasonably requested by any other party to evidence and reflect the transactions described herein and contemplated hereby and to carry into effect the intents and purposes of this Agreement. 12.12 Absence of Third Party Beneficiary Rights. No provisions of this Agreement are intended, nor will be interpreted, to provide or create any third party beneficiary rights or any other rights of any kind in any client, customer, affiliate, stockholder, or partner of any party hereto or any other person or entity unless specifically provided otherwise herein, and, except as so provided, all provisions hereof will be personal solely between the parties to this Agreement. 12.13 Public Announcement. Upon execution of this Agreement, HNC and CTI will issue a press release approved by both parties announcing the Merger. Thereafter, HNC may issue such press releases, and make such other disclosures regarding the Merger, as it determines are required under applicable securities laws or regulatory rules; provided, that HNC will afford CTI an opportunity to review and comment on such press releases prior to their publication. Prior to the publication of such press release (unless this Agreement has been terminated), neither party will make any public announcement relating to this Agreement or the transactions contemplated hereby and CTI will use its reasonable efforts to prevent any trading in HNC Common Stock by its officers, directors, employees, stockholders and agents. 12.14 Confidentiality. CTI and HNC recognize that they have received confidential information concerning the others during the course of the Merger negotiations and preparations. Accordingly, each of the parties hereto (a) represents that it has not permitted the unauthorized disclosure of any confidential information concerning the other parties hereto that was disclosed during the course of such negotiations and preparations and (b) agrees to not make use of or permit to be used any confidential information of the other party other than for the purpose of effectuating the Merger and related transactions. The obligations of CTI and HNC under this Section will terminate upon the Effective Time. Otherwise, the obligations under this Section will not apply to, and the term "confidential information" shall not include, information that (i) is or becomes part of the public domain, (ii) is disclosed by the disclosing party to third parties without restrictions on disclosure, (iii) is received by the receiving party from a third party without breach of a nondisclosure obligation to the other party, or (iv) is required to be disclosed by subpoena or by law. If this Agreement is terminated, all copies of documents containing confidential information shall be returned by the receiving party to the disclosing party. 12.15 CTI Disclosure Letter. The CTI Disclosure Letter shall be arranged in separate parts corresponding to the numbered and lettered sections contained in Article 3, and the information disclosed in any numbered or lettered part shall be deemed to relate to and to qualify only the particular representation or warranty set forth in the corresponding numbered or lettered Section in Article 3, and shall not be deemed to relate to or to qualify any other representation or 53 54 warranty (unless it is reasonably apparent from the information set forth in CTI Disclosure Letter, that such information qualifies another representation or warranty of CTI and FGC in Article 3). 12.16 Entire Agreement. This Agreement and the exhibits hereto constitute the entire understanding and agreement of the parties hereto with respect to the subject matter hereof and supersede all prior and contemporaneous agreements or understandings, inducements or conditions, express or implied, written or oral, between the parties with respect hereto other than the Confidentiality Agreement. The express terms hereof control and supersede any course of performance or usage of the trade inconsistent with any of the terms hereof. [THE REMAINDER OF THIS PAGE HAS INTENTIONALLY BEEN LEFT BLANK] 54 55 IN WITNESS WHEREOF, the parties hereto have executed this Agreement effective as of the date first above written. HNC SOFTWARE INC. CELERITY TECHNOLOGIES, INC. By: --------------------------------- By: --------------------------------- Title: ------------------------------ Title: ------------------------------ CTI MERGER CORP. Solely for Purposes of Sections 3, 5, 7.2, 11 and 12 hereof By: THE FRANK GATES COMPANIES, INC. --------------------------------- Title: By: ------------------------------ --------------------------------- Title: ------------------------------ [SIGNATURE PAGE TO AGREEMENT AND PLAN OF REORGANIZATION] [SIGNATURE PAGE TO AGREEMENT AND PLAN OF REORGANIZATION] 55 56 EXHIBIT INDEX TO AGREEMENT AND PLAN OF REORGANIZATION Exhibit A: Delaware Certificate of Merger Exhibit B: Ohio Certificate of Merger Exhibit C: Escrow Agreement Exhibit D: Investment Representation Letter Exhibit E: Matters to be Opined on by Fenwick & West LLP Exhibit F: Matters to be Opined on by Schottenstein, Zox & Dunn Co., L.P.A. Exhibit H: Non-Competition Agreement
56 EX-27.01 3 ex27-01.txt FINANCIAL DATA SCHEDULE
5 1,000 3-MOS 6-MOS DEC-31-2000 DEC-31-2000 APR-01-2000 JAN-01-2000 JUN-30-2000 JUN-30-2000 80,983 80,983 57,230 57,230 70,395 70,395 (7,457) (7,457) 0 0 218,645 218,645 61,446 61,446 (26,861) (26,861) 538,456 538,456 82,101 82,101 100,000 100,000 0 0 0 0 27 27 336,148 336,148 538,456 538,456 67,432 121,995 67,432 121,995 (32,083) (59,750) (32,083) (59,750) (58,713) (100,148) (1,075) (1,797) (1,342) (2,684) (25,781) (42,384) (5,636) (10,023) (20,145) (32,361) 0 0 0 0 0 0 (20,145) (32,361) (0.75) (1.22) (0.75) (1.22)
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