-----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, JEpQuvlBmatyI97X6KLAwCzvHRTfo+/9vSNDkTU8TA9g8QfwW1LBP0irvp/DcF6d +wX2kCqiLD4u0hYp8dfLDw== 0000936392-02-000144.txt : 20020414 0000936392-02-000144.hdr.sgml : 20020414 ACCESSION NUMBER: 0000936392-02-000144 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20020214 ITEM INFORMATION: Other events ITEM INFORMATION: Financial statements and exhibits FILED AS OF DATE: 20020214 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HNC SOFTWARE INC/DE CENTRAL INDEX KEY: 0000945093 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 330248788 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-26146 FILM NUMBER: 02548140 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 8-K 1 a79278e8-k.txt FORM 8-K PERIOD FEBRUARE 14, 2002 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 8-K Current Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Date of Report (Date of Earliest Event Reported): February 14, 2002 HNC SOFTWARE INC. (Exact name of Registrant as Specified in its Charter) DELAWARE (State or Other Jurisdiction of Incorporation) 0-26146 33-0248788 (Commission File Number) (I.R.S. Employer Identification Number) 5935 CORNERSTONE COURT WEST, SAN DIEGO, CA 92121 (Address of Principal Executive Offices) (858) 546-8877 (Registrant's Telephone Number, Including Area Code) ITEM 5. OTHER EVENTS. In the second quarter of 2001, HNC Software Inc. modified its reporting and evaluation of segment performance, which caused the composition of its reportable segment data under Statement of Financial Accounting Standards No. 131 to change. HNC is filing this Form 8-K to reflect revised business information, segment data and results of operations data for the referenced periods (see Item 7 below) to conform to HNC's new operating segment presentation. In addition, HNC announced its results for the fourth quarter of 2001 and for the year ended 2001 on January 23, 2002. Attached to this 8-K is a copy of the press release for that announcement, with the pro forma table attached to press release augmented to show both the pro forma and GAAP results. ITEM 7: FINANCIAL INFORMATION AND EXHIBITS. (c) EXHIBITS. The following exhibits are filed herewith: 23.01 Consent of Independent Accountants. 99.01 HNC's Business as of December 31, 2000. 99.02 Management's Discussion and Analysis of Results of Operations for the years ended December 31, 2000 and 1999. 99.03 Consolidated Financial Statements for the years ended December 31, 2000, 1999 and 1998. 99.04 Management's Discussion and Analysis of Results of Operations for the quarters ended March 31, 2001 and 2000. 99.05 Segment Data (unaudited) for the quarters ended March 31, 2001 and 2000. 99.06 HNC Press Release. 2 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this amendment to report to be signed on its behalf by the undersigned thereunto duly authorized. HNC SOFTWARE INC. Dated: February 14, 2002 By: /s/ Kenneth J. Saunders ------------------------------ Kenneth J. Saunders, Chief Financial Officer and Secretary (Principal Financial Officer) By: /s/ Russell C. Clark ------------------------------ Russell C. Clark, Vice President, Corporate Finance and Assistant Secretary (Principal Accounting Officer) 3 INDEX TO EXHIBITS EXHIBIT NO. DESCRIPTION - ----------- ----------- 23.01 Consent of Independent Accountants. 99.01 HNC's Business as of December 31, 2000. 99.02 Management's Discussion and Analysis of Results of Operations for the years ended December 31, 2000 and 1999. 99.03 Consolidated Financial Statements for the years ended December 31, 2000, 1999 and 1998. 99.04 Management's Discussion and Analysis of Results of Operations for the quarters ended March 31, 2001 and 2000. 99.05 Segment Data (unaudited) for the quarters ended March 31, 2001 and 2000. 99.06 HNC Press Release.
4 EX-23.01 3 a79278ex23-01.txt EXHIBIT 23.01 EXHIBIT 23.01 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 33-92902, No. 333-14323, No. 333-18871, No. 333-42819, No. 333-46875, No. 333-50623, No. 333-62195, No. 333-71923, No. 333-80965, No. 333-89165, No. 333-33952, No. 333-40344, No. 333-41388, No. 333-45442, No. 333-55398 and No. 333-62492) of HNC Software Inc. of our report dated January 24, 2001, except as to Note 15, to which the date is March 6, 2001, and as to Note 12, to which the date is February 13, 2002, relating to the financial statements of HNC Software Inc., which appears in this Current Report on Form 8-K of HNC Software Inc. dated February 14, 2002. PricewaterhouseCoopers LLP San Diego, California February 14, 2002 EX-99.01 4 a79278ex99-01.txt EXHIBIT 99.01 EXHIBIT 99.01 HNC'S BUSINESS AS OF DECEMBER 31, 2000 This exhibit contains forward-looking statements about our industry, management's beliefs and certain assumptions we have made. Words such as "anticipates," expects," "plans," "intends," "may," "will," "should," "believes," "estimates" or similar expressions identify forward-looking statements. These statements include, among other things, statements concerning our anticipated growth strategies, anticipated trends in our business and the markets that we serve, our expectations of our future performance and the market acceptance of our products, our plans for expanding our business, our plans for product functionality and features and the status of evolving technologies. Forward-looking statements are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, including, but not limited to, the risks discussed under the heading "Risk Factors." You should carefully consider these risks. Investors are cautioned not to place undue reliance on these forward-looking statements that speak only as of the date of this report. We undertake no obligation to revise or update any forward-looking statements for any reason. OVERVIEW We provide customer insight through Efficiency, Risk, Opportunity and Intelligent Response software suites that enable companies in the financial, insurance, telecommunications and e-commerce industries to acquire, manage and retain customers. Our technology helps businesses make the right decisions about their customers in real time. It can improve a business' speed and accuracy in differentiating between customer value and risk; determining what customers want without invading their privacy; delivering personalized service and managing customers more profitably; and developing customer loyalty. INDUSTRY BACKGROUND Today's competitive business environment has forced many companies to increase business efficiencies while improving their flexibility and responsiveness to changing market conditions. In particular, the widespread adoption of the Internet has changed the way many businesses operate. Consequently, companies continue to make significant investments in technology solutions designed to manage and analyze information, develop initiatives to boost customer loyalty and develop lasting customer relationships with profitable customers. Building lasting relationships with profitable customers requires insight into customer profitability and the elements driving it, and the ability to optimize interaction with the customer to improve profitability and maximize the lifetime value of the customer relationship. Relationships with customers increasingly depend on electronic interactions. Businesses must invest more resources to acquire, manage and retain customers. At the same time, customers have a variety of purchasing options and are only a click away from the competition. While businesses are experiencing increasing customer acquisition costs, customers are experiencing decreasing switching costs. As a result, there is an accelerated demand for the ability to analyze information concerning customer transaction patterns to enable companies to respond appropriately to customer needs and predict customer activity. In addition, there is an expanding recognition that tools, applications and services can help organizations better understand and retain their customers, and build relationships over the Internet. PLATFORM INTRODUCTION HNC's Customer Insight platform incorporates Efficiency, Risk, Opportunity and Intelligent Response software solutions. Our decision engines capitalize on information to provide answers in real time so businesses can more effectively acquire, manage or retain customers. Because the substantial majority of electronically stored information is unstructured, there is a real need for a natural language free-text analysis solution to optimize the use of stored data. HNC's platform provides this solution. The platform also utilizes neural networks to help predict which transactions are likely to result in negative activities such as fraud and payment delinquency, or positive activities including cross-sell and up-sell. In addition, the platform's decision support tools enable HNC's customers to analyze information to take advantage of opportunities while minimizing risks. The combination of HNC's core technologies -- decision engines, free text analysis, neural networks and decision support tools -- results in a customer profile engine that helps businesses attain customer insight. Specific capabilities of HNC's platform include: - EFFICIENCY SUITE. The HNC Efficiency Suite enables companies to make instant, automated decisions regarding customer applications, including the ability to identify and determine customer creditworthiness. This allows companies to simultaneously reduce costs and increase the speed of the customer acquisition process. In addition, it allows companies to process large quantities of applications and claims in real time through multiple acquisition and delivery channels. - RISK SUITE. The HNC Risk Suite enables companies to analyze the risks associated with acquiring, managing and retaining customers by analyzing patterns in customer transactions. Risks can include fraud, churn and bad debt. - OPPORTUNITY SUITE. The HNC Opportunity Suite enables companies to analyze the opportunities associated with acquiring, managing and retaining customers by analyzing patterns in customer transactions. Opportunities can include maximizing customer profitability by providing cross-sell and up-sell activities and focusing marketing efforts on more profitable customers. 2 - INTELLIGENT RESPONSE SUITE -- The HNC Intelligent Response Suite enables companies to search across different data repositories and understand the meaning of content in text, images, SKUs or symbols, and deliver information to devices such as PCs and wireless (including PDAs) devices. It also proactively makes recommendations based upon profiles and patterns, and learns to index and retrieve only the most accurate, relevant information. MARKETS/DOMAIN EXPERTISE HNC customers comprise leading Fortune 1000 and Global 2000 organizations in the financial, insurance, telecommunications and e-commerce industries. Within the financial services industry, HNC's customers include leading corporations on six continents, including nine out of the top 10 U.S. credit card issuers and 16 of the 25 largest credit card issuers worldwide. More than 100 insurance companies and state insurance funds -- including nine out of the 10 largest carriers -- are HNC customers. HNC has more than 50 wireless and wireline customers worldwide. In addition, more than 30 customers in industries including computer, hotel, media and retail, are currently using HNC's products to conduct e-commerce. STRATEGY - - Enhance and Expand Solution Platform. We intend to continue to commit capital and enhance our Customer Insight solution platform through internal development and through acquisitions. For example, our Risk solutions for fraud detection have been expanded from a single credit card fraud detection solution in 1992 to checking, debit card and online credit card fraud detection in the financial services sector; extended to workers compensation, Medicare and Medicaid fraud detection in the insurance sector; and billing, subscription and network fraud in the telecommunications sector. We are also expanding our Intelligent Response and Efficiency solutions within and across these industries. For example, in 2000 we extended our Efficiency solutions originally developed for the financial services sector into the telecommunications and insurance underwriting sectors. - - Continue to Penetrate New Vertical Markets. We intend to continue to expand into and explore new market segments within existing sectors through product extensions and/or acquisitions. For example, in the financial services sector we extended our solutions into the brokerage market in fiscal 2000 and introduced new e-commerce solutions to support business-to-business exchanges. We also entered into the wireless and m-commerce telecommunications market with solutions for fraud detection, churn reduction and Efficiency management. - - Expand Global Presence. In 2000 we started an initiative to drive global expansion by adding several senior level executives with global experience in sales and marketing in Europe, the Middle East and Africa (the EMEA), as well as the Asian-Pacific and Latin American regions. We significantly increased the number of sales, support and development personnel in these regions and we intend to continue to allocate increased resources to support accelerated global expansion. We are leveraging new and existing partnerships to drive growth such as EDS, which has led to contracts in both the EMEA and the Asian-Pacific 3 region. We also intend to expand in global markets through acquisitions, such as Systems/Link that provided direct inroads in the Latin American telecommunications market. - - Deepen Presence In Core Markets Through Multiple Delivery Models. In 2000 we delivered many of our solutions through a self-hosted and an application service provider, or ASP, channel to our customers for the first time, and we intend to continue to expand this channel of delivery. An ASP provides a contractual service that deploys, hosts, manages and rents access to software applications from a centrally managed facility, giving customers access to new application environments without up-front investments in licenses, servers and people. ASP's also offer mid-sized companies the full benefits of leading enterprise applications while minimizing the challenges, expense and risk associated with the implementation and ongoing maintenance of traditional software products. HNC benefits from offering its solutions through this delivery channel by expanding its market opportunity into mid-tier markets and deriving additional recurring revenue through a per user/per transaction model with reduced sales and implementation cycles. - - Strengthen and Develop Strategic Partnerships. We are increasing our focus on strengthening and developing additional relationships with channel distribution partners including value added resellers, or VARs, original equipment manufacturer distributors, or OEMs, strategic business partners, hardware platform partners, and consulting and implementation partners. The benefits we expect to receive from these partnerships include leveraging partner customer bases, sharing in co-operative marketing programs, and delivering unique, industry leading solutions. For example, we are developing a medical claim processing clearing house via the Web through our partnership with Web MD. In addition, the strategic partnerships we have developed in the merchant fraud market with Equifax, Thomson Financial and Digital Island have helped us win contracts with companies like Sears and Paymentech. - - Cross-Sell Customer Insight Solutions Within Existing Customer Base. HNC is increasingly leveraging its existing customer relationships to capitalize on opportunities to sell additional solutions. We are more closely integrating and cross-training our product development, account support and sales teams to increase collaboration on joint opportunities. For example, existing credit card fraud detection customers are also acquiring our Efficiency solutions. Also, the Efficiency solutions originally developed for the financial services industry are now successfully sold to our telecommunications and insurance customer base. - - Grow Through Acquisitions. In 2000 we made several acquisitions to facilitate growth into new markets and to deliver product extensions into existing markets. We continue to evaluate acquisitions that offer us the opportunity to enter new vertical markets or provide large market opportunity. We evaluate companies as acquisition targets that: have products or technologies that complement existing HNC solutions and/or can be enhanced by HNC's technologies; bring an experienced management team and domain expertise; deliver strong revenue and earnings growth; and leverage combined sales, marketing and distribution channels. In 2000, for example, we extended our Risk solutions in the financial services sector through our acquisition of CardAlert and our Opportunity solutions through our acquisition of CASA, by growing our presence in the marketing optimization arena. We strengthened our Efficiency solutions in the telecommunications sector through our acquisitions of Onyx Technologies and Systems/Link, by gaining a foothold in the wireless telecommunications market and an ASP delivery channel. We also garnered an EDI and network connectivity backbone in the 4 insurance sector through our acquisition of Celerity Technologies, which allows us to facilitate claims processing over the Internet. MARKETS AND PRODUCTS Our Customer Insight product family includes Efficiency, Risk, Opportunity and Intelligent Response software suites that enable companies in the financial, insurance, telecommunications and e-commerce industries to acquire, manage and retain customers. In 2000, we successfully acquired and integrated a number of acquisitions including Onyx Technologies, Systems/Link, CASA, Celerity Technologies and CardAlert Services, and as a result have expanded our product footprint, market penetration and ASP delivery channels. We intend to continue to expand our solution platform through internal product development initiatives as well as through strategic acquisitions that deliver product extensions for existing as well as new markets. Through the expansion of our solutions we expect to be able to penetrate new markets and gain greater market share of existing niche markets. EFFICIENCY
The HNC Efficiency Suite includes the following products: - ------------------------------------------------------------------------------------------------------------------ PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ COMPADVISOR COMPADVISOR reviews and reprices medical bills for workers' compensation. It uses a powerful decision engine to automate the bill review process and route as many as two-thirds of processed medical bills without manual intervention. CompAdvisor includes powerful electronic data interchange, or EDI, technology to reduce manual entry of data. - ------------------------------------------------------------------------------------------------------------------ AUTOADVISOR AUTOADVISOR is an integrated medical repricing software solution with a managed care component for the auto medical claims industry that automates the process of bill review with the same technology and quality results as CompAdvisor. AutoAdvisor addresses the need to reduce the $13-18 billion the auto insurance industry loses annually due to unnecessary medical claims. - ------------------------------------------------------------------------------------------------------------------ CAPSTONE CAPSTONE DECISION MANAGER is an intelligent new account decisioning system that can be DECISION MANAGER implemented within any lending environment. The system is ideally suited for helping large organizations automate complex lending decision processes in individual business areas or across the enterprise. - ------------------------------------------------------------------------------------------------------------------ CAPSTONE DECISION CAPSTONE DECISION MANAGER FOR INSURANCE CLAIMS is an intelligent decisioning system that MANAGER FOR interfaces with large enterprise systems to automate complex insurance claims transactions. INSURANCE CLAIMS - ------------------------------------------------------------------------------------------------------------------
5
- ------------------------------------------------------------------------------------------------------------------ PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ CAPSTONE DECISION CAPSTONE DECISION MANAGER FOR MEDICAL BILLS is an intelligent decisioning system that can be MANAGER FOR MEDICAL the hub of a medical bill processing platform for insurance payors. By automating the BILLS processing of a significant percentage of medical bills, routing medical bills to other programs like CompAdvisor or VeriComp and routing bills for professional human review, Capstone for Medical can greatly enhance the performance of legacy systems. - ------------------------------------------------------------------------------------------------------------------ APPLICATION DECISION APPLICATION DECISION MANAGEMENT automates the new account process and enables MANAGEMENT telecommunications carriers to process more applications per month, reduce headcount and (4SCORE) assign customers the most appropriate service. - ------------------------------------------------------------------------------------------------------------------ AC-WEB AC-WEB for the insurance industry incorporates AC-Manager functionality with the addition of allowing access to the server via a browser-based user interface. This eliminates the need for installations at each customer workstation. - ------------------------------------------------------------------------------------------------------------------ EC-WEB EC-WEB EC-Web is a Web browser-based package that allows corporate risk managers and human resources departments to electronically send and receive business documents in the national standard format, ANSI ASC X12. It is designed to electronically connect risk management and human resources departments with any claims administrator that can send and receive documents electronically. - ------------------------------------------------------------------------------------------------------------------ ADMIN-CONNECT ADMIN-CONNECT was created specifically for claims administrators, enabling them to send and receive injury reports using business-to-business e-commerce. This allows third party administrators and insurance carriers to send and receive business documents electronically in the ASC X12 format. AC-Manager incorporates Admin-Connect functionality along with additional network administration features. - ------------------------------------------------------------------------------------------------------------------ HOME & AWAY PREPAID BILLING & USAGE MONITORING (HOME & AWAY PREPAID BILLING) provides wireless carriers PREPAID BILLING with a solution to offer prepaid wireless telecommunications service or to perform usage monitoring. - ------------------------------------------------------------------------------------------------------------------
6
- ------------------------------------------------------------------------------------------------------------------ PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ EMPLOYER-CONNECT EMPLOYER-CONNECT is a Microsoft Windows-based PC package designed to send and receive injury reports in the ASC X12 format. It is designed to electronically connect risk management and human resource departments with an agency or organization that can send and receive documents electronically. EC-Manager incorporates Employer-Connect functionality and additional network administration features. - ------------------------------------------------------------------------------------------------------------------ PROVIDER-CONNECT PROVIDER-CONNECT is a Microsoft Windows-based PC package designed to send and receive injury reports in the ASC X12 format. It is designed to electronically connect healthcare providers with insurance carriers that can send and receive documents electronically. - ------------------------------------------------------------------------------------------------------------------ ROAMEX ROAMING DATA EXCHANGE NETWORK (ROAMEX) provides wireless telecommunications carriers with near real time records of roaming call data that occur outside a carrier's home network. Carriers use this data to detect fraud beyond their home network. - ------------------------------------------------------------------------------------------------------------------ SC-MANAGER SC-MANAGER for the insurance industry incorporates the functionality of State-Connect (see below) and includes additional business-to-business e-commerce project management tools/applications. - ------------------------------------------------------------------------------------------------------------------- SC-WEB SC-WEB incorporates State-Connect functionality (see below) along with a Web-enabled front end to allow workers' compensation injury reports to be entered via the Internet. - ------------------------------------------------------------------------------------------------------------------ STATE-CONNECT STATE-CONNECT is a Microsoft Windows-based application, which unlike traditional translators, specifically meets the business-to-business e-commerce requirements for state workers' compensation agencies. It is a user-friendly software application that requires minimum staffing and training. - ------------------------------------------------------------------------------------------------------------------- TRANS-CONNECT TRANS-CONNECT is a software package that allows claims and risk management software developers to integrate e-commerce solutions into their legacy applications for employers, claims administrators and state jurisdictions. - -------------------------------------------------------------------------------------------------------------------
7 RISK The HNC Risk Suite includes the following products:
- ------------------------------------------------------------------------------------------------------------------ PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ MIRA MIRA (MICRO INSURANCE RESERVE ANALYSIS) is an easy-to-use, integrated information system for estimating workers' compensation claim loss reserves. MIRA is installed at more than 50 insurance companies, state funds and third-party administrators. - ------------------------------------------------------------------------------------------------------------------ VERICOMP VERICOMP CLAIMANT is an insurance-claimant fraud detection system that utilizes our advanced CLAIMANT neural network predictive technology to identify claims that fit historical patterns of fraud and abuse. VeriComp Claimant saves time and money through early and accurate detection of fraudulent claims. - ------------------------------------------------------------------------------------------------------------------ VERICOMP VERICOMP EMPLOYER is a predictive software solution created specifically to detect workers' EMPLOYER compensation premium fraud and abuse. This powerful tool enables auditors and other review staff to identify suspicious policies and prioritize premium audit efforts. - ------------------------------------------------------------------------------------------------------------------ VERICOMP SUBRO VERICOMP SUBRO is a new predictive software system that can help insurance carriers recover significant losses by automatically identifying and notifying claims adjusters of claims that should actually be paid by another party. - ------------------------------------------------------------------------------------------------------------------ ECMDIRECTOR ECMDIRECTOR is a financial services predictive software solution that reduces cost by more accurately identifying claims that would benefit most from case management and by automating claim management decisions. - ------------------------------------------------------------------------------------------------------------------ SPYDER SPYDER is a predictive software solution designed to combat healthcare fraud and abuse in group healthcare, Medicaid and Medicare. Using HNC's advanced neural network predictive technology, Spyder is also available in a new real time version as well as a version specifically developed to detect dental fraud and abuse. - ------------------------------------------------------------------------------------------------------------------ FALCON FALCON is the leader in real time fraud detection and prevention for credit card issuers. Falcon's neural networks examine transaction, cardholder, and merchant data to detect a wide range of credit card fraud quickly and accurately. - ------------------------------------------------------------------------------------------------------------------ FALCON DEBIT FALCON DEBIT is a financial services software product that examines transaction, cardholder, and merchant data to detect debit card fraud. - ------------------------------------------------------------------------------------------------------------------
8
- ------------------------------------------------------------------------------------------------------------------ PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ FALCON CHEQUE FALCON CHEQUE runs in a bank's check processing center and uses neural networks, expert rules, and HNC's proprietary transaction pattern profiling technology to detect many types of checking account fraud. - ------------------------------------------------------------------------------------------------------------------ EAGLE EAGLE is a merchant risk management system designed to protect merchants from emerging fraud trends, manage risk and profitability, and increase operational efficiency. - ------------------------------------------------------------------------------------------------------------------ 4WARN APPLICATION FRAUD MANAGEMENT (4WARN) is a telecommunications market solution that confirms identity authenticity during the customer acquisition process, to detect individuals who attempt identity deception. - ------------------------------------------------------------------------------------------------------------------ CARDALERT NETWORK CARDALERT NETWORK provides early detection and common-purchase-point analysis of payment card fraud on shared Automated Teller Machine (ATM) and point-of-sale systems. Through daily transaction data downloads provided by participating networks, CardAlert can identify and link fraudulent transactions, identify compromised cards, and notify affected financial institutions to prevent further losses. - ------------------------------------------------------------------------------------------------------------------ PROFITMAX SUBSCRIPTION FRAUD MANAGEMENT (PROFITMAX) helps financial services companies reduce write-offs and losses associated with fraudulent applications for service by persons who have no intention to pay. The solution utilizes HNC's profiling engine and advanced predictive models to quickly and accurately detect subscription fraud. HNC's decision rules engine is used to counteract predicted fraudulent activity. - ------------------------------------------------------------------------------------------------------------------ ATACS AND FRAUDTEC TECHNICAL FRAUD MANAGEMENT (ATACS AND FRAUDTEC) enables telecommunications carriers to reduce bad debt expenses related to fraudulent use of their network. These solutions incorporate profile modeling to detect suspected fraudulent activity and include a case manager to monitor and take action on potential instigators of fraud. ATACS uses neural network models to automatically prioritize cases and prompt investigations of transactions with the highest probability of being fraudulent. - ------------------------------------------------------------------------------------------------------------------
9
- ------------------------------------------------------------------------------------------------------------------ PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ ATACS ONLINE ATACS ONLINE (ADVANCED TELECOMMUNICATIONS ABUSE CONTROL SYSTEM) delivers profiling, neural network modeling and case management through an easy to use browser-based interface in an ASP environment. Telecommunications providers of every size can significantly reduce losses associated with fraud through the use of this tool formerly available only to the largest carriers. - ------------------------------------------------------------------------------------------------------------------ EFALCON EFALCON is a real time Internet payment fraud detection and risk management service for online merchants and their service providers. Delivered through an ASP delivery channel, the system also provides strategy management and customer service tools to help merchants save legitimate transactions that appear risky, as well as set policies for accepting and rejecting transactions. - ------------------------------------------------------------------------------------------------------------------ COMPCOMPARE COMPCOMPARE is a benchmarking database that allows users to generate detailed comparative analyses between their claims data and insurance industry data. It features online access to HNC's workers' compensation database. The product is marketed by NCCI (the National Council on Compensation Insurance, Inc.) through a joint marketing agreement with HNC. - ------------------------------------------------------------------------------------------------------------------ PROVIDER-COMPARE PROVIDER-COMPARE is a physician profiling system that compares one physician to a peer group of physicians for similar claim populations, identifies providers with significantly higher costs, and uses provider report cards and treatment pattern analysis to educate providers to improve financial outcomes. The product is marketed by NCCI through a joint marketing agreement with HNC. - ------------------------------------------------------------------------------------------------------------------
OPPORTUNITY The HNC Opportunity Suite includes the following products:
- ------------------------------------------------------------------------------------------------------------------ PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ PROFITMAX PROFITMAX PROFITABILITY provides transaction-based, real time authorization and action PROFITABILITY decisions that enhance the profitability of credit card portfolios. Using neural networks and HNC's cardholder transaction pattern profiling technology, ProfitMax Profitability analyzes each cardholder account and predicts future profitability. - ------------------------------------------------------------------------------------------------------------------
10
- ------------------------------------------------------------------------------------------------------------------ PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ PROFITMAX MARGIN PROFITMAX MARGIN MANAGER predicts margin risk for equity, investment-grade debt and mutual MANAGER fund securities at the portfolio, account, and security levels. The solution utilizes analytical models to formulate an assessment of margin account risk. Armed with the insight these predictions provide, brokerages can make more intelligent risk management decisions. - ------------------------------------------------------------------------------------------------------------------ PROFITMAX CHURN CHURN RISK MANAGEMENT (PROFITMAX) helps telecommunications carriers increase revenues by RISK MANAGEMENT improving customer retention. Churn risk is predicted using HNC's profiling engine and advanced predictive models. Churn prevention treatments are formulated and executed using HNC's decision rules engines. - ------------------------------------------------------------------------------------------------------------------ PROFITVISION PROFITVISION is a comprehensive, enterprise-wide solution that analyzes the profitability of customer relationships, products, and business units for financial services companies. It incorporates an interface to core accounting systems and increases the accuracy of profitability measurement through matched-maturity funds transfer pricing and sophisticated cost-allocation methods, such as activity-based costing. - ------------------------------------------------------------------------------------------------------------------ MARKETING MARKETING OPTIMIZATION is an intelligent cross-sell optimization solution that selects the OPTIMIZATION most profitable promotion offer that a financial institution might present to a customer. - ------------------------------------------------------------------------------------------------------------------
INTELLIGENT RESPONSE HNC's Intelligent Response products include:
- ------------------------------------------------------------------------------------------------------------------ PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ MINDWAVE REACTION MINDWAVE REACTION uses text characterization, analysis and Intelligent Response technology to automatically categorize text, e-mail and Web inquiries; automatically respond to e-mail and Web self-help inquiries; and accurately search electronic content to find relevant answers across multiple knowledge bases. - ------------------------------------------------------------------------------------------------------------------ MINDWAVE PROACTION MINDWAVE PROACTION adds proactive and predictive capabilities to Mindwave Reaction, so companies can provide key audiences with data they need. Proaction observes and tracks online transaction patterns; provides accurate analysis that translates to precise sales and marketing targeting methods; profiles and groups users into specific categories; and proactively suggests relevant information or products based on user profiles. - ------------------------------------------------------------------------------------------------------------------
11
- ------------------------------------------------------------------------------------------------------------------ PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------------------ OFFER TARGETING Designed for high-volume online retailers, OFFER TARGETING delivers one-on-one personalization technology. Using neural network technology, Offer Targeting analyzes an individual shopper's interests and transaction patterns to determine other complementary products he or she may be interested in. Using analyzed interests coupled with previous transaction patterns, Offer Targeting can up-sell, cross-sell, provide insights about groups of customers and predict future purchasing transaction patterns. - ------------------------------------------------------------------------------------------------------------------ FORM-FILL FORM-FILL is a service provided to digital "wallet" vendors and merchants. Currently, most online merchants require customers to fill out information forms as a precondition to a sale. Our patented context vector technology equips the Form-Fill service to read any Web-form and complete it, using free-form text analysis and processing. Applying our adaptive learning technology, Form-Fill learns with each interaction and applies that knowledge to future transactions so that the more a customer uses Form-Fill service (via a digital wallet), the more powerful this tool becomes. The eHNC Form-Fill service automatically tracks merchant-specific information, including reward codes, affinity programs, and site-specific user names and passwords. The Form-Fill service does not require any action on the part of the merchant, and therefore can be used for almost all e-commerce transactions.
SALES & MARKETING We sell and market our software and services globally through our direct sales organization and strategic partners, including distribution, hardware platform and service and consulting partners. Through these direct and indirect sales channels, we are focusing on three key initiatives to accelerate sales: - Develop and expand strategic partnerships on a global scale; - Commit sales and marketing resources internationally to accelerate global expansion; and - Leverage our existing customer base and cross-sell solutions within this base. The national sales staff is based at our corporate headquarters in San Diego, as well as in our other United States field offices in California, Colorado, Connecticut, Florida, Georgia, Illinois, Maryland, Massachusetts, Missouri, New Jersey, New Mexico, New York, North Carolina, Ohio, Pennsylvania, Texas and Virginia. Internationally, we have field sales offices in the United Kingdom, The Netherlands, Japan and Singapore. To support our sales force, we conduct 12 comprehensive marketing programs, which include demand generation, public relations, advertising, seminars, trade shows and ongoing customer communication programs. Our sales staff is generally product-based and is assigned a geographic territory. - - Service Bureaus. We have licensed First Data Resources, Inc., or First Data, Electronic Data Services, Total Systems and Equifax to act as service bureaus, providing an alternate channel of distribution for end-users of our Falcon product. We have also licensed First Data as a service bureau for our ProfitMax product. We generally assist our service bureau partners in the sales effort, often employing our direct sales force in the process. These service bureaus pay us monthly usage fees based on the volume of transactions processed. We also have an outsourced bill review service bureau servicing the insurance industry. The service bureau provides both turnkey bill review services, as well as the capability to handle overflow needs of customers through our locations in California, Missouri and Texas. - - ASP (Application Service Provider). We provide Internet credit-card fraud detection to e-commerce merchants through an ASP delivery channel. In the telecommunications market we provide a suite of fraud detection solutions and Efficiency solutions through the ASP channel and in the insurance industry our EDI/Network Connectivity group offers ASP versions of several injury reporting products including AC-Web, EC-Web and SC-Web. - - International and Export Activity. International operations and export sales represented 19.3% of our total revenues in 2000, 23.2% in 1999, and 23.1% in 1998. International sales result primarily from Falcon product sales, in addition to sales of Retek's products during the first nine months of 2000, fiscal 1999 and fiscal 1998. We intend to continue expansion of our operations outside the United States, and to enter additional international markets, which will require significant management attention and financial resources. We have committed and continue to commit significant time and development resources to customizing our products for selected international markets, and to developing international sales and support channels. Our efforts to develop products, databases, and models for targeted international markets or to develop additional international sales and support channels may not be successful. International sales have additional inherent risks, including longer payment cycles, unexpected changes in regulatory requirements, import and export restrictions and tariffs, difficulties in staffing and managing foreign operations, the burdens of complying with a variety of foreign laws, greater difficulty or delay in accounts receivable collection, potentially adverse tax consequences and political and economic instability. Our international sales are currently primarily denominated in United States dollars, and a small portion is denominated in other currencies, primarily those of Western Europe and Canada. An increase in the value of the United States dollar relative to foreign currencies could make our products more expensive, and therefore potentially less competitive, in foreign markets. In the future, to the extent our international sales are denominated in local currencies, foreign currency translations may contribute to significant fluctuations in our business, financial condition and results of operations. The imposition of exchange or price controls or other restrictions on foreign currencies could also harm our business. 13 - - Sales Cycle Risks. Due in part to the mission-critical nature of our applications, potential customers perceive high risk in connection with adoption of our products. As a result, customers have been cautious in making decisions to acquire our products. In addition, because the purchase of our products typically involves a significant commitment of capital, and may involve shifts by the customer to a new software and/or hardware platform, delays in completing sales can arise while customers complete their internal procedures to approve large capital expenditures and test and accept new technologies that effect key operations. For these and other reasons, the sales cycle associated with the purchase of our products is typically lengthy, unpredictable and holds a number of significant risks over which we have little or no control, including customers' budgetary constraints and internal acceptance reviews. The sales cycle associated with the licensing of our products can typically range from 60 days to 18 months. As a result of the length of the sales cycle and the typical size of customers' orders, our ability to forecast the timing and amount of specific sales is limited. - - Competition. The market for customer insight solutions is intensely competitive and is constantly changing. Competitors, many of which have substantially greater financial resources than we do, vary in size and in the scope of the products and services they offer. We encounter competition from a number of sources, including: - Other application software companies, including enterprise software vendors; - Management information systems departments of customers and potential customers, including financial institutions, insurance companies, telecommunications carriers and retailers; - Third party professional services organizations, including consulting divisions of public accounting firms;' - Internet companies; - Hardware suppliers that bundle or develop complementary software; - Network and telecommunications switch manufacturers, and service providers that seek to enhance their value-added services; - Neural-network tool suppliers; and - Managed care organizations. - - Pricing in the Marketplace. We believe that most of our products are competitively priced when compared to our competitors' products. The market for our products is highly competitive, and we expect that we will face increasing pricing pressures from our customers, current competitors and new market entrants. In particular, increased competition could reduce or eliminate premiums and cause further price reductions. In addition, competition could negatively impact our ability to obtain new long-term contracts and renewals of existing long-term contracts on favorable terms. Any reduction in the price of our products could negatively impact our business, financial condition and results of operations. - - Competitive Factors. We believe that the principal competitive factors affecting our markets include technical performance (for example, accuracy in detecting credit card fraud or 14 evaluating workers' compensation claims), access to unique proprietary databases, availability in ASP format and product attributes like adaptability, scalability, interoperability, functionality, ease-of-use, product reputation, quality, performance, price, customer service and support, the effectiveness of sales and marketing efforts and our reputation. Although we believe that our products currently compete favorably with respect to these factors, we may not be able to maintain our competitive position against current and potential competitors, especially competitors with significantly greater financial, marketing, service, technical support and other resources. Some of our current competitors, and many of our potential competitors, have significantly greater financial, technical, marketing and other resources than we do, as well as broader integrated product lines. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the development, promotion and sale of their products than we can. They may also possess marketing advantages due to their ability to market integrated suites of related products that are vital to the customer's computing infrastructure. This would enable them to sell products that compete with ours, even where their products may be inferior or more expensive. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of our prospective customers. It is possible that new competitors or alliances among competitors may emerge and rapidly gain significant market share. Also, we rely upon our customers to provide data, expertise and other support for the ongoing updating of our models. Our customers, most of which have significantly greater financial and marketing resources than we do, may compete with us in the future or otherwise discontinue their relationships with us, or cease to provide us with critical data or support of our business, all of which could significantly harm our business. CUSTOMER SERVICE & SUPPORT A high level of continuing maintenance, service and support is critical to maintaining the performance of our predictive software solutions. Service and support are also essential to our objective of developing long-term relationships with, and obtaining recurring revenues from, our customers. Our service and support activities are related to system installation, performance validation and ongoing consultation on the optimal use of our products. - - Model and Rule Updates. Most of our product license agreements obligate us to provide periodic data, model and/or rule updates to maintain system performance. Our technical personnel generally assist the customer with installation of updates. We make commitments to update models and rules at varying intervals, according to both periodically scheduled updates (for example quarterly and annually) as well as unscheduled updates, provided the customer has met its commitments to provide data to us. The choice of data source and data updates are important to customers because data are the fundamental building blocks used to create accurate predictive models. We provide various models built on industry-specific or customer-specific data to meet individual application requirements. Customers and data suppliers provide us with historical transaction data for turnkey models, trend analyses and product updates. This combination of proprietary turnkey customized and user-developed models allows us to offer products that solve a broad range of predictive application problems. 15 - - Education. We offer comprehensive education and training programs to our customers. We provide on-site training services associated with many of our products. Fees for education and training services are generally included in the pricing of usage-priced products, but may be charged separately in other cases. - - Consulting. Our consultants are available to work with our customers' user application groups and information systems organizations. Customers that buy consulting services are usually planning large implementations or want to optimize the performance of our products in their operating environments. Fees for consulting are generally included in the pricing of usage-priced products, but may be charged separately in other cases. TECHNOLOGY At the heart of our predictive software solutions lie two critical functions. The first of these is the ability to predict which individuals are most likely to exhibit certain critical business transaction patterns. Examples of these transaction patterns include fraud, payment delinquency, and responsiveness to cross-sell/up-sell efforts. The second critical function is the ability to select an appropriate action to either encourage (in the case of a cross-sell) or discourage (in the case for delinquency) an individual's predicted transaction patterns. Our key technologies are designed to perform one or both of these critical functions. Our technologies include neural-network models, intelligent decision engines, profiles, traditional statistical models, business models, expert rules and context vectors. In addition to current technologies, we strive to develop new and innovative technologies that enable new or expanded predictive software capabilities. Some of our longer-term research projects are partially funded through contracts with the U.S. Government or members of the U.S. Intelligence Community. - - Neural-network Technology. The term "neural network" refers to a family of nonlinear, statistical modeling techniques, which were derived from the work of scientists engaged in understanding biological intelligence. While we are far from having a complete understanding of biological intelligence, the techniques proposed by these scientists have proven to be very useful in solving difficult, complex business and engineering problems. We have adopted many of these techniques in our predictive software solutions. We use neural-network techniques to build models of complex transaction patterns such as consumer credit card fraud. These models are created through a process called "training." Training involves exposing a large data set of examples of the transaction patterns to a neural network algorithm. Often hundreds of thousands to millions of examples are provided. The neural network processes this data to identify patterns in the data that are predictive of the transaction patterns being modeled. Once training is complete, the neural network uses these learned patterns to predict the probability that a new individual will exhibit the modeled transaction patterns. We have developed proprietary high-speed and parallel-processor boards to accelerate training and execution of our neural-network software. Although other statistical methods can be used, our neural-network technology distinguishes itself in its ability to build highly accurate models more rapidly than possible with other methods. This provides us with a significant competitive advantage in developing and 16 deploying products. Further, our experience with neural-network technology has led to the development of proprietary methodologies for applying that technology to real time, transaction-based business problems. - - Profiling Technology. Many of our products operate on transactional data, such as credit card purchase transactions, or other types of data that change over time, such as worker's compensations claims. In their raw form, these data are very difficult to use in model building for several reasons. First, a single transaction contains very little information about the transaction patterns of the individual that generated the transaction. Second, truncations change rapidly over time. Finally, this type of data can often be incomplete. To overcome these data problems, we have developed a set of proprietary techniques that transform raw transactional data into a format that is suitable for model building. We refer to this set of techniques as our profiling technology. As the name suggests, our profiling technology accumulates data across multiple transactions to create profiles of transaction patterns. Although these profiles are unintelligible to a human, they provide our neural-network models with the information needed to predict complex transaction patterns. - - Rule-based Technology. Predicting transaction patterns is only half the battle in determining how to best manage or interact with a customer. The other half involves optimizing the response or action, given the transaction patterns that have been identified and the corresponding predicted outcome. To provide this response optimization, many of our products combine specially trained neural-network models with rule-based techniques. Rules provide an effective method of capturing and applying such well-defined information as marketing strategies, corporate policies, and standard operating procedures. We have developed rule engines that operate efficiently in a real time, transaction-oriented system. We believe that our combination of these rule engines with neural-network models represents a significant technological advantage over more traditional approaches to decision automation. - - Context Vector Technology. Much of the information produced and used by the business world is in the form of text documents. Extracting this information and using it in predictive solutions has been very difficult with traditional analysis methods. This problem has been amplified by the huge increase in Internet usage, which generates an enormous amount of textual data. Our proprietary context vector technology solves many of the problems encountered in using textual data in predictive software solutions. Context vectors provide a means to encode textual information in a form that can be easily processed by computers. The basic idea is to associate a context vector with an object based on its textual description. For example, an online user can be described by the Web pages that he or she reads. An email can be characterized by the text contained within it and a product can be identified by a textual description. Using our proprietary training algorithms, context vectors are assigned to objects in such a way that vectors for related objects will be closer together than vectors for unrelated objects. Thus, the problem of associating similar objects based upon a textual description is solved, by finding vectors that are closest to each other. 17 Many text-processing problems can be solved using context vector technology. For example, traditional query and retrieval consists of finding documents that include the content that is related and responsive to the query. Other examples include: matching a Web user with a banner ad, associating an e-mail with an automatic response, or recommending products that may appeal to an online buyer. When combined with our other technologies, such as neural networks and rule-based systems, we believe that context vectors can improve the performance of existing applications. - - Risks of Entering New Markets. Our success depends upon our ability to enter new markets by successfully developing new products for those markets on a timely and cost-effective basis. In order to develop new products, we often require proprietary customer data for decision model development and system installation. As a result, completion of new products (particularly new products for new markets we are entering) may be delayed until we can extract sufficient amounts of statistically relevant data to develop the models. During this development process, we rely on our potential customers in the new market to provide us with relevant data and to help train our personnel in the use and meaning of the data in the specific industry. These relationships also assist us in establishing a presence and credibility in the new market. These potential customers, most of which have significantly greater financial and marketing resources than we do, may compete with us in the future or otherwise discontinue their relationships with or support of us, either during development of our products or later on. If we fail to obtain adequate third-party support for new product development, our ability to enter new markets could be impaired, and consequently our business, financial condition and results of operations could be negatively impacted. - - Research & Development. Our research and development expenses were $75.5 million in 2000, $50.2 million in 1999, and $32.7 million in 1998. We believe that our future success depends on our ability to continually maintain and improve our core technologies, enhance our existing products, and develop new products and technologies that meet an expanding range of markets and customer requirements. We intend to expand our existing product offerings and to introduce new predictive software solutions. In the development of new products and enhancements to existing products, we use our own development tools extensively. We have traditionally relied primarily on the internal development of our products. Based on timing and cost considerations, however, we have acquired, and in the future may consider acquiring, technology or products from third parties. For example, we acquired technology and products in connection with our acquisitions of PCS, FTI and ATACS in 1998, WebTrak in 1999, and CASA, AIM, Onyx Technologies, Celerity Technologies, HighTouch, CardAlert and Systems/Link in 2000. The expense associated with acquired technology and products is separately stated on our financial statements as acquired in-process research and development and is not included in our research and development expenses above. Visionary research has long been a key component of HNC's business plan. We continually monitor research developments internal and external to HNC. We sponsor research programs to develop the ideas that we believe have the most potential. In some cases, external funding (i.e., Government grants) is used to develop initial concepts. One example of this is our Cortronics program. Originally funded by the Defense Advanced Research Projects Agency, or DARPA, the program is now fully supported by HNC. The Cortronics project is a long-term research project focused on developing and applying computer models of regions of 18 the cerebral cortex to recognize and associate patterns in text, speech and vision. The objective of this work is to develop intelligent computing systems that are much more capable of interacting with and reasoning about their environments than current systems. - - Government Research. We strategically plan and execute our long-term research projects. In addition to funds allocated for research, we receive research contracts from a variety of sources, including the United States Government. Our Government and commercial contract customers have included DARPA, the United States Air Force, the Office of Naval Research, and several organizations within the U.S. Intelligence Community. We believe that these contracts augment our ability to maintain existing technologies and investigate new technologies that may or may not be used in our products. The United States Government typically retains intellectual property rights and licenses in the technologies we develop, directly or indirectly, under government sponsored research contracts and in some cases can terminate our rights to these technologies if we fail to commercialize them on a timely basis. Historically, these research contracts have not resulted in the development of products contributing to near-term revenue. - - Quality Control. We perform all quality assurance and develop documentation internally. We intend to continue to support industry standard operating environments, client-server architectures and network protocols. Our specialists in neural network model development, software engineering, user interface design, product documentation and quality improvement are responsible for maintaining and enhancing the performance, quality and usability of all of our predictive software solutions. Our marketing group is responsible for authoring and updating all user documentation and other publications. - - Technology Risks. The market for our predictive software solutions is characterized by rapidly changing technologies, including improvements in computer hardware, network operating systems, programming tools, programming languages, operating systems and database technology. Our success will depend upon our ability to continue to develop and maintain competitive technologies, enhance our current products and develop, in a timely and cost-effective manner, new products that meet changing market conditions, including evolving customer needs, new competitive product offerings, emerging industry standards and changing technology, such as the growth of Internet-based applications. We may not be able to develop and market product enhancements or new products that respond to changing technologies on a timely basis, or at all. We have previously experienced significant delays in the development and introduction of new products and product enhancements, primarily due to difficulties with model development, which has in the past required multiple iterations, as well as difficulties with acquiring needed data and adapting to particular operating environments. The length of these delays has varied depending upon the size and scope of the project and the nature of the problems encountered. - - Intellectual Property & Other Proprietary Rights. We rely on a combination of patent, copyright, trademark and trade secret laws and confidentiality procedures to protect our proprietary rights. We currently own 15 issued United States patents and have 24 United States patent applications pending. We have applied for international patent protection utilizing the Patent Cooperation Treaty. We have pending and granted patents in the following 19 countries: Australia, Canada, France, Germany, Italy, Japan, the Netherlands, and the United Kingdom. Our United States patents expire at dates that range from December 2008 to October 2017. Patents may never issue on our pending patent applications or on any future applications we submit. In addition, the patents we currently hold may not be upheld as valid and may not prevent the development of competitive products. We seek to protect our software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. As part of our confidentiality procedures, we generally enter into invention assignment and proprietary information agreements with our employees and independent contractors and nondisclosure agreements with our distributors, corporate partners and licensees, and limit access to and distribution of our software, documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise to obtain and use our products or technology without authorization, or to develop similar technology independently. In addition, to ensure that customers will not be negatively impacted by an interruption in our business, we often place the source code for our products into escrow, which may increase the likelihood of misappropriation or other misuse of our intellectual property. Moreover, effective protection of intellectual property rights may be unavailable or limited in foreign countries in which we have done and/or may do business. We have developed technologies for research projects conducted under agreements with various United States Government agencies or their subcontractors. Although we have acquired commercial rights to these technologies, the United States Government typically retains ownership of intellectual property rights and licenses in the technologies we develop under these contracts, and in some cases can terminate our rights to these technologies if we fail to commercialize them on a timely basis. In addition, under United States Government contracts, the results of our research may be made public by the government, which could limit our competitive advantage with respect to future products based on funded research. In the past, we have received communications from third parties asserting that our trademarks infringe upon other parties' trademarks, or that data we use is copyrighted by an independent third party, none of which resulted in litigation or material losses to us. In addition, we have been involved in patent litigation. As the number of software products increases and the functionality of these products further overlaps, we believe that software developers' risk of infringement claims will increase. Given our ongoing efforts to develop and market new technologies and products, we may receive claims from other third parties asserting that our products infringe upon their intellectual property rights. Licenses to disputed third-party technology or intellectual property rights might not be available on reasonable commercial terms, if at all. Furthermore, we may initiate claims or litigation against third parties for infringement of our proprietary rights or to establish the validity of our proprietary rights. Litigation could result in significant expense to us, and divert the efforts of our technical and management personnel, whether or not it is resolved in our favor. As a result of an adverse ruling in any litigation, we might be required to pay substantial damages, discontinue the use and sale of infringing products, expend significant resources to develop non-infringing 20 technology or obtain and pay for licenses to infringing technology. In addition, a court might invalidate our patents, trademarks or other proprietary rights. In the event of a successful claim against us, and our failure to develop or license a substitute technology, our business, financial condition and results of operations would be harmed. EMPLOYEES As of December 31, 2000, we had 1,121 employees, including 438 in product development and support, 216 in customer service, 123 in sales and marketing, 162 in service bureau and 182 in finance, administration and management information systems. Most of our employees are located in the United States. None of our employees are represented by a labor union. We have experienced no work stoppages and believe that our employee relationships are generally good. Our success depends to a significant degree upon the continued service of our senior management and other key research, development, sales and marketing personnel. Only a small number of our employees have employment agreements, and these agreements may not result in the retention of these employees. In the past, we have experienced difficulty in recruiting a sufficient number of qualified technical and sales employees. In addition, competitors may attempt to recruit, and be successful in recruiting, our key employees. We may not be successful in attracting, assimilating, and retaining personnel. RISK FACTORS FLUCTUATIONS IN OUR REVENUES AND OPERATING RESULTS MIGHT LEAD TO REDUCED PRICES FOR OUR STOCK. Our revenues and operating results have varied significantly in the past and in some quarters we have experienced net losses. We expect fluctuations in our operating results to continue for the foreseeable future. As a result, we believe that you should not rely on period-to-period comparisons of our financial results as an indication of our future performance. It is possible that in some future periods our operating results may fall below the expectations of market analysts and investors. In this event the market price of our common stock would likely fall. Factors that are likely to cause our revenues and operating results to fluctuate include the following: - changes in the volume of our sales; - a decrease in recurring revenues or the loss of key customers; - the timing or deferral, or the reduction or cancellation, of customer orders or purchases; - the timing of our new product announcements and introductions in comparison to our competitors; - delays in the release of final commercial versions of our products; - changes in the mix of our distribution channels; 21 - the amount and timing of our operating expenses; - our ability to fulfill our obligations under percentage-of-completion contracts; - our success in completing pilot installations within contracted fee budgets; - competitive conditions in the industries we serve; - economic conditions in our targeted markets; - domestic and international economic conditions; - changes in prevailing technologies; - expenses and charges related to our acquisition of other businesses; - increased operating expenses related to the development of new products, including products for the Internet; - our ability to recognize revenues in accordance with generally accepted accounting principles in the quarter in which we expect to recognize those revenues. THE LENGTHY SALES CYCLE OF OUR PRODUCTS MAKES IT DIFFICULT FOR US TO DETERMINE WHEN SALES WILL OCCUR, AND WE MAY NOT BE ABLE TO COMPENSATE FOR UNANTICIPATED REVENUE SHORTFALLS. We cannot predict the timing of the recognition of our revenues accurately because of the length of our sales cycles. As a result, if sales forecasted from specific customers are not realized, we may be unable to compensate for the resulting revenue shortfall and our operating results would be harmed. The sales cycle to license our products can typically range from 60 days to 18 months. Customers are often cautious in making decisions to acquire our products, because purchasing our products typically involves a significant commitment of capital, and may involve shifts by the customer to a new software and/or hardware platform or changes in the customers operational procedures. Delays in completing sales can arise while customers complete their internal procedures to approve large capital expenditures and test and accept our applications. We may incur substantial sales and marketing expenses and expend significant management effort while potential customers are evaluating our products and before they place an order with us. Consequently, if orders for our products are not received as anticipated, our operating results could be harmed. THE CHALLENGES ASSOCIATED WITH EFFECTIVELY INTEGRATING ACQUIRED BUSINESSES COULD PREVENT US FROM REALIZING THE INTENDED BENEFITS OF THESE ACQUISITIONS. During 2000, we completed the acquisition of seven businesses (one of which was divested in connection with the spin-off of our former subsidiary Retek). Integrating and organizing the remaining six acquired businesses creates challenges for our operational, financial and 22 management information systems and can pose difficulties in maintaining our corporate culture. If we do not adequately address issues presented by growth through acquisitions, we may not fully realize the intended benefits, including any financial benefits, of these acquisitions and may incur increased costs and expenses. WE EXPECT TO CONTINUE TO MAKE STRATEGIC ACQUISITIONS, WHICH COULD PUT A STRAIN ON OUR RESOURCES, CAUSE DILUTION TO OUR STOCKHOLDERS AND ADVERSELY AFFECT OUR FINANCIAL RESULTS. We believe that our future growth may depend, in part, upon our ability to successfully complete future acquisitions of businesses and technologies. Integrating newly acquired organizations and technologies into our business could put a strain on our resources and be expensive and time consuming. In addition, we may not succeed in integrating acquired businesses or technologies and may not achieve anticipated revenue and cost benefits. Further, our acquisition strategy and future acquisitions could result in any of the following risks: - increased competition for acquisition opportunities could inhibit our growth and our ability to complete suitable acquisitions, and could also increase the price we would have to pay to complete acquisitions, which might result in dilution to the equity interests of our stockholders; - if we are unable to complete acquisitions successfully, we might not be able to successfully develop and market products for new industries or for markets with which we may not be familiar; - we might not be able to coordinate the diverse operating structures, policies and practices of companies we acquire or to successfully integrate the employees of the acquired companies into our organization and culture, which could impair employee morale and productivity; - despite due diligence reviews, acquired businesses may bring with them unanticipated liabilities, risks or operating costs that could harm our results of operations or business or require unbudgeted expenses; - if we fail to retain the services of key employees of acquired companies for significant time periods after the acquisition of their companies, we may experience difficulty in managing the acquired company's business and not realize the anticipated benefits of the acquisition; - the accounting treatment of acquisitions can result in significant acquisition-related accounting charges and expenses that can reduce our reported results of operations both at the time of the acquisition and in future periods; and - additional acquisitions may require us to issue shares of our stock and stock options to owners of the acquired businesses, resulting in dilution to our stockholders. 23 IF WE FAIL TO EFFECTIVELY RESPOND TO CHANGES IN OUR BUSINESS THEN OUR CORPORATE ORGANIZATION WILL BE DISRUPTED AND WE WILL BE DIVERTED FROM OUR BUSINESS PLAN. In recent years, we have experienced changes in our operations that have placed significant demands on our administrative, operational and financial resources. These demands, which are expected to continue to challenge our management and operations, include the following: - growth and diversification of our customer base; - expansion of our product functionality and the number of products we market and support; - expansion of our product lines into new markets, industries and technology mediums; - increase in the number of our employees; and - geographic dispersion of our operations and personnel. These changes require us to manage an increasing number of relationships with customers and other third parties, as well as a larger workforce. In addition, we will need to adapt our operational and financial control systems, if necessary, to respond to changes in the size and diversification of our business. If we fail to manage changes effectively, our employee-related costs and employee turnover could increase and we could face disruptions that compromise our ability to execute on our business plan. IF OUR SOFTWARE PRODUCTS DO NOT ACHIEVE WIDESPREAD MARKET ACCEPTANCE, OUR BUSINESS REPUTATION AND FINANCIAL PERFORMANCE WOULD SUFFER. The rate at which businesses have adopted our products has varied significantly by market and by product within each market, and we expect to continue to experience variations to the degree to which our products are accepted in our target markets in the future. In particular, the acceptance of our products may be limited by factors such as: - the failure of prospective customers to perceive value in predictive software solutions; - the reluctance of our prospective customers to replace their existing solutions with our products; and - the emergence of new technologies that could cause our products to be less competitive or obsolete. In addition, because the market for customer insight solutions is still in a relatively early stage of development, we cannot accurately assess the size of the market, and we have limited insight into trends that may emerge and affect our business. For example, we may have difficulty in predicting customer needs and new technologies, developing products that could address those needs and technologies, and establishing a distribution strategy for these products. We may also have difficulties in predicting the competitive environment that will develop. 24 IF WE FAIL TO KEEP UP WITH RAPIDLY CHANGING TECHNOLOGIES, OUR PRODUCTS COULD BECOME LESS COMPETITIVE OR OBSOLETE. In our markets, technology changes rapidly, and there are continuous improvements in computer hardware, network operating systems, programming tools, programming languages, operating systems, database technology and the use of the Internet. If we fail to enhance our current products and develop new products in response to changes in technology or industry standards, our products could rapidly become less competitive or obsolete. For example, the rapid growth of the Internet environment creates new opportunities, risks and uncertainties for businesses, such as ours, which develop software solutions that must also be designed to operate in Internet, intranet and other online environments. Our future success will depend, in part, upon our ability to: - internally develop new and competitive technologies; - use leading third-party technologies effectively; - continue to develop our technical expertise; - anticipate and effectively respond to changing customer needs; - time new product introductions in a way that minimizes the impact of customers delaying purchases of existing products in anticipation of new product releases; and - Influence and respond to emerging industry standards and other technological changes. DELAYS IN THE DEVELOPMENT OF NEW PRODUCTS OR PRODUCT ENHANCEMENTS COULD HARM OUR OPERATING RESULTS AND OUR COMPETITIVE POSITION. The development of new, technologically advanced products is a complex and uncertain process that requires innovation, highly skilled personnel and accurate anticipation of technological and market trends. We have previously experienced significant delays in the development and introduction of new products and product enhancements, primarily due to difficulties with model development, which has in the past required multiple iterations, as well as difficulties with acquiring data and adapting to particular operating environments. The length of these delays has varied depending upon the size and scope of the project and the nature of the problems encountered. If we are unable to meet the introduction schedules for our new products or product enhancements, customers may switch their allegiance to competitive products or refuse to purchase our solutions, which would harm our competitive position and our operating results. WE DERIVE A SUBSTANTIAL PORTION OF OUR REVENUES FROM OUR COMPADVISOR AND FALCON PRODUCTS, AND OUR REVENUE WILL DECLINE IF THE MARKET DOES NOT CONTINUE TO ACCEPT THESE PRODUCTS. Our CompAdvisor and Falcon products in the aggregate accounted for 40.3% of our total revenues in 2000. CompAdvisor accounted for 23.5% of total revenues in 2000 and Falcon accounted for 16.8% of total revenues in 2000. We expect these products will continue to account for a substantial portion of our total revenues for the foreseeable future. Our revenue will decline if the market does not continue to accept these products. Factors that might affect the market acceptance of CompAdvisor include the following: 25 - simplification of state workers' compensation fee schedules; - changes in the overall payment system or regulatory structure for workers' compensation claims; - technological change; - our inability to obtain or use state fee schedule or claims data; - saturation of market demand; - loss of key customers; and - industry consolidation. Demand for, or use of, Falcon, could decline as a result of factors that reduce the effectiveness of Falcon's fraud detection capabilities. For example, patterns of credit card fraud might change in a manner that the Falcon product line would not detect. In addition, other methods of credit card fraud prevention such as smart cards may reduce customers' need for the Falcon product line. Because many Falcon customers are banks and related financial institutions, sales of our Falcon products are subject to changes in the financial services industry such as fluctuations in interest rates and the general economic health of financial services companies, which affect their capital expenditure budgets. In addition, the financial services industry tends to be cyclical, which may result in variations in demand for our Falcon products. There is a continuing trend toward consolidation in the financial services industry, which has reduced our customer base and may lead to lost or delayed sales and reduced demand for our Falcon products. Industry consolidation also could affect our base of recurring revenues derived from contracts in which we are paid on a per-transaction basis, when consolidated customers combine their operations under one contract with us which, in some cases, could result in lower payments to us than those previously paid by our customers separately. WE DEPEND ON DATA TO UPDATE OUR STATISTICAL MODELS, AND FAILURE TO TIMELY OBTAIN THIS DATA COULD HARM THE PERFORMANCE OF OUR PRODUCTS. The development, installation and support of our credit card fraud control and profitability management, loan underwriting and insurance products require periodic updates of our statistical models. To develop these updates, we must develop or obtain a reliable source of sufficient amounts of current and statistically relevant data to analyze transactions and update our models. In most cases, these data must be periodically updated and refreshed to enable our predictive products to continue to work effectively in a changing environment. We do not own or control much of the data that we require, most of which are collected privately and maintained in proprietary databases. Generally, our customers agree to provide us the data we require to analyze transactions, report results and build new predictive models. If we fail to maintain good relationships with these customers, we could lose access to required data and our products might become less effective. In addition, our CompAdvisor product uses data from state workers' 26 compensation fee schedules adopted by state regulatory agencies. Third parties have previously asserted copyright interests in this data. These assertions, if successful, could prevent us from using the data. We may not be able to continue to obtain adequate amounts of statistically relevant data on time, in the required formats or on reasonable terms and conditions, whether from customers or commercial suppliers. IF WE ARE UNABLE TO COMPETE EFFECTIVELY WITH EXISTING OR NEW COMPETITORS, OUR RESULTING LOSS OF COMPETITIVE POSITION COULD RESULT IN PRICE REDUCTIONS FOR OUR PRODUCTS, FEWER CUSTOMER ORDERS AND LOSS OF MARKET SHARE. The market for predictive software solutions is intensely competitive and is constantly changing. Some of our competitors or potential competitors have substantially greater financial, technical and marketing resources than we do. These competitors may be able to respond more rapidly than we can to new or emerging technologies or changes in customer requirements. They may also devote greater resources to the development, promotion and sale of their products than we do. In addition, they may have the ability to sell products competitive to ours at lower prices as part of integrated suites of several related products that are vital to the customer's computing infrastructure. This may cause customers to purchase products of our competitors that directly compete with our products in order to acquire other products of the competitor. Our competitors vary in size and in the scope of the products and services they offer. We encounter competition from a number of sources, including: - other application software companies, including enterprise software vendors; - management information systems departments of customers and potential customers, including financial institutions, insurance companies, telecommunications carriers and retailers; - third-party professional services organizations, including consulting divisions of public accounting firms; - Internet companies; - hardware suppliers that bundle or develop complementary software; - network and telecommunications switch manufacturers, and service providers that seek to enhance their value-added services; - neural-network tool suppliers; and - managed care organizations. We expect to experience additional competition from other established and emerging companies, as well as from other technologies. For example, our Falcon and eFalcon products compete against other methods of preventing credit card fraud, such as credit card activation 27 programs, credit cards that contain the cardholder's photograph, smart cards and other card authorization techniques. Increased competition, whether from other products or new technologies, could result in price reductions, fewer customer orders, loss of customers, reduced gross margins and loss of market share, any of which could negatively impact our business. We expect to face increasing pricing pressures from our current competitors and new market entrants. Price reductions could negatively impact our margins and results of operations. Price competition could also harm our ability to obtain new long-term contracts and renewals of existing long-term contracts on favorable terms. Furthermore, a number of our current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of our prospective customers. As a result, new competitors or alliances among competitors may emerge and rapidly gain significant market share. We may not be able to compete effectively against current and potential competitors, especially those with significantly greater resources and market leverage. IF WE LOSE KEY PERSONNEL, WE MIGHT NOT BE ABLE TO MANAGE OUR BUSINESS SUCCESSFULLY. Our future success depends to a significant degree upon the continued service of members of our senior management and other key research, development, sales and marketing personnel. We generally do not have employment agreements with our employees, and the few employment agreements we do have with a small number of our employees may not result in the retention of these employees. As a result, we could experience the untimely loss of a member of the management team on little or no advance notice. We could also lose the services of a key employee of a business we acquire before we have had adequate time to familiarize ourselves with the operating details of that business and obtain a suitably experienced replacement. Our future performance will also depend, in part, upon the ability of our officers to work together effectively. Our management personnel may not be successful in carrying out their duties or running our company. Any dissent among members of management could impair our ability to make strategic decisions quickly in a rapidly changing market. IF WE DO NOT RECRUIT AND RETAIN QUALIFIED PERSONNEL, OUR ABILITY TO EXECUTE OUR BUSINESS PLAN WOULD BE COMPROMISED. Our future success depends upon our ability to attract, retain and motivate highly skilled employees. Competition for employees in our industry is intense. We have historically experienced difficulty in recruiting a sufficient number of qualified sales and technical employees. In addition, competitors and other businesses may be successful in attempts to recruit our key employees, particularly if they can offer more attractive stock options or other equity compensation packages. Many of our technical employees possess unique skills and are not easily replaceable, and loss of technical personnel could harm our product development efforts. We expect to continue to experience difficulty in hiring and retaining highly skilled employees with appropriate qualifications. 28 OUR FUTURE RESULTS COULD BE HARMED BY ECONOMIC, POLITICAL, REGULATORY AND OTHER RISKS ASSOCIATED WITH INTERNATIONAL SALES. International operations and export sales represented 19.3% of our total revenues in 2000. We intend to continue to expand our operations outside the United States and to enter additional international markets, which will require significant management attention and financial resources. For more mature products, like Falcon, we may need to increase our international sales in order to continue to expand our customer base. We have committed and continue to commit significant time and development resources to customizing and adapting our products for selected international markets, and to developing international sales and support channels. These international marketing efforts require us to incur increased sales, marketing, development and support expenses. If our efforts do not generate additional international sales on a timely basis, our margins and earnings would be harmed. To the extent that our revenues from international operations represent an increasing portion of our total revenues, we will be subject to increased exposure to international risks. As a result, our future results could be affected by a variety of factors, including: - changes in foreign currency exchange rates; - changes in the political or economic conditions of a country or region, particularly in emerging markets; - trade protection measures, such as tariffs, EEU software directives and import or export licensing requirements; - potentially negative consequences from changes in tax laws; - potentially reduced protection for intellectual property rights; - difficulty in managing widespread sales operations; and - slower payment cycles from international customers. IF OUR PRODUCTS DO NOT COMPLY WITH GOVERNMENT REGULATIONS THAT APPLY TO US OR TO OUR CUSTOMERS, WE COULD BE EXPOSED TO LIABILITY OR OUR PRODUCTS COULD BECOME OBSOLETE. Many of our customers must comply with a number of government regulations and other industry standards, and as a result, many of our key products must also be compliant. For example, our financial services products are affected by the Fair Credit Reporting Act, by Regulation B under the Equal Credit Opportunity Act, by regulations governing the extension of credit to consumers and by Regulation E under the Electronic Fund Transfers Act, as well as non-governmental VISA and MasterCard electronic payment standards. Fannie Mae and Freddie Mac regulations, among others, for conforming loans, affect our mortgage services products. Insurance-related regulations may in the future apply to our insurance products. If our products fail to comply with existing or future regulations and standards, our customers or we could be subject to legal action by regulatory authorities or by third parties, including actions seeking civil or criminal penalties, injunctions against our use of data or preventing use of our products or civil damages. In addition, we may also be liable to our customers for failure of our products to comply with regulatory requirements. If state-mandated workers' compensation laws or regulations or state workers' compensation fee schedules are simplified, these changes would 29 diminish the need for, and the benefit provided by, CompAdvisor. In many states, including California, there have been periodic legislative efforts to reform workers' compensation laws in order to reduce the cost of workers' compensation insurance and to curb abuses of the workers' compensation system. Changes in workers compensation laws or regulations could adversely affect our insurance products by making them obsolete, or by requiring extensive changes in these products to reflect new workers' compensation rules. To the extent that we sell new products targeted to markets that include regulated industries and businesses, our products will need to comply with these additional regulations. IF WE FAIL TO PROTECT AND PRESERVE OUR INTELLECTUAL PROPERTY WE COULD LOSE AN IMPORTANT COMPETITIVE ADVANTAGE. Our success and ability to compete substantially depend upon our internally developed proprietary technologies, which we protect through a combination of patent, copyright, trademark and trade secret laws and confidentiality procedures. We also seek to protect our software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. Despite the measures we take to protect our intellectual property, it may be possible for a third party to copy or otherwise to obtain and use our products or technology without authorization, or to develop similar technology independently. In addition, patents may not be issued with respect to our pending or future patent applications, and our patents may not be upheld as valid or may not prevent the development of competitive products. To ensure that customers will not be harmed by an interruption in our business, we often place software source code for our products into escrow, which may increase the likelihood of misappropriation or other misuse of our intellectual property. Any disclosure, loss, invalidity of, or failure to protect, our intellectual property could negatively impact our competitive position, and ultimately, our business. We have developed technologies under research projects conducted under agreements with various United States Government agencies or subcontractors. Although we have acquired commercial rights to these technologies, the United States Government typically retains ownership of intellectual property rights and licenses in the technologies developed by us under these contracts, and in some cases can terminate our rights in these technologies if we fail to commercialize them on a timely basis. Under our contracts with the United States Government, the results of our research may be made public by the government, which could limit our competitive advantage with respect to future products based on our research. WE COULD BE SUBJECT TO CLAIMS OF INFRINGEMENT OF THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS, WHICH COULD RESULT IN SIGNIFICANT EXPENSE AND LOSS OF INTELLECTUAL PROPERTY RIGHTS. In the past, we have received communications from third parties asserting that our trademarks infringe upon their trademarks, or that data we use is copyrighted by them, none of which has resulted in litigation or material losses. We have also been involved in patent litigation. Given our ongoing efforts to develop and market new technologies and products, we may from time to time be served with other claims from third parties asserting that our products or technologies infringe their intellectual property rights. Any litigation to determine the validity of these claims, including claims arising through our contractual indemnification of our customers and other business partners against infringement, regardless of their merit or resolution, would likely be costly and time consuming and divert the efforts and attention of our management and technical 30 personnel. We cannot be certain we would prevail in this litigation given the complex technical issues and inherent uncertainties in intellectual property litigation. If this litigation resulted in an adverse ruling, we could be required to: - pay substantial damages; - cease the use or sale of infringing products; - expend significant resources to develop non-infringing technology; - discontinue the use of certain technology; or - obtain a license under the intellectual property rights of the third party claiming infringement, which license may not be available on reasonable terms, or at all. A license, if obtained, might require that we pay substantial royalties or license fees that would reduce our margins. OUR PRODUCTS MAY HAVE DEFECTS, WHICH COULD DAMAGE OUR REPUTATION, DECREASE MARKET ACCEPTANCE OF OUR PRODUCTS, CAUSE US TO LOSE CUSTOMERS AND REVENUE AND RESULT IN LIABILITY TO US. Products as sophisticated as ours are likely to contain errors or failures when first introduced or as new versions are released. To the extent that we develop new products that operate in new environments, such as the Internet, the possibility for program errors and failures may increase due to factors including the use of new technologies or the need for more rapid product development that is characteristic of the Internet market. In the future, we may experience delays in releasing new products or product enhancements as problems are corrected. Errors or defects in our products that are significant, or are perceived to be significant, could result in the rejection of our products, damage to our reputation, lost revenues, diverted development resources and increased service and support costs and warranty claims. In addition, because our products are used in business-critical applications, any product errors or failures may give rise to substantial product liability claims. OUR COMMON STOCK PRICE FLUCTUATES AND HAS BEEN VOLATILE. The market price of our common stock has been, and will likely continue to be, subject to wide fluctuations. Many factors could cause the price of our common stock to rise and fall, including: - variations in our quarterly results; - announcements of new products by us or our competitors - acquisitions of businesses or products by us or our competitors; - recruitment or departure of key personnel; 31 - the gain or loss of significant orders; - the gain or loss of significant customers; - changes in the estimates of our operating performance or changes in recommendations by any securities analysts that follow our stock; and - market conditions in our industry, the industries of our customers and the economy as a whole. In addition, stocks of technology companies have experienced extreme price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of these companies. Public announcements by companies in our industry about, among other things, their performance, accounting practices or legal problems could cause the market price of our common stock to decline regardless of our actual operating performance. In the past, securities class action litigation has often been brought against a company following a period of volatility in the market price of its securities. We may in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management's attention and resources. OUR CERTIFICATE OF INCORPORATION AND DELAWARE LAW CONTAIN PROVISIONS THAT COULD DISCOURAGE OR PREVENT A TAKEOVER, EVEN IF AN ACQUISITION WOULD BENEFIT OUR STOCKHOLDERS. Under our certificate of incorporation, our board of directors is authorized to issue up to 4,000,000 shares of preferred stock without any further vote or action by our stockholders. The rights of the holders of our common stock will be subject to the rights of the holders of any preferred stock that we may issue in the future. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. We have no current plans to issue shares of preferred stock. In addition, Section 203 of the Delaware General Corporation Law restricts business combinations with any "interested stockholder" as defined by the statute. The statute could make it more difficult for a third party to acquire us, even if an acquisition would benefit our stockholders. 32 EX-99.02 5 a79278ex99-02.txt EXHIBIT 99.02 EXHIBIT 99.02 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999 OVERVIEW On September 29, 2000, HNC spun-off its former subsidiary Retek, Inc. ("Retek") through the distribution of all Retek shares then owned by HNC. As a result of this distribution, Retek is no longer affiliated with HNC. In April 2001, we announced and began to implement a reorganization that involved realigning our internal organization from a vertical market orientation to a horizontal product platform. As a result, we changed our reportable segments beginning in the second quarter of 2001 to reflect the new method in which management primarily organizes and evaluates internal financial information to make operating decisions and assess performance. Our current reportable segments include our Efficiency, Risk and Opportunity product suites. The following discussion and analysis of our results of operations for 2000 and 1999 has been restated to conform to our current segment presentation. These reclassifications have no impact on our consolidated results of operations for these periods, as originally reported on our Form 10-K for the year ended December 31, 2000. Our revenues and operating results have varied significantly in the past and in some quarters we have experienced net losses. We expect fluctuations in our operating results to continue for the foreseeable future. As a result, we believe that investors should not rely on period-to-period comparisons of our financial results as an indication of our future performance. Further, we derive a substantial portion of our revenues from our CompAdvisor and Falcon products. Our CompAdvisor and Falcon products in the aggregate accounted for 40.3% of our total revenues in 2000. CompAdvisor accounted for 23.5% of total revenues in 2000 and Falcon accounted for 16.8% of total revenues in 2000. We expect these products will continue to account for a substantial portion of our total revenues for the foreseeable future. Our revenue will decline if the market does not continue to accept these products. 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. In addition, in the past we have acquired several companies and may continue to do so in the future. During 2000, we completed the spin-off of our former Retek subsidiary. Such transactions typically affect the comparability of our historical financial results. Acquisitions also typically generate significant continuing charges that decrease our net income, often for many fiscal periods. 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 would likely be harmed. Statements in this exhibit contain forward-looking information about our anticipated future operating expenses, our expectations for our international operations and about the assumptions and projections underlying our in-process research and development expense. Forward-looking statements are subject to risks and uncertainties. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, including, but not limited to, the following: - The timing of execution of large contracts; - The loss of any key customer; - Variations in the amount of recurring revenues; - The deferral, reduction or cancellation of customer orders or purchases; - The timing of our new product announcements and introductions and those of our competitors; - Delays in the release of final commercial versions of our products; - Changes in the mix of our distribution channels; - The amount and timing of our costs and operating expenses; - Our ability to fulfill our obligations under percentage-of-completion contracts; - Our success in completing pilot installations within contracted fee budgets; - Changes in our product offerings; - Competitive conditions in the industries we serve; - Economic conditions in our targeted markets; - Domestic and international economic conditions; - Changes in prevailing technologies; - Expenses and charges related to our acquisition of other businesses; and - Our ability under generally accepted accounting principles to recognize revenues in the quarter in which we expect to recognize those revenues. You should carefully consider these risks. Investors are cautioned not to place undue reliance on these forward-looking statements that speak only as of the date of this report. We undertake no obligation to revise or update any forward-looking statements for any reason. 2 RESULTS OF OPERATIONS REVENUES Our revenues are comprised of license and maintenance revenues and services and other revenues. Total revenues for 2000 increased by $38.0 million, or 17.5%, over 1999. Our revenues during 2000 and 1999 are summarized as follows, and include Retek's revenues through the September 29, 2000 spin-off date:
YEAR ENDED DECEMBER 31, ------------------------- 2000 1999 -------- -------- (IN THOUSANDS) CORE HNC: License and maintenance revenues ......... $130,834 $109,983 Services and other revenues .............. 64,135 37,747 -------- -------- 194,969 147,730 -------- -------- RETEK: License and maintenance revenues ......... 35,229 45,965 Services and other revenues .............. 24,686 23,194 -------- -------- 59,915 69,159 -------- -------- Total Consolidated Revenues .................. $254,884 $216,889 ======== ========
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 perpetual and short-term periodic licenses of our software is generally recognized upon delivery. Transactional-based fees under software license arrangements are recognized as revenue based on system usage or when fees based on system usage exceed monthly minimum license fees. Software maintenance fees are recognized as revenue ratably over the maintenance periods. Transactional-based fees under network service or internal hosted software arrangements are recognized as revenue based on system usage or when fees based on system usage exceed monthly minimum license fees. Amounts received under contracts in advance of delivery or performance are recorded as deferred revenue and are generally recognized within one year from receipt. The following table presents our license and maintenance revenues by segment for 2000 and 1999:
YEAR ENDED DECEMBER 31, ------------------------- 2000 1999 -------- -------- (IN THOUSANDS) LICENSE AND MAINTENANCE REVENUES: Efficiency ............................... $ 61,212 $ 48,765 Risk ..................................... 54,298 46,946 Opportunity .............................. 9,144 8,987 Other .................................... 6,180 5,285 -------- -------- Core HNC ........................... 130,834 109,983 Retek .................................... 35,229 45,965 -------- -------- $166,063 $155,948 ======== ========
3 License and maintenance revenues in 2000 increased by $10.1 million, or 6.5%, compared with 1999. This increase consisted of a $20.9 million, or 19.0% increase within Core HNC, offset by a $10.7 million, or 23.4% decline at Retek. The increase at Core HNC was primarily attributable to a $12.4 million, or 25.5% increase in our Efficiency segment and a $7.4 million, or 15.7% increase in our Risk segment. The increase within our Efficiency segment was attributable primarily to growth from acquisitions, including revenues derived through the sale of our 4SCORE, RoamEX and Connectivity products, along with an increase in ProfitMax revenues, partially offset by a decline in Capstone and other product revenues. The increase within our Risk segment was attributable primarily to increased revenues derived from of our Falcon and eFalcon products and to acquisition-related growth derived primarily from CardAlert Network revenues, offset by a decline in MIRA product revenues resulting from the sale of fewer MIRA perpetual licenses in 2000 as compared to 1999. Services and Other Revenues. Services and other revenues are comprised of installation and implementation revenues, remote hosted service operation 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 operations in the period any losses are first identified. Installation or setup fees associated with network service and internally hosted software agreements are recognized ratably over the longer of the customer contract period or estimated life of the customer relationship. Remote hosted service fees derived from the review and repricing of customers' medical bills are recognized as revenue when the processing services are performed. The following table presents our services and other revenues by segment for 2000 and 1999:
YEAR ENDED DECEMBER 31, ------------------------- 2000 1999 ------- ------- (IN THOUSANDS) SERVICE AND OTHER REVENUES: Efficiency ............................. $41,741 $23,422 Risk ................................... 14,128 8,827 Opportunity ............................ 5,538 1,000 Other .................................. 2,728 4,498 ------- ------- Core HNC ......................... 64,135 37,747 Retek .................................. 24,686 23,194 ------- ------- $88,821 $60,941 ======= =======
4 Services and other revenues in 2000 increased $27.9 million, or 45.7%, compared to 1999. This increase consisted of a $26.4 million, or 69.9% increase at Core HNC and a $1.5 million, or 6.4% increase at Retek. The increase at Core HNC was primarily attributable to a $18.3 million, or 78.2% increase in our Efficiency segment, a $4.5 million, or 453.8% increase in our Opportunity segment and a $5.3 million, or 60.1% increase in our Risk segment. The increase within our Efficiency segment was attributable primarily to an increase in Capstone implementation revenues along with an increase in revenues associated with our remote hosted service operations, including the commencement of full-scale hosted service operations for a primary customer. The increase in our Opportunity segment was attributable primarily to an increase in marketing optimization service revenues, resulting from our acquisition of CASA in 2000, and to an increase in ProfitVision installation revenues. The increase in our Risk segment was attributable primarily to an increase in ProviderCompare/CompCompare service revenues and to Spyder development revenues, partially offset by a decline in Falcon product installation revenues. Revenues From Non-U.S. Regions. International operations and export sales represented 19.3% and 23.2% of our total revenues in 2000 and 1999, respectively. During 2000 and 1999, approximately 4.8% and 5.2% of our sales were denominated in currencies other than our functional currency, which is the U.S. dollar. These foreign currencies are primarily those of Western Europe and Canada. During 2000, approximately 33.4% of our international sales were derived from Retek. In 1999, the majority of our international sales were derived from Retek. We believe that international sales represent a significant opportunity for revenue growth and anticipate that our international sales may increase as a percentage of our total revenue in the future. However, there can be no assurance that our efforts to develop products, databases, and models for targeted international markets or in developing additional international sales and support channels will be successful. COST OF REVENUES License and Maintenance Cost of revenues. License and maintenance costs primarily represent our expenses for personnel engaged in customer support, travel to customer sites and documentation materials. Our license and maintenance cost of revenues were $60.5 million in 2000 and $41.6 million in 1999. The following table summarizes our license and maintenance cost of revenues by operating segment, both in absolute dollars and as a percentage of license and maintenance revenues:
YEAR ENDED DECEMBER 31, ----------------------------------------- 2000 1999 ------------------ ------------------ (IN THOUSANDS) LICENSE AND MAINTENANCE COST OF REVENUES Core HNC operating segments ...... 36,666 28.0% 34,914 31.7% Retek segment .................... 15,059 42.7% 6,358 13.8% ------- ---- ------- ---- 51,725 31.1% 41,272 26.5% Amounts not allocated to segments: Stock-based compensation expense . 2,658 1.6% 280 0.1% Expenses related to Retek spin-off 6,086 3.7% -- -- ------- ---- ------- ---- HNC Consolidated ............... $60,469 36.4% $41,552 26.6% ======= ==== ======= ====
5 Our license and maintenance cost of revenues percentage in 2000 increased by 9.8% compared to 1999. Of this increase, 4.6% was attributable to increases within our combined Core HNC and Retek operating segments and 5.2% of this increase was attributable to our recognition in 2000 of increased stock-based compensation charges and non-recurring expenditures relating to our Retek spin-off. For a further discussion regarding stock-based compensation charges and expenditures relating to our Retek spin-off, refer to the sections entitled "Stock-Based Compensation Expense" and "Expenses Related to Spin-Off of Retek" appearing below. In 2000, the 4.6% license and maintenance cost of revenues percentage increase within our operating segments was attributable to a 3.7% decline at HNC, offset by a 28.9% increase at Retek. The decrease in Core HNC's license and maintenance cost of revenues percentage was attributable primarily to our recognition of one-time, non-recurring license fees related to Falcon product sales, with minimal associated costs, increased license and maintenance revenues resulting from acquisitions, including primarily those related to RoamEx and 4SCORE products, with a lower percentage cost increase, and increased revenues associated with e-commerce products having lower associated costs, partially offset by the sale of fewer MIRA perpetual licenses, with minimal associated costs, in 2000 versus 1999. Services and Other Cost of Revenues. Services and other expenses consist of personnel and other expenses associated with providing installation and implementation services and performing development, consulting, and research development contracts, and the costs associated with hosted service operations. Our services and other cost of revenues were $72.9 million in 2000 and $41.3 million in 1999. The following table summarizes our services and other cost of revenues by operating segment, both in dollars and as a percentage of services and other revenues:
YEAR ENDED DECEMBER 31, ----------------------------------------- 2000 1999 ------------------ ------------------ (IN THOUSANDS) SERVICES AND OTHER COST OF REVENUES Core HNC operating segments ...... 44,413 69.2% 24,291 64.4% Retek operating segment .......... 19,349 78.4% 16,626 71.7% ------- ---- ------- ---- 63,762 71.8% 40,917 67.1% Amounts not allocated to segments: Stock-based compensation expense . 2,548 2.9% 354 0.6% Expenses related to Retek spin-off 6,603 7.4% -- -- ------- ---- ------- ---- HNC Consolidated ............... $72,913 82.1% $41,271 67.7% ======= ==== ======= ====
6 Our services and other cost of revenues percentage in 2000 increased by 14.4% compared to 1999. Of this increase, 4.7% was attributable to increases within our combined Core HNC and Retek operating segments and 9.7% of this increase was attributable to our recognition in 2000 of increased stock-based compensation charges and non-recurring expenditures relating to our Retek spin-off. For a further discussion regarding stock-based compensation charges and expenditures relating to our Retek spin-off, refer to the sections entitled "Stock-Based Compensation Expense" and "Expenses Related to Spin-Off of Retek" appearing below. In 2000, the 4.7% services and other cost of revenues percentage increase within our operating segments was attributable to a 4.8% increase at Core HNC and a 6.7% increase at Retek. The increase within Core HNC was attributable primarily to the increased use of third party consultants, who have a higher average cost than internal resources, in connection with Capstone product implementations and to increased costs associated with Spyder and ProviderCompare/CompCompare development work performed during the year, partially offset by improved cost efficiencies associated with the growth in our hosted service customer base. 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. Research and development expense totaled $75.5 million in 2000 and $50.2 million in 1999. Research and development expense in 2000 increased by $25.3 million, or 50.5%, compared to 1999. Of this increase, $16.5 million, or 32.9%, was attributable to increased expenditures within our combined Core HNC and Retek operating segments, and $8.8 million, or 17.6%, was attributable to our recognition in 2000 of increased stock-based compensation charges as well as non-recurring expenditures relating to our Retek spin-off. For a further discussion regarding stock-based compensation charges and expenditures relating to our Retek spin-off, which we do not allocate to our operating segments, refer to the sections entitled "Stock-Based Compensation Expense" and "Expenses Related to Spin-Off of Retek" appearing below. Within our operating segments, the 2000 increase consisted of a $12.9 million, or 48.8% increase within Core HNC and an increase of $3.6 million, or 15.9% related to Retek. The absolute dollar increase at Core HNC was attributable primarily to increases in staffing and related costs to support new product development activities. Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," requires capitalization of software development costs from the time technological feasibility is established until the product is available for general release to customers. Based on our product development process, technological feasibility is not established until completion of a working model. Costs we incur between completion of the working model and the point at which a product is ready for general release have been insignificant. As a result, no significant software development costs were capitalized through December 31, 2000. We anticipate that research and development expenses 7 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. Sales and marketing expenses totaled $89.9 million in 2000 and $46.3 million in 1999. Sales and marketing expense in 2000 increased by $43.6 million, or 94.4%, compared to 1999. Of this increase, $20.5 million, or 44.5%, was attributable to increased expenditures within our combined Core HNC and Retek operating segments, and $23.1 million, or 49.9%, was attributable to our recognition in 2000 of increased stock-based compensation charges as well as non-recurring expenditures relating to our Retek spin-off. For a further discussion regarding stock-based compensation charges and expenditures relating to our Retek spin-off, which we do not allocate to our operating segments, refer to the sections entitled "Stock-Based Compensation Expense" and "Expenses Related to Spin-Off of Retek" appearing below. Within our operating segments, the 2000 increase consisted of a $12.0 million, or 45.8% increase at Core HNC and an $8.6 million, or 43.9% increase related to Retek. The absolute dollar increases at Core HNC was attributable primarily to increases in staffing related to the expansion of our direct sales and marketing staff, including that resulting from acquisitions. Also contributing to the increases were additional 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 the EMEA (Europe, the Middle East and Africa), the Asian-Pacific and Latin American regions, as well as other international markets, expand our domestic sales and marketing organization and increase the breadth of our product lines. 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 insurance and professional services expenses. General and administrative expenses totaled $53.3 million in 2000 and $33.8 million in 1999. General and administrative expense in 2000 increased by $19.5 million, or 57.9%, compared to 1999. Of this increase, $10.8 million, or 32.0%, was attributable to increased expenditures within our combined Core HNC and Retek operating segments, and $8.7 million, or 25.9%, was attributable to the net effect of our recognition of non-recurring expenditures relating to our Retek spin-off, offset by a decline in stock-based compensation charges in 2000 as compared to 1999. For a further discussion regarding stock-based compensation charges and expenditures relating to our Retek spin-off, which we do not allocate to our operating segments, refer to the sections entitled "Stock-Based Compensation Expense" and "Expenses Related to Spin-Off of Retek" appearing below. 8 Within our operating segments, the 2000 increase consisted of a $9.1 million, or 51.6% increase at Core HNC and a $1.7 million, or 26.6% increase related to Retek. The absolute dollar increases at Core HNC was attributable primarily to additional staffing and related expenses to support a higher volume of business, resulting in part from our acquisitions. TRANSACTION-RELATED AMORTIZATION AND COSTS Transaction-related amortization and costs primarily include acquisition-related amortization during 2000 and 1999. Additional costs include $0.8 million related to the write-off of deferred offering costs during 2000 and $0.6 million related to the write-off of deferred merger costs during 1999. Transaction-related amortization and costs increased from $9.2 million in 1999 to $43.7 million in 2000. This increase was primarily attributable to incremental intangible asset amortization charges as a result of our business acquisitions during 1999 and 2000. The average amortization period and useful life for these intangible assets is approximately 3.5 years. IN-PROCESS RESEARCH AND DEVELOPMENT EXPENSE 2000 ACQUISITIONS In-process research and development expense was $7.6 million in 2000, related to one-time write-offs in connection with the acquisitions of CASA ($1.4 million), Celerity ($1.1 million), HighTouch ($4.0 million), Systems/Link ($0.7 million) and CardAlert ($0.4 million). 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. CASA, acquired in the first quarter of 2000, is an advanced analytic solutions company that provides account optimization and precision marketing solutions. Prior to 2000, CASA primarily sold its Adaptive Dynamic Marketing solutions 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, which in-process research and development projects were estimated at the time of acquisition to achieve technological feasibility in 2000. Celerity Technologies, acquired in the second quarter of 2000, is involved in developing and marketing electronic data interchange ("EDI") solutions 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. Prior to our acquisition, Celerity Technologies 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 Technologies had a number of new technologies under development related to Web-enabling and EDI network technologies, which in-process research and development projects were estimated at the time of acquisition to achieve technological feasibility in 2000. 9 HighTouch, acquired in the second quarter of 2000 by Retek, is a provider of customized software and services relating to customer relationship management ("CRM"). Prior to our 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 a fully integrated standardized off-the-shelf CRM product, which in-process research and development project was estimated at the time of acquisition to achieve technological feasibility in 2000. Systems/Link, acquired in the third quarter of 2000, is a software developer that creates data management solutions for large telecommunications companies. The company provides applications for real-time data collection, call detail record exchange, fraud control and prepaid services for carriers. At the time of acquisition, Systems/Link had a new technology under development related to a real-time roamer record exchange system for enhanced fraud control capabilities, which in-process research and development project was estimated at the time of acquisition to achieve technological feasibility in 2001. CardAlert, acquired in the third quarter of 2000, provides ATM and debit card risk management services to domestic financial institutions and debit card networks. The company's Accelerated Detection technology analyzes daily ATM transactions for fraudulent activity. Prior to its acquisition, CardAlert primarily provided fraud detection services to large domestic debit card networks. At the time of acquisition, CardAlert had a new technology under development related to fraud detection for signature-based credit card activity, which in-process research and development project was estimated at the time of acquisition to achieve technological feasibility in the third quarter of 2001. We used an independent appraisal firm to assist us with our valuations of the fair market values of the purchased assets in connection with these acquisitions. 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 research and development 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 rates) for determining present values of the projected cash flows. Stages of completion were 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 pertaining to these acquisitions: CASA prepared a detailed set of projections forecasting revenue from the new algorithms as well as gross profit and operating profit margins; Celerity and HNC prepared a detailed set of projections forecasting revenue from the Web-enabling and EDI technology as well as gross profit and operating profit margins; Retek prepared a detailed set of projections forecasting revenue from the HighTouch CRM technology as well as gross profit and operating profit margins; Systems/Link and HNC prepared a detailed set of projections forecasting revenue from the real-time roamer record exchange technology as well as gross profit and operating profit margins; and CardAlert and HNC prepared a detailed set of projections forecasting 10 revenue from the credit card fraud detection 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, incomplete technology represents a mix of near and mid-term prospects for the acquired businesses and imparts a level of uncertainty as to their 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 based upon the following methodologies: 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, HighTouch, Systems/Link and CardAlert, the discount rates attributable to the businesses were 22.0%, 19.3%, 21.2%, 21.0% and 21.0%, respectively, which were used for valuing completed technology. Since incomplete technology would require a higher return than completed technology, the valuation reports prepared by our appraiser utilized discount rates of 27.0%, 24.3%, 26.2%, 31.0% and 31.0% for CASA, Celerity, HighTouch, Systems/Link and CardAlert, 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 in-process research and development for the CASA, Celerity, HighTouch, Systems/Link and CardAlert projects have reached completion or 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. 1999 ACQUISITION In-process research and development expenses was $1.5 million in 1999, related to a one-time write-off in connection with Retek's acquisition of WebTrak in the fourth quarter of 1999. At the time of acquisition, certain WebTrak products were under development. 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. Retek used an independent appraisal firm to assist in the valuation of the fair market values of the purchased assets of WebTrak. 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. Retek provided assumptions by product line of revenue, cost of goods sold and operating expense to the appraiser to assist in the valuation. The in-process research and development 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 rates) for determining present values of the projected cash flows. Stages of completion were estimated by considering time, cost, and complexity of tasks completed prior to the acquisition as a percentage of total 11 time, cost and effort required for the total project up to achieving technological feasibility. Earnings associated with WebTrak's incomplete technology were discounted at a rate of 26.4%. OTHER OPERATING EXPENSES During 2000, we recorded an impairment charge of $1.2 million related to the abandonment of a lease and associated property and equipment. No impairment charges were recorded in 1999. INTEREST INCOME Interest income totaled $12.9 million in 2000 and $6.3 million in 1999. The increase in interest income in 2000 compared to 1999 is attributable primarily to increased interest earned as a result of higher average cash and investment balances during 2000. INTEREST EXPENSE Interest expense totaled $4.2 million in 2000 and $5.7 million in 1999. The majority of our interest expense during each of these years relates to our Convertible Subordinated Notes (the "Notes"). The decline in interest expense in 2000 compared to 1999 is attributable primarily to the conversion of $83.6 million of the Notes into our common stock during the third quarter of 2000, whereas the outstanding convertible note balance during all of 1999 was $100.0 million. EXPENSE RELATED TO DEBT CONVERSION In connection with the conversion of $83.6 million in Notes during 2000, we incurred and paid $12.7 million in conversion premiums to the note holders, which we recorded as a debt conversion expense. OTHER EXPENSE, NET Other expense, net totaled $3.4 million in 2000 and $0.2 million in 1999. The increase in 2000 compared to 1999 is attributable primarily to a $2.8 million charge related to the write-down of our investment in Network Commerce in 2000. MINORITY INTEREST IN LOSSES (INCOME) OF CONSOLIDATED SUBSIDIARIES Minority interest in losses (income) of consolidated subsidiaries totaled $7.6 million in 2000 and $0.7 million in 1999, and represents other stockholders' share of the losses (income) of our consolidated subsidiaries, including that relating to Retek in 2000 and 1999. INCOME TAXES The provision (benefit) for income taxes was $(33.1) million in 2000 and $0.5 million in 1999. The differences between the provision (benefit) for income taxes recorded and that computed by applying taxes at statutory rates during 2000 and 1999 are attributable primarily to the effect of non-deductible expenses, offset by the effect of Retek's loss attributable to minority interest 12 stockholders and the generation of tax credit carryforwards during each of these years. Significant non-deductible expenses in 2000 include the effect of one-time write-offs of in-process research and development related to acquisitions, stock-based compensation expense, acquisition related amortization, Retek spin-off costs, and debt conversion expense. Significant non-deductible expenses in 1999 include the effect of a one-time write-off of in-process research and development related to an acquisition, stock-based compensation expense, acquisition related amortization and stock redemption charges. STOCK-BASED COMPENSATION EXPENSE Within our statement of operations, stock-based compensation charges have been classified as follows in 2000 and 1999:
YEAR ENDED DECEMBER 31, ----------------------- 2000 1999 ------- ------- (IN THOUSANDS) License and maintenance ................ $ 2,658 $ 280 Services and other ..................... 2,548 354 Research and development ............... 4,167 1121 Sales and marketing .................... 10,629 441 General and administrative ............. 1,668 9,789 ------- ------- $21,670 $11,985 ======= =======
During 2000, we recorded net stock-based compensation expense totaling $21.7 million, consisting of $13.8 million in stock-based compensation charges attributable to our Retek spin-off, which are discussed separately below, and $7.9 million in additional net compensation expense. This additional net compensation expense relates primarily to the amortization of unearned stock-based compensation of $8.8 million (of which $8.3 million related to Retek) and also includes additional net compensation income of $0.9 million, primarily related to the reversal of compensation expense recorded in 1999 on variable awards, as a result of a decline in the fair values of these awards during 2000. During 1999, Retek granted stock options to employees and directors to purchase Retek common stock at an exercise price of $10.00 per share when the deemed fair market value of Retek's common stock was $13.00 per share. As a result, Retek recorded unearned stock-based compensation totaling $21.9 million representing the aggregate intrinsic value of the options on the date of grant. Additionally, during 2000, Retek recorded additional unearned stock-based compensation totaling $1.8 million related to an employee option grant having an exercise price below the fair value of Retek's common stock on the date of grant. Amortization of Retek's unearned stock-based compensation totaled $1.9 million during 1999 and $8.3 million during the period from January 1, 2000 through the Retek spin-off date of September 29, 2000. Retek's unearned stock-based compensation balance of $13.3 million at September 29, 2000, net of forfeiture reductions, was removed from our consolidated equity accounts in connection with the Retek spin-off. During 1999, in addition to Retek's amortization of unearned stock-based compensation as described above, we recorded stock-based compensation expense totaling $10.1 million. This compensation expense relates primarily to stock awards granted to former employees and non-employee consultants, of which $8.0 million was calculated at intrinsic value while the 13 remainder related to variable awards measured at fair value. The intrinsic value charge consisted primarily of a one-time charge of $6.1 million related to a key employee severance agreement executed in the fourth quarter of 1999. The fair values of HNC's variable awards during 2000 and 1999 were estimated using the Black-Scholes option pricing model with the following weighted average assumptions: dividend yield of 0.0% for both years; risk-free interest rate of 5.02% and 5.23% in 2000 and 1999, respectively; volatility of 100% for both years; and expected lives from four months to one year according to the vesting date and subsequent exercise period of each option grant, and our stock prices on the various grant dates as well as on December 31, 2000 and 1999. In August 2000, we accelerated the vesting of 25 percent of the outstanding stock options that would have been unvested as of the September 15, 2000 record date to afford our option holders the opportunity to participate in receipt of the Retek share dividend. As a result of this award modification, we recorded a non-cash stock-based compensation charge of $6.7 million during the third quarter of 2000 in accordance with Financial Accounting Standards Board Interpretation No. 44, or FIN 44. Additionally, as a result of the proportionate option repricing in connection with the Retek spin-off, certain options failed to qualify for fixed accounting treatment under FIN 44. As a result, we recorded a one-time charge to operations of $7.1 million related to the modification and cash repurchase of options in connection with the Retek spin-off. EXPENSES RELATED TO SPIN-OFF OF RETEK During 2000, we incurred $48.2 million in non-recurring expenses associated with our spin-off of Retek, excluding stock-based compensation charges totaling $13.8 million that are discussed above. Within our statement of operations, these expenses have been classified as follows in 2000:
YEAR ENDED DECEMBER 31, 2000 ----------------- (IN THOUSANDS) License and maintenance ..................... $ 6,086 Services and other .......................... 6,603 Research and development .................... 5,770 Sales and marketing ......................... 12,880 General and administrative .................. 16,846 ------- $48,185 =======
These expenses consisted primarily of a $40.4 million charge related to the accrual of cash bonuses payable to employees and directors who held unvested stock options as of the record date for the Retek dividend, along with investment banking, legal, accounting and other non-recurring costs related to the Retek spin-off. SEGMENT CONTRIBUTION MARGIN The following section summarizes the primary reasons for fluctuations in segment contribution margin in 2000 compared to 1999, as we have reported in Note 12 entitled "Segment 14 Information" in the Notes to Consolidated Financial Statements, appearing in Exhibit No. 99.03 to this Report on Form 8-K. Segment contribution margin for our Efficiency segment increased from $21.6 million in 1999 to $38.1 million in 2000, and as a percentage of segment revenues increased from 29.9% to 37.0%. The absolute dollar increase was attributable to increased segment revenues, as previously discussed herein, offset by an increase in direct segment operating expenses. The segment contribution margin percentage increase was attributable primarily to increased cost efficiencies related to the growth in our hosted service customer base along with higher margins associated with acquired products, including primarily RoamEx and 4Score products, offset in part by a decrease in Capstone product implementation margins due to the increased use of third party consultants, who have a higher average cost than internal resources. The contribution margin percentage was also reduced by increased research and development spending on Efficiency segment products. Segment contribution margin for our Risk segment increased from $40.7 million in 1999 to $50.2 million in 2000, and as a percentage of segment revenues increased from 73.0% to 73.3%. The absolute dollar increase was attributable to increased segment revenues, as previously discussed herein, offset by an increase in direct segment operating expenses. Although the overall segment contribution margin percentage remained relatively flat period over period, the margin increase was primarily due to the recognition of non-recurring license fees in 2000 related to Falcon product sales, with minimal associated costs, offset by the sale of fewer MIRA product perpetual licenses and increased development costs associated with Spyder and ProviderCompare/CompCompare development work performed during the year. The contribution margin percentage was also reduced by increased research and development spending on Risk segment products. Segment contribution margin for our Opportunity segment decreased from $4.2 million in 1999 to $2.6 million in 2000, and as a percentage of segment revenues decreased from 42.5% to 17.8%. The absolute dollar decrease was attributable to increased segment revenues, as previously discussed herein, offset by a larger increase in direct segment operating expenses. The segment contribution margin percentage decrease was attributable primarily to an increase in marketing optimization service revenues resulting from our acquisition of CASA in the first quarter of 2000, which contributed to lower product margins during most of 2000, and to increased ProfitVision product development costs. Segment contribution margin for our Other segment decreased from $3.0 million in 1999 to $1.2 million in 2000, and as a percentage of segment revenues decreased from 30.6% to 13.9%. The absolute dollar decrease was attributable to a decline in segment revenues along with an increase in direct segment operating expenses. The segment contribution margin percentage decrease was attributable primarily to a decline in perpetual license revenues associated with various products and to increased research and development expenditures in 2000 related to our Intelligent Response product lines. 15 EX-99.03 6 a79278ex99-03.txt EXHIBIT 99.03 EXHIBIT 99.03 CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of HNC Software Inc. In our opinion, the accompanying consolidated balance sheet of HNC Software Inc. and the related consolidated statements of operations, of cash flows and of changes in stockholders' equity and comprehensive income present fairly, in all material respects, the financial position of HNC Software Inc. and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PRICEWATERHOUSECOOPERS LLP San Diego, California January 24, 2001, except as to Note 15, to which the date is March 6, 2001, and Note 12, to which the date is February 13, 2002 1 HNC SOFTWARE INC. CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ASSETS
DECEMBER 31, ---------------------------- 2000 1999 --------- --------- Current assets: Cash and cash equivalents ................................................ $ 69,271 $ 136,340 Marketable securities available for sale-debt ............................ 44,779 22,368 Marketable securities available for sale-equity .......................... 250 6,810 Trade accounts receivable, net ........................................... 43,856 64,189 Deferred income taxes .................................................... 15,045 20,384 Other current assets ..................................................... 8,402 11,144 --------- --------- Total current assets ............................................. 181,603 261,235 Marketable securities available for sale-debt .............................. 48,453 68,563 Equity investments ......................................................... 14,719 14,219 Property and equipment, net ................................................ 20,826 22,219 Goodwill, net .............................................................. 96,810 17,280 Intangible assets, net ..................................................... 47,522 11,788 Deferred income taxes ...................................................... 33,844 18,085 Other assets ............................................................... 3,964 3,032 --------- --------- $ 447,741 $ 416,421 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities ................................. $ 38,675 $ 30,049 Deferred revenue ......................................................... 9,876 15,274 --------- --------- Total current liabilities ........................................ 48,551 45,323 Non-current liabilities .................................................... 259 4,111 Convertible Subordinated Notes ............................................. 16,357 100,000 --------- --------- Total liabilities ................................................ 65,167 149,434 --------- --------- Commitments and contingencies (Notes 8 and 14) Minority interest in consolidated subsidiaries ............................. -- 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: 32,286 and 25,704 shares issued and outstanding, respectively ......... 32 26 Common stock in treasury, at cost -- 49 and 882 shares, respectively .... (3,251) (19,613) Paid-in capital .......................................................... 499,705 275,955 Retained earnings (accumulated deficit) .................................. (104,209) 12,209 Notes receivable from stockholders ....................................... (9,049) -- Unearned stock-based compensation ........................................ (577) (20,511) Accumulated other comprehensive income (loss) ............................ (77) 1,507 --------- --------- Total stockholders' equity ....................................... 382,574 249,573 --------- --------- $ 447,741 $ 416,421 ========= =========
See accompanying notes to consolidated financial statements. 2 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31, ------------------------------------------- 2000 1999 1998 --------- --------- --------- Revenues: License and maintenance ................................................. $ 166,063 $ 155,948 $ 139,294 Services and other ...................................................... 88,821 60,941 39,314 --------- --------- --------- Total revenues .................................................. 254,884 216,889 178,608 --------- --------- --------- Operating expenses: License and maintenance (including stock-based compensation and Retek spin-off expense totaling $8,744 and $280 in 2000 and 1999, respectively) ............. 60,469 41,552 33,473 Services and other (including stock-based compensation and Retek spin-off expense totaling $9,151 and $354 in 2000 and 1999, respectively) ............................................... 72,913 41,271 28,656 Research and development (including stock-based compensation and Retek spin-off expense totaling $9,937 and $1,121 in 2000 and 1999, respectively) ................................................... 75,490 50,176 32,669 Sales and marketing (including stock-based compensation and Retek spin-off expense totaling $23,509 and $441 in 2000 and 1999, respectively) ................................................... 89,925 46,259 34,515 General and administrative (including stock-based compensation and Retek spin-off expense totaling $18,514 and $9,789 in 2000 and 1999, respectively) ............................................... 53,321 33,777 18,977 Transaction-related amortization and costs .............................. 43,734 9,158 3,202 In-process research and development ..................................... 7,601 1,480 6,090 Other (Note 1) .......................................................... 1,172 -- -- --------- --------- --------- Total operating expenses ........................................ 404,625 223,673 157,582 Operating income (loss) ................................................... (149,741) (6,784) 21,026 Interest income ........................................................... 12,924 6,299 6,799 Interest expense .......................................................... (4,231) (5,747) (4,460) Expense related to debt conversion ........................................ (12,676) -- -- Other expense, net ........................................................ (3,378) (226) (29) Minority interest in losses (income) of consolidated subsidiaries ......... 7,582 722 (126) --------- --------- --------- Income (loss) before income tax provision (benefit) ............. (149,520) (5,736) 23,210 Income tax provision (benefit) ............................................ (33,102) 536 12,758 --------- --------- --------- Net income (loss) ............................................... $(116,418) $ (6,272) $ 10,452 ========= ========= ========= Earnings per share: Basic net income (loss) per share ....................................... $ (4.08) $ (0.25) $ 0.41 ========= ========= ========= Diluted net income (loss) per share ..................................... $ (4.08) $ (0.25) $ 0.39 ========= ========= ========= Shares used in computing basic net income (loss) per share ................ 28,529 24,969 25,362 ========= ========= ========= Shares used in computing diluted net income (loss) per share .............. 28,529 24,969 26,650 ========= ========= =========
See accompanying notes to consolidated financial statements. 3 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, --------------------------------------- 2000 1999 1998 --------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) ................................................. $(116,418) $ (6,272) $ 10,452 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Provision for doubtful accounts ................................. 6,505 5,112 3,172 Depreciation and amortization ................................... 53,045 17,583 10,827 Acquired in-process research and development .................... 7,601 1,480 6,090 Loss (gain) on asset impairments and dispositions ............... 1,172 222 (56) Write-down of marketable security ............................... 2,750 -- -- Non-cash stock-based compensation expense ....................... 15,896 11,985 2,387 Deferred income tax (benefit) expense ........................... (35,384) (4,625) 4,039 Minority interest in (losses) income of consolidated subsidiaries (7,582) (722) 126 Changes in assets and liabilities: Trade accounts receivable ..................................... (40,458) (35,606) (26,111) Deferred income taxes ......................................... (291) 4,645 6,864 Other assets .................................................. (8,753) (4,635) (2,312) Accounts payable and accrued liabilities ...................... 15,954 9,750 4,361 Deferred revenue .............................................. 39,562 5,670 1,024 --------- --------- --------- Net cash provided by (used in) operating activities ........ (66,401) 4,587 20,863 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Net sales (purchases) of marketable securities .................... (18,332) 7,856 (74,120) Cash paid for equity investments .................................. (4,750) (17,225) -- Issuance of employee loans ........................................ (1,500) (200) -- Acquisitions of property and equipment ............................ (25,366) (16,093) (8,086) Cash paid in business acquisitions, net of cash acquired .......... (22,773) (5,098) (8,883) --------- --------- --------- Net cash used in investing activities ...................... (72,721) (30,760) (91,089) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from issuances of HNC common stock ................... 88,298 50,107 10,536 Net proceeds from issuances of Retek common stock ................. 5,635 84,897 -- Repurchase of HNC common stock for treasury ....................... (18,616) (50,383) -- Spin-off of Retek subsidiary ...................................... (30,463) -- -- Proceeds from sales of receivables ................................ 32,585 23,711 -- Proceeds from repayments of stockholder notes ..................... 3,047 -- Net proceeds from issuance of Convertible Subordinated Notes ...... -- -- 96,913 Repayments of notes payable to stockholders ....................... -- -- (770) Repayment of debt and capital lease obligations ................... (7,367) (78) (160) --------- --------- --------- Net cash provided by financing activities .................. 73,119 108,254 106,519 --------- --------- --------- Effect of exchange rate changes on cash ............................. (1,066) (8) (94) --------- --------- --------- Net increase (decrease) in cash and cash equivalents ................ (67,069) 82,073 36,199 Cash and cash equivalents at beginning of the period ................ 136,340 54,267 18,068 --------- --------- --------- Cash and cash equivalents at end of the period ...................... $ 69,271 $ 136,340 $ 54,267 ========= ========= =========
See accompanying notes to consolidated financial statements. 4 CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS) (IN THOUSANDS)
COMMON STOCK TREASURY STOCK EARNINGS ------------------------ ------------------------ PAID-IN (ACCUMULATED SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT) --------- --------- --------- --------- --------- ------------ BALANCE AT DECEMBER 31, 1997 ..... 24,538 $ 25 -- $ -- $ 95,919 $ 8,029 Common stock options exercised ... 748 1 8,602 Common stock issued under Employee Stock Purchase Plan ............ 68 1,933 Tax benefit from stock option transactions ................... 7,569 Compensation related to vested options in Aptex buy-back ...... 3,346 Unearned stock-based compensation expense ........................ Common stock issued for acquisition of PCS ............. 143 5,088 Common stock issued for acquisition of FTI ............. 397 14,725 Unrealized gain on marketable securities, net of tax ......... Foreign currency translation adjustment, net of tax ......... Net income ....................... 10,452 --------- --------- --------- --------- --------- --------- BALANCE AT DECEMBER 31, 1998 ..... 25,894 $ 26 -- $ -- $ 137,182 18,481 --------- --------- --------- --------- --------- --------- Purchase of HNC stock for treasury (2,266) (2) 2,266 (50,381) Common stock options exercised ... 1,916 2 (1,384) 30,768 16,418 Common stock issued under Employee Stock Purchase Plan ............ 115 2,808 Tax benefit from stock option transactions ................... 16,993 Unearned stock-based compensation expense ........................ 21,462 Non-cash stock-based compensation expense ........................ 10,077 Effect of Retek's initial public offering ....................... 69,539 Common stock issued for PCS earn-out ....................... 45 1,476 Unrealized gain on marketable securities, net of tax ......... Foreign currency translation adjustment, net of tax ......... Net loss ......................... (6,272) --------- --------- --------- --------- --------- --------- BALANCE AT DECEMBER 31, 1999 ..... 25,704 $ 26 882 $ (19,613) $ 275,955 $ 12,209 --------- --------- --------- --------- --------- --------- Common stock options exercised ... 3,324 3 (1,026) 32,637 64,340 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 ............ 106 (106) 4,149 (974) Effect of common stock issued under Retek Employee Stock Purchase Plan .................. 3,635 Tax benefit from stock option transactions ................... 36,392 Stock-based compensation expense . 9,217 Retek initial public offering costs .......................... (243) Spin-off of Retek subsidiary ..... (121,571) Common stock issued in business Acquisitions ................... 1,529 1 133,200 Effect of Retek common stock issued in business acquisition . 5,432 Effect of Retek common stock issued in business alliance .... 8,010 Common stock issued upon conversion of Subordinated Notes .......................... 1,872 2 82,319 Common stock issued for PCS earn-out ................... 50 3,993 Interest accrued on stockholder notes .......................... Repayment of stockholder notes .......................... Unrealized loss on marketable securities, net of tax ......... Foreign currency translation adjustment, net of tax ......... Net loss ......................... (116,418) --------- --------- --------- --------- --------- --------- BALANCE AT DECEMBER 31, 2000 ..... 32,286 $ 32 49 $ (3,251) $ 499,705 $(104,209) ========= ========= ========= ========= ========= ========= STOCKHOLDER UNEARNED OTHER TOTAL NOTES STOCK-BASED COMPREHENSIVE STOCKHOLDERS' COMPREHENSIVE RECEIVABLE COMPENSATION INCOME (LOSS) EQUITY INCOME (LOSS) ----------- ------------ ------------- ------------- ------------- BALANCE AT DECEMBER 31, 1997 ..... $ -- $ -- $ (113) $ 103,860 $ 17,457 Common stock options exercised ... 8,603 Common stock issued under Employee Stock Purchase Plan ............ 1,933 Tax benefit from stock option transactions ................... 7,569 Compensation related to vested options in Aptex buy-back ...... 3,346 Unearned stock-based compensation expense ........................ (2,508) (2,508) Common stock issued for acquisition of PCS ............. 5,088 Common stock issued for acquisition of FTI ............. 14,725 Unrealized gain on marketable securities, net of tax ......... 47 47 47 Foreign currency translation adjustment, net of tax ......... (94) (94) (94) Net income ....................... 10,452 10,452 --------- --------- --------- ---------- ========= BALANCE AT DECEMBER 31, 1998 ..... $ -- $ (2,508) $ (160) $ 153,021 $ 10,405 --------- --------- --------- ---------- ========= Purchase of HNC stock for treasury (50,383) Common stock options exercised ... 47,188 Common stock issued under Employee Stock Purchase Plan ............ 2,808 Tax benefit from stock option transactions ................... 16,993 Unearned stock-based compensation expense ........................ (19,911) 1,551 Non-cash stock-based compensation expense ........................ 1,908 11,985 Effect of Retek's initial public offering ....................... 69,539 Common stock issued for PCS earn-out ....................... 1,476 Unrealized gain on marketable securities, net of tax ......... 2,084 2,084 2,084 Foreign currency translation adjustment, net of tax ......... (417) (417) (417) Net loss ......................... (6,272) (6,272) --------- --------- --------- ---------- ========= BALANCE AT DECEMBER 31, 1999 ..... $ -- $ (20,511) $ 1,507 $ 249,573 $ (4,605) --------- --------- --------- ---------- ========= Common stock options exercised ... (11,857) 85,123 Purchase of HNC common stock for treasury ....................... (18,616) Release of FTI escrow shares into treasury ....................... (1,808) Common stock issued under Employee Stock Purchase Plan ............ 3,175 Effect of common stock issued under Retek Employee Stock Purchase Plan .................. 3,635 Tax benefit from stock option transactions ................... 36,392 Stock-based compensation expense . 6,679 15,896 Retek initial public offering costs .......................... (243) Spin-off of Retek subsidiary ..... 13,255 1,594 (106,722) Common stock issued in business Acquisitions ................... 133,201 Effect of Retek common stock issued in business acquisition . 5,432 Effect of Retek common stock issued in business alliance .... 8,010 Common stock issued upon conversion of Subordinated Notes .......................... 82,321 Common stock issued for PCS earn-out ................... 3,993 Interest accrued on stockholder notes .......................... (239) (239) Repayment of stockholder notes .......................... 3,047 3,047 Unrealized loss on marketable securities, net of tax ......... (2,112) (2,112) (2,112) Foreign currency translation adjustment, net of tax ......... (1,066) (1,066) (1,066) Net loss ......................... (116,418) (116,418) --------- --------- --------- ---------- ========= BALANCE AT DECEMBER 31, 2000 ..... $ (9,049) $ (577) $ (77) $ 382,574 $(119,596) ========= ========= ========= ========== =========
5 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 1 -- HNC SOFTWARE INC. AND OUR SIGNIFICANT ACCOUNTING POLICIES HNC Software Inc. We develop, market, and support innovative predictive software solutions for leading service industries. These intelligent decision management solutions employ proprietary neural-network predictive decision engines, profiles, traditional statistical modeling, business models, expert rules and/or context vector technology to convert existing data and business experiences into meaningful recommendations and actions. We currently serve the financial services, insurance, telecommunications and e-business markets. Principles of Consolidation and Basis of Presentation Our consolidated financial statements include our assets, liabilities, and results of operations, as well as those of our wholly-owned subsidiaries and Retek Inc. ("Retek"), which was a majority-owned subsidiary prior to its spin-off in September 2000. The ownership of other interest holders in Retek was reflected as minority interest. All significant inter-company balances and transactions have been eliminated. The preparation of financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Certain prior year amounts have been reclassified to conform to the current year presentation. Revenue Recognition Software revenue is recognized upon meeting all of the following criteria: execution of a written license agreement, contract or purchase order; delivery of software and/or authorization keys; the license fee is fixed and determinable; and collectibility of the proceeds is assessed as being probable. For multiple-element agreements, total fees are allocated to each element based on vendor-specific objective evidence of fair value or using the residual method when applicable. Allocated fees are recognized separately for each element when it is delivered, providing other criteria referenced above are met. Vendor-specific objective evidence is generally based on the price charged when an element is sold separately, or if not yet sold separately, is established by authorized management. For perpetual license and maintenance arrangements, vendor-specific objective evidence for maintenance services is determined based on contractual renewal rates for those services. For term license and maintenance arrangements, vendor-specific objective evidence for maintenance services is also determined based on contractual renewal rates for 6 those services, and license and maintenance fees are unbundled only if the maintenance term and renewal rates are considered to be substantive. Revenue from perpetual and short-term periodic licenses of our software is generally recognized upon delivery. Transactional-based license fees under software license arrangements are recognized as revenue based on system usage or when fees based on system usage exceed monthly minimum license fees. Software maintenance fees are recognized as revenue ratably over the maintenance periods. 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. Contract losses are recorded as a charge to operations in the period any losses are first identified. Unbilled accounts receivable are stated at estimated realizable value. Transactional-based fees under network service or internally hosted software arrangements are recognized as revenue based on system usage or when fees based on system usage exceed monthly minimum license fees. Installation or setup fees associated with network service and internally hosted software agreements are recognized ratably over the longer of the customer contract period or estimated life of the customer relationship. Amounts received under contracts in advance of performance are recorded as deferred revenue and are generally recognized within one year from receipt. Statement of Operations Data Within our statement of operations, components of operating expenditures in 2000 and 1999 include stock-based compensation expense and non-recurring expenses related to our spin-off of Retek that have been classified as follows:
YEAR ENDED DECEMBER 31, ----------------------- 2000 1999 ------- ------- STOCK-BASED COMPENSATION EXPENSE: License and maintenance ................... $ 2,658 $ 280 Services and other ........................ 2,548 354 Research and development .................. 4,167 1,121 Sales and marketing ....................... 10,629 441 General and administrative ................ 1,668 9,789 ------- ------- $21,670 $11,985 ======= ======= EXPENSE RELATED TO SPIN-OFF OF RETEK: License and maintenance ................... $ 6,086 Services and other ........................ 6,603 Research and development .................. 5,770 Sales and marketing ....................... 12,880 General and administrative ................ 16,846 ------- $48,185 =======
7 Cash and Cash Equivalents Cash and cash equivalents include amounts on deposit with financial institutions and investments in money market accounts and commercial paper purchased with maturities of three months or less from the date of purchase. The carrying amounts of cash and cash equivalents approximate fair value because of the short-term maturities of these financial instruments. Marketable Securities Management determines the appropriate classification of our investments in marketable debt and equity securities at the time of purchase, and re-evaluates this designation at each balance sheet date. We have classified all of our marketable securities as "available for sale" and carry them at fair value with unrealized gains or losses related to these securities included in other comprehensive income (loss). Realized gains and losses on the sale of investments available for sale are determined using the specific identification method. Losses resulting from other than temporary declines in fair value are charged to operations. Equity Investments Our investments in equity securities of companies over which we do not have significant influence, are accounted for under the cost method. We use the equity method to account for our investments in entities over which we have a voting interest of 20% to 50%, or over which we otherwise have the ability to exercise significant influence. Under the equity method, the investment is originally recorded at cost and adjusted to recognize our share of net earnings or losses of the investee, limited to the extent of our investment in, advances to, and financial guarantees for the investee. At December 31, 2000, all of our equity investments in other entities were accounted for under the cost method. Sales of Receivables From time to time, we enter into agreements to sell an undivided interest in specifically identified trade accounts receivable. We sell these trade accounts receivable to a financial institution for a fee, based principally upon defined short-term market rates. Once sold, these receivables are not included in our trade accounts receivable balance on our consolidated balance sheet. During 2000 and 1999, we sold $32,585 and $23,711 of receivables, respectively. We did not sell any receivables during 1998. Fees that we paid related to receivables sold totaled $430 and $364 during 2000 and 1999, respectively, and are included in interest expense in our consolidated statement of operations. Property and Equipment Property and equipment are recorded at cost less accumulated depreciation and amortization. Major renewals and improvements are capitalized, while repair and maintenance costs are expensed as incurred. Depreciation and amortization charges are calculated using the straight-line method over the estimated useful lives of the assets ranging from three to seven years. Leasehold improvements are amortized over the shorter of their estimated useful lives or the 8 remaining term of the related lease. Depreciation and amortization expense related to property and equipment totaled $11,753, $8,215, and $6,102 during 2000, 1999, and 1998, respectively. The cost and accumulated depreciation for property and equipment sold, retired or otherwise disposed of are relieved from the accounts, and resulting gains or losses are recorded in operations. Intangible Assets Intangible assets include goodwill, acquired software development costs, customer base, assembled work force, covenants not to compete, and trademarks. These assets resulted from our acquisitions accounted for under the purchase method of accounting (see Note 3). Amortization expense related to intangible assets totaled $42,372, $8,560, and $3,203 during 2000, 1999, and 1998, respectively. We amortize these assets using the straight-line method over their estimated useful lives as follows:
ESTIMATED USEFUL LIFE ------------ Goodwill................................................ 3 to 5 years Software development costs.............................. 3 to 5 years Customer base........................................... 3 to 5 years Assembled work force.................................... 3 to 5 years Covenants not to compete................................ 2 to 3 years Trademarks.............................................. 5 years
We continually review the events and circumstances related to the financial performance and economic environment of the Company for factors that would provide evidence of the impairment of enterprise-level goodwill. If such factors exist, suggesting impairment, we use the market value method to determine the extent of the impairment. Software Development Costs Development costs of software to be licensed or sold that are incurred from the time technological feasibility is established until the product is available for general release to customers are capitalized and reported at the lower of cost or net realizable value. Through December 31, 2000, no significant development costs were incurred after technological feasibility was reached. Internal-Use Software Costs incurred to develop internal-use software during the application development stage are also capitalized and reported at the lower of cost or net realizable value. Application development stage costs generally include costs associated with internal-use software configuration, coding, installation and testing. Costs of significant upgrades and enhancements that result in additional functionality are also capitalized whereas costs incurred for maintenance and minor upgrades and enhancements are expensed as incurred. 9 Long-lived Assets We assess potential impairments to our long-lived and intangible assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. An impairment loss is recognized when the undiscounted cash flows expected to be generated by an asset (or group of assets) is less than its carrying amount. Any required impairment loss would be measured as the amount by which the asset's carrying value exceeds its fair value, and would be recorded as a reduction in the carrying value of the related asset and a charge to operations. During 2000, we recorded an impairment charge of $1,172 related to the abandonment of a lease and associated property and equipment. The impairment charge consisted of the write-off of the remaining net book value of abandoned property and equipment that was deemed to have insignificant remaining value at the time of disposal, as well as charges associated with future facility lease cash obligations, net of estimated sublease income as determined through consultation with an independent lease broker. Estimated lease brokerage fees were also included in this charge. No impairment charges were recorded in 1999 or 1998. Income Taxes Current income tax expense is the amount of income taxes expected to be payable for the current year, prior to the recognition of benefits from stock option deductions. A deferred income tax asset or liability is computed for the expected future impact of differences between the financial reporting and tax bases of assets and liabilities as well as the expected future tax benefit to be derived from tax loss and tax credit carry-forwards. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount "more likely than not" to be realized in future tax returns. Tax rate changes and tax credit reinstatements are reflected in income during the period the changes are enacted. Stock-Based Compensation We measure compensation expense for our employee stock-based compensation awards using the intrinsic value method, and provide pro forma disclosures of net income (loss) and net income (loss) per common share as if a fair value method had been applied. Therefore, compensation cost for employee stock awards is measured as the excess, if any, of the fair value of our common stock at the grant date over the amount an employee must pay to acquire the stock. Compensation expense is amortized over the related service periods using the accelerated methodology prescribed by Financial Accounting Standards Board Interpretation No. 28. Compensation expense for awards that are forfeited is reversed against compensation expense in the period of forfeiture. 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 at which a performance commitment has been obtained or the awards are fully vested. Fair value of stock-based awards is determined using the Black-Scholes option pricing model with weighted average assumptions for dividend yield, risk-free interest rate, expected volatility, and contractual life. 10 Net Income (Loss) Per Common Share Basic net income (loss) per common share is computed as net income (loss) divided by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is computed as net income (loss) divided by the weighted average number of common shares and dilutive potential common shares outstanding during the period, using the treasury stock method. The computation for basic and diluted net income (loss) per share is as follows:
YEAR ENDED DECEMBER 31, ----------------------------------------- 2000 1999 1998 --------- --------- --------- NET INCOME (LOSS) USED: Net income (loss) used in computing basic and diluted net income (loss) per common share ..................................... $(116,418) $ (6,272) $ 10,452 ========= ========= ========= SHARES USED: Weighted average common shares outstanding used in computing basic net income per common share ................................. 28,529 24,969 25,362 Weighted average options to purchase common stock as determined by application of the treasury stock method .............. -- -- 1,227 Additional common shares issued for PCS acquisition earn-out ........ -- -- 23 Employee Stock Purchase Plan common stock equivalents ............... -- -- 38 --------- --------- --------- Shares used in computing diluted net income per common share ........ 28,529 24,969 26,650 ========= ========= =========
The conversion of our 4.75% Convertible Subordinated Notes (see Note 9) outstanding during 2000, 1999 and 1998, into 3,512, 2,230 and 1,834 common shares, respectively, were not included in the computation of diluted net income (loss) per common share, as their effect in such periods would be anti-dilutive. For 2000 and 1999, weighted average options to purchase 2,064 and 6,491 shares of common stock, respectively, and Employee Stock Purchase Plan common stock equivalents of 196 and 56 shares of common stock, respectively, were not included in the computation of diluted net loss per common share as their effect in these periods would be anti-dilutive. Foreign Currency Translation The financial statements of our international operations have been translated into U.S. dollars using period-end exchange rates for assets and liabilities and average exchange rates during the period for revenues and expenses. Cumulative translation gains and losses are excluded from results of operations and recorded as a separate component of other comprehensive income (loss). Gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than our entity's local currency) are recorded in operations. Comprehensive Income (Loss) Comprehensive income (loss) is the change in our equity (net assets) during each period from transactions and other events and circumstances from non-owner sources. It includes net income 11 (loss), foreign currency translation adjustments and unrealized gains and losses, net of tax, on our investments in marketable securities. Concentration of Risk Our financial instruments that potentially expose us to concentrations of risk consist primarily of cash and cash equivalents, marketable securities and accounts receivable, which are generally not collateralized. Our policy is to place our cash, cash equivalents, and marketable securities with high credit quality financial institutions, commercial companies and government agencies in order to limit the amount of credit exposure. We enter into software license and installation agreements and commercial development contracts primarily with large customers in the services industries (financial, insurance and telecommunications). We do not require collateral from our customers, but our credit extension and collection policies include analyzing the financial condition of potential customers, establishing credit limits, monitoring payments, and aggressively pursuing delinquent accounts. We maintain allowances for potential credit losses. Segment Reporting Our operating segments are presented consistently with the way that our management organizes and evaluates financial information for making internal operating decisions and assessing performance. Certain prior year segment information has been reclassified to conform to the current year presentation. Advertising and Promotion Costs Advertising and promotion costs are expensed as incurred. Advertising and promotion costs totaled $8,006, $3,651 and $1,791 in 2000, 1999 and 1998, respectively, and are included in sales and marketing expense 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" ("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 deferred the adoption requirement until the first quarter of 2001. We adopted this new accounting standard effective January 1, 2001. The adoption of FAS 133 in the first quarter of 2001 is not expected to have a significant impact on our consolidated financial position, results of operations or disclosures. In September 2000, the Financial Accounting Standards Board issued Statement of Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("FAS 140"), which replaces Statement of Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of 12 Liabilities." FAS 140 revises the standards for accounting and disclosures for securitizations and other transfers of financial assets and collateral. The primary provisions of this statement are effective for us in the second quarter of 2001. We have not yet determined the impact, if any, that this statement will have on our consolidated financial position or results of operations. 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, Retek sold 6,325 shares of its common stock. Prior to the offering, we transferred to Retek all of the shares of our wholly owned subsidiary, Retek Information Systems, Inc. On August 7, 2000, HNC's board of directors declared a dividend of all of the shares of Retek common stock held by HNC, or 40,000 shares, to complete the spin-off of our Retek subsidiary. We received a private letter ruling from the Internal Revenue Service that HNC's dividend of its shares of Retek common stock would be tax-free to HNC and our stockholders for U.S. federal income tax purposes. This dividend was paid on September 29, 2000 to all HNC stockholders of record as of September 15, 2000 using a distribution ratio of approximately 1.243 shares of Retek common stock for each share of HNC common stock held. Cash was paid in lieu of fractional shares. The shares of Retek common stock that we distributed in the Retek spin-off constituted all the Retek shares owned by HNC and represented approximately 83.9% of Retek's outstanding shares as of the September 29, 2000 distribution date. As a result of our distribution of our Retek common shares, Retek is no longer affiliated with HNC. In connection with this spin-off, we eliminated net assets totaling $121,213 from our consolidated balance sheet, including cash and cash equivalents of $30,463. Additionally, we eliminated the minority interest associated with Retek of $14,491 and net equity totaling $106,722. In connection with the spin-off of our Retek subsidiary, we accelerated the vesting of 25 percent of the outstanding HNC stock options that would have been unvested as of the September 15, 2000 record date in order to afford our option holders the opportunity to participate in receipt of the dividend. Additionally, we offered option holders the opportunity to exercise a portion of their vested options prior to the record date through the issuance of secured, full recourse promissory notes payable to HNC (the "Stockholder Notes"). The Stockholder Notes bear interest at the rate of 10.0% per annum, and are collateralized by the underlying shares of stock. Loans totaling $11,857 were originally extended to option holders. At December 31, 2000, stockholder notes receivable totaled $9,049, net of repayments, and have been recorded as a reduction to stockholders' equity. In connection with the Retek dividend, we also adjusted the exercise price of all HNC stock options that were outstanding immediately following payment of the dividend. The adjusted stock option exercise prices were calculated by multiplying the pre-dividend option exercise price by the price of HNC common stock immediately after payment of the dividend, and dividing that product by the price of HNC common stock immediately before payment of the dividend. The vesting acceleration of HNC stock options and the adjustment to HNC stock option exercise prices that were greater than the closing price of HNC common stock on September 29, 2000 resulted in stock-based compensation charges (see Note 13). 13 Because the adjustment to the exercise price of HNC options described above was less than the change in value of unvested HNC stock options resulting from the Retek distribution, we paid cash bonuses to employees and directors who held unvested stock options as of the record date, and recorded a related charge to operations in the amount of $40,427. These bonuses were paid out in October 2000 and January 2001. NOTE 3 -- ACQUISITIONS In September 2000, we acquired all of the outstanding stock and other securities of Systems/Link Corporation ("Systems/Link") in exchange for the issuance of 634 shares of our common stock, including 40 underlying shares associated with stock options we exchanged, and $5,512 in cash. We placed 142 of the shares issued and $1,275 of the cash portion of the purchase price into escrow, to secure indemnification obligations of the former Systems/Link stockholders. Systems/Link is a software developer that creates data management solutions for large telecommunications companies, providing applications for real-time data collection, call detail record exchange, fraud control and prepaid services to carriers. We applied the purchase method of accounting for the acquisition of Systems/Link, which resulted in a purchase price of $42,549. The excess of this amount over the net liabilities assumed was $56,416, of which $55,686 was allocated to intangible assets, including goodwill, and $730 was allocated to in-process research and development. In September 2000, we acquired all of the outstanding stock and other securities of CardAlert Services, Inc. ("CardAlert") in exchange for the issuance of 208 shares of our common stock. We placed 42 of the shares issued into escrow to secure indemnification obligations of the former CardAlert stockholders. CardAlert provides ATM and debit card risk management services to domestic financial institutions and debit card networks. We applied the purchase method of accounting for the acquisition of CardAlert, which resulted in a purchase price of $12,608. The excess of this amount over the net liabilities assumed was $12,976, of which $12,555 was allocated to intangible assets, including goodwill, and $421 was allocated to in-process research and development. In May 2000, Retek acquired all of the outstanding stock and other securities of HighTouch Technologies, Inc. ("HighTouch") in exchange for the issuance of 389 shares of Retek's common stock and $18,000 in cash. HighTouch is a provider of customized software and services relating to customer relationship management. Retek applied the purchase method of accounting for the acquisition of HighTouch, which resulted in a purchase price of $26,308. The excess of this amount over the net liabilities assumed was $30,558, of which $26,558 was allocated to intangible assets, including goodwill, and $4,000 was allocated to in-process research and development. In April 2000, we acquired all of the outstanding stock and other securities of Celerity Technologies, Inc. ("Celerity") in exchange for the issuance of 220 shares of our common stock and $2,400 in cash. We placed 33 of the shares issued into escrow to secure indemnification obligations of the former Celerity shareholders. Celerity develops and markets electronic data interchange solutions for the workers' compensation industry. We applied the purchase method of accounting for the acquisition of Celerity, which resulted in a purchase price of $18,591. The excess of this amount over the net liabilities assumed was $20,769, of which $19,719 was 14 allocated to intangible assets, including goodwill and $1,050 was allocated to in-process research and development. In March 2000, we acquired all of the outstanding stock and other securities of Onyx Technologies, Inc. ("Onyx") in exchange for the issuance of 382 shares of our common stock, including 30 underlying shares associated with stock options we exchanged, and $1,500 in cash. We placed 105 of the shares issued and $450 of the cash portion of the purchase price into escrow to secure indemnification obligations of the former Onyx shareholders. During September 2000 and March 2001, we released from escrow without claim a total of 70 shares of our common stock and $300 in cash. The remaining 35 shares and $150 in cash are scheduled to be released from escrow in September 2001 and March 2002. Onyx is a provider of online data access and customer acquisition analysis for telecommunications, financial and retail service companies. We applied the purchase method of accounting for the acquisition of Onyx, which resulted in a purchase price of $49,555, of which $3,500 represented our initial 1999 investment in Onyx. The excess of this amount over the net liabilities assumed of $51,163 was allocated to intangible assets, including goodwill. In March 2000, we acquired all of the outstanding stock and other securities of the Center for Adaptive Systems Applications, Inc. ("CASA") in exchange for the issuance of 226 shares of our common stock, including 80 underlying shares associated with stock options we exchanged. CASA is an advanced analytics solutions company that develops and markets account optimization and precision marketing solutions. We placed 38 of the shares issued into 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. The excess of this amount over the net liabilities assumed was $27,260, of which $25,860 was allocated to intangible assets, including goodwill, and $1,400 was allocated to in-process research and development. In March 2000, we acquired all of the outstanding stock and other securities of Adaptive Systems Applications, Inc. ("AIM") in exchange for 9 shares of our common stock, including 0.4 underlying shares associated with stock options we exchanged. AIM provides marketing process automation, campaign execution software, and client-to-vendor data management to direct marketers of enhancement services. We applied the purchase method of accounting for the acquisition of AIM, which resulted in a purchase price of $1,656, of which $750 represents our initial 1999 investment in AIM. The excess of this amount over the net liabilities assumed of $1,785 was allocated to intangible assets, including goodwill. In October 1999, Retek acquired WebTrak Limited ("WebTrak") for a cash payment of $5,333 and the issuance of a $2,667 convertible note, which was subsequently converted into shares of Retek common stock. WebTrak is a United Kingdom company that develops, markets and sells business-to-business products that enable users to publish and share a critical path on the Internet, and allow Web-based collaboration to improve the new product design and development process. The application of the purchase method of accounting for the acquisition resulted in an excess of cost over net liabilities assumed of $8,131, of which $6,651 was allocated to intangible assets, including goodwill, and $1,480 was allocated to in-process research and development. 15 In March 1998, we acquired Practical Control Systems Technologies, Inc. ("PCS"; renamed Retek Logistics, Inc.) in exchange for 143 shares of our common stock, 14 shares of which were placed into escrow to secure indemnification obligations of the former PCS stockholders, plus the contingent right, subject to the achievement of certain financial objectives during 1998 and 1999, to receive additional shares of our common stock. During 1999, the escrow shares were released without claim. Additionally, we issued 45 shares in 1999 and 50 shares in 2000, related to the PCS' achievement of financial objectives during 1998 and 1999, respectively. PCS is a supplier of fully integrated distribution center management software products that address the distribution needs of the retail, wholesale and manufacturing industries. The application of the purchase method of accounting for the acquisition resulted in an excess of cost over net liabilities assumed of $9,530, of which $7,780 was allocated to intangible assets, including initial goodwill and additional goodwill recorded as a result of the contingent shares issued, and $1,750 was allocated to in-process research and development. In April 1998, we acquired Financial Technology Inc. ("FTI"; renamed HNC Financial Solutions, Inc.) in exchange for the issuance of 397 shares of our common stock, 97 of which were placed in escrow to secure indemnification obligations of the former FTI stockholders, and a cash payment of $1,500. FTI develops and markets profitability measurement and decision-support software products and related support services to banks and other similar financial institutions. The application of the purchase method of accounting for the acquisition resulted in an excess of cost over net liabilities assumed of $19,186, of which $16,186 was allocated to intangible assets, including goodwill, and $3,000 was allocated to in-process research and development. In May 2000, we entered into a settlement agreement with the former FTI stockholders pertaining to the release and distribution of the 97 shares of our common stock that were placed into escrow to secure potential indemnification obligations. 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' contractual indemnification obligations to us. In June 1998, we acquired the Advanced Telecommunications Abuse Control System ("ATACS") product line in exchange for $4,750 in cash. ATACS is a fraud-management software solution for wire-line, wireless and Internet telecommunication service providers. The application of the purchase method of accounting for the acquisition resulted in an excess of cost over net liabilities assumed of $4,932, of which $3,592 was allocated to intangible assets, including goodwill, and $1,340 was allocated to in-process research and development. During the fourth quarter of 1998, we acquired the outstanding minority shares of Aptex Software Inc. ("Aptex"). Pursuant to the merger and related transactions, we acquired the outstanding stock held by Aptex employees for $5,321 in cash, and exchanged all outstanding Aptex stock options into options to purchase 380 shares of our common stock. As a result of this merger, we incurred a one-time charge to operations of $2,459 and recorded unearned stock-based compensation of $2,508. The application of the purchase method of accounting to this transaction resulted in an excess of cost over net assets acquired, of which $3,788 was allocated to intangible assets, including goodwill. 16 In-process research and development recorded in connection with the above-mentioned purchase transactions represents the present value of the estimated after-tax cash flows expected to be generated by purchased technologies which, as of the acquisition dates, had not yet reached technological feasibility. The cash flow projections for revenues were based on estimates of relevant market sizes and growth factors, expected industry trends, the anticipated nature and timing of new product introductions, product sales cycles and the estimated life of each product's underlying technology. Estimated operating expenses and income taxes were deducted from estimated revenue projections to arrive at estimated after-tax cash flows. Projected operating expenses include costs of revenues, marketing and selling expenses, general and administrative expenses, and research and development, including estimated costs to maintain the products once they have been introduced into the market and are generating revenue. 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 following table summarizes in the aggregate, for all purchase acquisitions during 2000, 1999 and 1998, the goodwill and identified intangible assets recorded:
YEAR ENDED DECEMBER 31, ------------------------------------ 2000 1999 1998 -------- -------- -------- GOODWILL .................................... $131,499 $ 61 $ 21,770 -------- -------- -------- INTANGIBLE ASSETS: Acquired software development costs ....... 40,834 4,940 6,604 Customer base ............................. 9,938 180 1,197 Assembled Workforce ....................... 6,633 240 866 Other ..................................... 4,422 1,230 909 -------- -------- -------- 61,827 6,590 9,576 -------- -------- -------- TOTAL ....................................... $193,326 $ 6,651 $ 31,346 ======== ======== ========
The unaudited pro forma results of operations below present the impact on our results of operations as if the Systems/Link, CardAlert, HighTouch, Celerity, Onyx, CASA and AIM acquisitions had occurred on January 1, 1999, and as if the WebTrak, PCS, FTI and Aptex acquisitions had occurred on January 1, 1998, instead of on their respective acquisition dates:
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------------------ 2000 1999 1998 --------------------------- ------------------------- ------------------------ PROFORMA PRO FORMA PRO FORMA HISTORICAL COMBINED HISTORICAL COMBINED HISTORICAL COMBINED ---------- ---------- ---------- --------- ---------- --------- (UNAUDITED) (UNAUDITED) (UNAUDITED) Total revenues .......... $ 254,884 $ 270,192 $ 216,889 $ 239,690 $ 178,608 $ 181,048 Total net income (loss) ................ (116,418) (121,344) (6,272) (6,868) 10,452 8,577 Basic net income (loss) per share ..... $ (4.08) $ (4.03) $ (0.25) $ (0.26) $ 0.41 $ 0.34 Diluted net income (loss) per share ...... $ (4.08) $ (4.03) $ (0.25) $ (0.26) $ 0.39 $ 0.32
17 NOTE 4 -- COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
DECEMBER 31, ----------------------- 2000 1999 -------- -------- Trade accounts receivable, net: Billed ...................................................... $ 41,860 $ 56,738 Unbilled .................................................... 5,593 13,890 -------- -------- 47,453 70,628 Less allowance for doubtful accounts and sales returns ........ (3,597) (6,439) -------- -------- $ 43,856 $ 64,189 ======== ========
Unbilled accounts receivable represent revenue recorded in excess of amounts billable pursuant to contract provisions and generally become billable at contractually specified dates or upon the attainment of milestones. Unbilled amounts are expected to be realized within one year. During 2000, 1999, and 1998, we reserved $6,505, $5,112, and $3,172, wrote off $3,661, $1,049, and $3,917 and recovered $104, $0, and $79 of our allowance for doubtful accounts and sales returns. Additionally, in connection with the spin-off of Retek on September 29, 2000, we removed Retek's allowance for doubtful accounts and sales returns of $5,787 from our consolidated balance sheet.
DECEMBER 31, ------------------------- 2000 1999 --------- --------- Property and equipment, net: Computer equipment and software .................... $ 34,389 $ 28,320 Furniture and fixtures ............................. 8,312 11,397 Leasehold improvements ............................. 4,897 3,585 --------- --------- 47,598 43,302 Less accumulated depreciation and amortization ....... (26,772) (21,083) --------- --------- $ 20,826 $ 22,219 ========= ========= Goodwill, net: Goodwill ........................................... 126,053 22,740 Less accumulated amortization ...................... (29,243) (5,460) --------- --------- $ 96,810 $ 17,280 ========= ========= Intangible assets, net: Acquired software development costs ................ 41,538 14,532 Customer base ...................................... 9,935 1,377 Assembled work force ............................... 6,779 1,106 Other .............................................. 4,266 2,234 --------- --------- 62,518 19,249 Less accumulated amortization ...................... (14,996) (7,461) --------- --------- $ 47,522 $ 11,788 ========= ========= Accounts payable and accrued liabilities: Accounts payable ..................................... $ 5,712 $ 9,867 Accrued payroll and related benefits ................. 16,539 12,572 Accrued interest payable ............................. 260 1,583 Accrued external costs related to spin-off ........... 6,913 -- Income taxes payable ................................. 2,662 45 Other ................................................ 6,589 5,982 --------- --------- $ 38,675 $ 30,049 ========= =========
The carrying amounts of accrued liabilities approximate fair value because of the short-term maturities of these financial instruments. 18 NOTE 5 -- MARKETABLE SECURITIES At December 31, 2000 and 1999, the amortized cost and estimated fair value of marketable securities available for sale were as follows:
DECEMBER 31, 2000 ----------------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- ------- U.S. government and federal agencies ............... $59,841 $ 13 $ -- $59,854 U.S. corporate debt .............. 30,765 111 -- 30,876 U.S. corporate equity ............ 250 -- -- 250 Foreign corporate debt ........... 2,500 2 -- 2,502 ------- ------- ------- ------- $93,356 $ 126 -- $93,482 ======= ======= ======= =======
DECEMBER 31, 1999 ----------------------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- -------- U.S. government and federal agencies ............... $ 62,233 $ -- $ (54) $ 62,179 U.S. corporate debt .............. 22,415 -- (109) 22,306 U.S. corporate equity ............ 3,000 3,810 -- 6,810 Foreign corporate debt ........... 6,484 -- (38) 6,446 -------- -------- -------- -------- $ 94,132 $ 3,810 $ (201) $ 97,741 ======== ======== ======== ========
During the fourth quarter of 2000, we assessed the impairment in value of our $3,000 investment in Network Commerce Inc. (See Note 6) to be other than temporary and, accordingly, we wrote this investment down to $250 as of December 31, 2000, representing the aggregate fair value of our investment in this entity based on the closing market price of this publicly traded security on December 31, 2000. As a result of this write-down, we recorded a loss of $2,750 that is included in other expense, net in our statement of operations. As of December 31, 1999, we had recorded an unrealized gain of $3,810 related to our investment in this entity. No significant gains or losses were realized on our investments during 1999 or 1998. At December 31, 2000 and 1999, all foreign corporate debt investments were denominated in U.S. dollars. NOTE 6 -- EQUITY INVESTMENTS In July 2000, we became a limited partner in Azure Capital Partners Venture Fund, a venture capital investment management fund, through an initial investment of $2,250. We have committed to invest an additional $2,750 into this fund during 2001. Our commitment to this fund will not exceed 2% of total fund ownership. This investment is being accounted for using the cost method. In July 2000, we invested $1,000 to purchase an approximate 4% interest in Burning Glass Technologies, LLC, a privately held developer of statistical and predictive technologies for use in the employment marketplace. This investment is being accounted for using the cost method. 19 In March 2000, we invested $1,500 to maintain our approximate 6% ownership interest in Open Solutions Inc. ("OSI"). In April 1999, we had previously invested $6,000 to purchase an approximate 6% interest in OSI. OSI is a developer of client/server core data processing solutions for community banks and credit unions. This investment is being accounted for using the cost method. In October 1999, we invested $3,500 to purchase an approximate 13% interest in Onyx Technologies, Inc. ("Onyx"), a provider of online data access and customer acquisition analysis for telecommunications, financial and retail service companies. In March 2000, we acquired Onyx (see Note 3). In June 1999, we invested $3,000 to purchase an approximate 1% interest in Network Commerce Inc. ("Network Commerce"; formerly ShopNow.com Inc.), an e-commerce company that helps customers and merchants buy and sell merchandise online. In September 1999, Network Commerce became a public company. As a result, we reclassified our investment in Network Commerce in our consolidated balance sheet to a short-term available for sale investment classification (see Note 5). In July 1999, we invested $2,000 to purchase an approximate 16% interest in KeyLime Software Inc., a privately held software company specializing in the development of certain data mining technologies. This investment is accounted for using the cost method. In March 1999, we invested $2,000 to purchase an approximate 3% interest in Qpass Inc., a Web-wide transaction and customer service network enabling commerce in digital goods and services. This investment is accounted for using the cost method. In March 1999, we invested $750 to purchase an approximate 16% interest in AIM Solutions, Inc. ("AIM"), a company that provides marketing process automation, campaign execution software, and client-to-vendor data management to direct marketers of enhancement services. In March 2000, we acquired AIM (see Note 3). NOTE 7 -- CREDIT AGREEMENT We have a Credit Agreement with a bank that provides for a $15,000 revolving line of credit through July 11, 2001. During 2000 and 1999, we had no amounts outstanding under this revolving line of credit. The agreement contains covenants that restrict our ability to pay cash dividends and make loans, advances or investments without the bank's consent. As of December 31, 2000, we were in compliance with all covenants under this agreement. Borrowings under this agreement bear interest at LIBOR plus 0.5%, which is payable monthly. The applicable interest rate was 7.06% at December 31, 2000. 20 NOTE 8 -- OPERATING LEASES At December 31, 2000, we are obligated through 2007 under non-cancelable operating leases for our facilities and equipment as follows:
NET FUTURE FUTURE MINIMUM LESS SUBLEASE MINIMUM LEASE LEASE PAYMENTS INCOME PAYMENTS -------------- ------------- ------------- 2001 .................... $ 7,546 $ (283) $ 7,263 2002 .................... 7,052 -- 7,052 2003 .................... 5,007 -- 5,007 2004 .................... 2,377 -- 2,377 2005 .................... 1,832 -- 1,832 After 2005 .............. 622 -- 622 -------- -------- -------- $ 24,436 $ (283) $ 24,153 ======== ======== ========
Our corporate headquarters lease provides for scheduled rent increases and an option to extend the lease for five years with changes to the terms of the lease agreement and a refurbishment allowance. Rent expense under operating leases totaled $9,075, $6,172 and $3,689 during 2000, 1999, and 1998, respectively, net of sublease income of $555, $1,286, and $1,029, respectively. NOTE 9 -- CONVERTIBLE SUBORDINATED NOTES In March 1998, we completed an offering of $100,000 of 4.75% Convertible Subordinated Notes (the "Notes"), due on March 1, 2003, which we fully and unconditionally guaranteed. The Notes were originally 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 also had 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. This offering resulted in net proceeds to us of $97,000 after the payment of underwriters' commissions but before the deduction of offering expenses. Debt issuance costs were recorded at cost and are being amortized using the straight-line method, which approximates the effective interest-method, over the life of the Notes. During 2000, $83,643 of the Notes were converted into HNC common stock 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). In connection with these note conversions, we issued 1,872 shares of our common stock. Additionally, we paid $12,676 million in conversion premiums to the converting note holders, which we recorded as a debt conversion charge. As of December 31, 2000, $16,357 of the Notes remained outstanding. In connection with the spin-off of our Retek subsidiary, the indenture governing the Notes required an adjustment to the conversion price of the remaining outstanding Notes. This conversion price was based upon a formula that calculated an adjusted conversion rate using the relative per common share values of HNC and Retek as of the date of the spin-off. As a result of this adjustment, the remaining Notes became convertible into our common stock at a conversion rate of 100.20 shares per $1,000 principal amount of the Notes 21 (equivalent to a conversion price of $9.98 per share). As discussed in Note 15, the remaining outstanding Notes were converted into our common stock in March 2001. The fair value of the Notes at December 31, 2000 was estimated to be $48,657, calculated based upon the fair value of the underlying shares of HNC common stock that the Notes were convertible into as of this date based upon the revised conversion rate. Cash amounts paid for interest related to the Notes totaled $4,750, $4,750, and $2,335 during 2000, 1999, and 1998, respectively. NOTE 10 -- TREASURY, COMMON AND PREFERRED STOCK During 2000, we repurchased 250 shares of our outstanding common stock for treasury at a cost of $18,616. During 1999, we repurchased 2,266 shares of our outstanding common stock for treasury at a cost of $50,383. During March 1998, we completed a secondary public offering of 2,100 shares of common stock (of which 2,080 shares were sold by selling stockholders and 20 shares were sold by us) at a price to the public of $34.50 per share, which resulted in net proceeds of $655 after the payment of underwriters' commissions but before the deduction of offering expenses. Our Board of Directors is authorized to issue up to 4,000 shares of preferred stock and to determine the rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The rights of common stockholders will be superceded by the rights of any preferred stock holders, if preferred stock is issued in the future. NOTE 11 -- INCOME TAXES The income tax provision (benefit) is summarized as follows:
YEAR ENDED DECEMBER 31, ---------------------------------------- 2000 1999 1998 -------- -------- -------- CURRENT: Federal ............... $ -- $ 3,869 $ 6,659 State ................. -- 1,042 1,549 Foreign ............... 2,282 250 511 DEFERRED: Federal ............... (33,899) (3,958) 3,218 State ................. (1,485) (694) 715 Foreign ............... 27 106 -------- -------- -------- $(33,102) $ 536 $ 12,758 ======== ======== ========
Income before income tax provision (benefit) was taxed under the following jurisdictions:
YEAR ENDED DECEMBER 31, ------------------------------------------- 2000 1999 1998 --------- --------- --------- Domestic ................ $(154,945) $ (6,521) $ 21,388 Foreign ................. 5,425 785 1,822 --------- --------- --------- $(149,520) $ (5,736) $ 23,210 ========= ========= =========
22 A reconciliation of the income tax provision (benefit) to the amount computed by applying the statutory federal income tax rate to income before income tax provision (benefit) is summarized as follows:
YEAR ENDED DECEMBER 31, ------------------------------------ 2000 1999 1998 -------- -------- -------- Amounts computed at statutory federal rate ....... $(52,332) $ (2,008) $ 8,123 State income taxes, net of federal benefit ....... (965) 226 1,472 Non-deductible debt conversion expense ........... 4,437 -- -- Non-deductible spin-off expense .................. 4,820 -- -- Tax credit carry-forwards generated .............. (1,005) (642) (949) Non-deductible stock redemption compensation expense .......................................... -- 543 835 Non-deductible acquired technology and amortization ..................................... 12,110 1,947 2,895 Minority interest in Retek ....................... (2,654) (253) -- Stock based compensation ......................... 1,910 407 -- Other, net ....................................... 577 316 382 -------- -------- -------- Income tax provision (benefit) ................... $(33,102) $ 536 $ 12,758 ======== ======== ========
During 2000, 1999 and 1998, we realized certain tax benefits related to stock option transactions in the amounts of $36,392, $16,993 and $7,569, respectively. The tax benefits from these stock option tax deductions were credited directly to paid-in capital. Deferred tax assets (liabilities) are summarized as follows:
DECEMBER 31, ---------------------- 2000 1999 -------- -------- Taxable pooling basis difference ........................... $-- $ 14,955 Net operating loss carry-forwards .......................... 54,953 11,257 Tax credit carry-forwards .................................. 5,713 6,251 Allowance for doubtful accounts ............................ 1,431 2,506 Deferred tax liabilities related to purchase accounting ... (18,159) -- Stock based compensation ................................... 741 4,106 Other ...................................................... 4,210 (606) -------- -------- 48,889 38,469 Deferred tax asset valuation allowance ..................... -- -- -------- -------- Net deferred tax assets .......................... $ 48,889 $ 38,469 ======== ========
No valuation allowance has been recorded against our net deferred tax assets as we believe it to be more likely than not that our tax assets will be realized. At December 31, 2000, we had federal and state net operating loss carry-forwards totaling $143,187 and $84,189, respectively. The federal net operating loss carry-forwards include $4,772 that expires in 2011, $24,618 that expires in 2019 and $113,797 that expires in 2020. The state net operating loss carry-forwards expire from 2002 through 2010. 23 At December 31, 2000, we also had $2,391 of federal research and development credit carry-forwards that expire from 2001 to 2020, $1,643 of state research and development credit carry-forwards that have no expiration dates, $1,525 of foreign tax credit carry-forwards that expire from 2000 to 2005, and federal and state alternative minimum tax credits of $150 and $4, respectively, that have no expiration dates. These net operating loss and research and development credit carry-forwards are subject to annual limitations and also are limited to utilization solely by the segment that generated them. Should a substantial change in our ownership occur, as defined by the Tax Reform Act of 1986, there will be additional annual limitations on our utilization of net operating loss and research and development credit carry-forwards. We paid $484, $6,312 and $1,151 of income taxes during 2000, 1999 and 1998, respectively. NOTE 12 -- SEGMENT INFORMATION In April 2001, we announced and began to implement a reorganization that involved realigning our internal organization from a vertical market orientation to a horizontal product platform. As a result, our reportable segments were changed to reflect the new method in which management primarily organizes and evaluates internal financial information to make operating decisions and assess performance, based upon the product suites of our Critical Action Technology Platform (formerly our Customer Insight platform). The following segment information for the years ended December 31, 2000 and 1999 has been revised to conform to our current segment presentation. Segment information for the year ended December 31, 1998 has not been presented as it is impracticable to conform that year's segment information to the current segment presentation. Segment information on a vertical market orientation is also presented for comparative purposes. Our Critical Action Technology Platform consists of our Efficiency, Risk and Opportunity Suites. Our Efficiency Suite enables companies to make instant, automated decisions regarding customer applications for loans, credit or services, including the ability to identify and determine customer creditworthiness. This allows companies to simultaneously reduce costs and increase the speed of the customer acquisition process. In addition, it allows companies to process large quantities of applications and claims in real time through multiple acquisition and delivery channels. Our Risk Suite enables companies to analyze the risks associated with acquiring, managing and retaining customers by analyzing patterns in customer transactions, and includes analysis of fraud, churn and bad debt. Our Opportunity Suite enables companies to analyze the opportunities associated with acquiring, managing and retaining customers by analyzing patterns in customer transactions. The Opportunity Suite can maximize customer profitability by providing cross-sell and up-sell activities and focusing marketing efforts on more profitable customers. Additionally, as presented herein, our "Other" segment category includes our Advanced Technology Solutions group, which primarily conducts research and development for the United States government and other internally funded projects, as well as other miscellaneous products. Retek, which we spun-off to stockholders effective September 29, 2000, is also presented separately below. 24 The accounting policies of our operating segments are the same as those described in Note 1. We evaluate the performance of our segments and allocate resources to them based on segment revenue and segment contribution margin. The Company does not have any inter-segment sales. Under our new internal organization and reporting structure, we do not allocate or report our assets by operating segment. Accordingly, segment asset information is not presented. Segment revenues and segment contribution margins for the years ended December 31, 2000 and 1999 are as follows:
YEARS ENDED DECEMBER 31, ------------------------ 2000 1999 --------- --------- EFFICIENCY SUITE Total revenues ................................... 102,953 72,187 Direct segment operating expenses (1) ............ (64,842) (50,623) --------- --------- Segment contribution margin ...................... $ 38,111 $ 21,564 ========= ========= RISK SUITE Total revenues ................................... 68,426 55,773 Direct segment operating expenses (1) ............ (18,251) (15,047) --------- --------- Segment contribution margin ...................... $ 50,175 $ 40,726 ========= ========= OPPORTUNITY SUITE Total revenues ................................... 14,682 9,987 Direct segment operating expenses (1) ............ (12,062) (5,745) --------- --------- Segment contribution margin ...................... $ 2,620 $ 4,242 ========= ========= OTHER Total revenues ................................... 8,908 9,783 Direct segment operating expenses (1) ............ (7,671) (6,791) --------- --------- Segment contribution margin ...................... $ 1,237 $ 2,992 ========= ========= TOTAL SEGMENT CONTRIBUTION MARGIN ................ $ 92,143 $ 69,524 ========= ========= Reconciliation to operating loss: Total segment contribution margin ................ $ 92,143 $ 69,524 Indirect operating expenses (2) .................. (82,677) (51,367) Retek operating loss, excluding non-cash and non-recurring charges included below (3) .... (36,845) (2,318) Stock-based compensation expense ................. (21,670) (11,985) Transaction-related amortization and costs ....... (43,734) (9,158) In-process research and development .............. (7,601) (1,480) Expense related to spin-off of Retek ............. (48,185) -- Other operating expenses ......................... (1,172) -- --------- --------- Total operating loss ............................. $(149,741) $ (6,784) Interest income .................................. 12,924 6,299 Interest expense ................................. (4,231) (5,747) Expense related to debt conversion ............... (12,676) -- Other expense, net ............................... (3,378) (226) Minority interest in losses of consolidated Subsidiaries .................................... 7,582 722 --------- --------- Loss before income taxes ......................... $(149,520) $ (5,736) ========= =========
- -------------------------------------------------------------------------------- (1) Direct segment operating expenses include direct costs such as direct labor costs related to product research and development, sales, and marketing activities, direct support and installation costs, and other product-specific costs of sales. Direct costs reflect only direct controllable expenses associated with each segment's line of business. 25 (2) Indirect operating expenses consist of costs not directly attributable to a segment, such as general and administrative expenses, corporate marketing expenses, depreciation and amortization, facilities expenses, information technology overhead costs, and other indirect, non-product specific costs. (3) Includes Retek revenues of $59,915 and $69,159 for the years ended December 31, 2000 and 1999, respectively. Reported segment revenues and Retek revenues represent the Company's total revenues as displayed in the Company's consolidated statement of operations. During 2000, 1999 and 1998, one product line in the Risk Suite segment accounted for 16.8%, 15.4% and 14.5% of our total revenues, respectively. During those same periods, revenues from one product in the Efficiency Suite segment accounted for 23.5%, 20.9% and 21.5% of our total revenues, respectively. During 1999 and 1998, one Retek product accounted for 10.1% and 13.2% of our total revenues, respectively. Revenue and long-lived assets by geographical area are summarized as follows:
YEAR ENDED DECEMBER 31, ---------------------------------- 2000 1999 1998 -------- -------- -------- Revenue by geographical area: United States ...................... $205,361 $166,505 $137,332 Foreign ............................ 49,523 50,384 41,276 -------- -------- -------- Total revenue ............... $254,884 $216,889 $178,608 ======== ======== ========
DECEMBER 31, --------------------- 2000 1999 -------- -------- Long-lived assets by geographical area: United States ................................ $168,963 $ 54,174 Foreign ...................................... 159 145 -------- -------- Total long-lived assets ............... $169,122 $ 54,319 ======== ========
Our foreign revenues are from export sales and international operations. Export sales include sales from the United States to foreign countries. International operations include sales by foreign operations. Revenues from international operations and export sales, primarily to Western Europe, Japan and Canada, represented 19.3%, 23.2% and 23.1% of total revenues in 2000, 1999 and 1998, respectively. Export sales totaled $42,540, $37,713 and $27,840 in 2000, 1999 and 1998, respectively. PRIOR YEAR SEGMENT PRESENTATION Prior to April 2001, our reportable segments were based upon our method of internal reporting to management, who viewed our business for these periods by vertical market. Excluding Retek, our primary operating segments included HNC Financial Solutions ("HNC FS"), HNC Insurance Solutions ("HNC IS") and HNC Telecommunications Solutions ("HNC TS"). HNC FS provided transaction-based, real-time fraud detection, authorization and action decisions for applications such as credit card charge authorization and the loan approval decision 26 process. Our HNC FS segment also included the activities associated with our former eHNC division, the activities of which we reintegrated into FS in July 2000. HNC IS provided 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. HNC TS provided our telecommunications carrier customers with the ability to reduce fraud losses and determine customer profitability. HNC TS is presented below along with activities associated with our Advanced Technology Solutions group, which primarily conducted research and development for the United States government, as well as corporate activity. Retek, which we spun-off to stockholders effective September 29, 2000, is also presented separately below. The accounting policies of our operating segments are the same as those described in Note 1. We evaluated the performance of our segments and allocated resources to them based on operating income. Inter-segment sales were accounted for at fair value as if the sales were to third parties. Each segment represented a strategic business unit that offered unique products and services to their functional markets. The table below presents segment data for certain statement of operations and balance sheet line items as of and for the years ended December 31, 2000, 1999 and 1998. Segment revenues are summarized as follows:
YEAR ENDED DECEMBER 31, ---------------------------------- 2000 1999 1998 -------- -------- -------- Segment revenue: HNC FS .............................. $ 95,668 $ 73,641 $ 63,244 HNC IS .............................. 81,382 66,790 52,140 HNC TS and other .................... 17,919 7,299 6,555 -------- -------- -------- HNC, excluding Retek ............. 194,969 147,730 121,939 Retek .............................. 59,915 69,159 56,669 -------- -------- -------- Total consolidated revenue ...... $254,884 $216,889 $178,608 ======== ======== ========
During 2000, 1999 and 1998, one product line in the HNC FS segment accounted for 16.8%, 15.4% and 14.5% of our total revenues, respectively. During those same periods, revenues from one product in the HNC IS segment accounted for 23.5%, 20.9% and 21.5% of our total revenues, respectively. During 1999 and 1998, one product in the Retek segment accounted for 10.1% and 13.2% of our total revenues, respectively. Segment operating income (loss), excluding all non-cash and non-recurring charges that we do not allocate between segments, is summarized as follows: 27
YEAR ENDED DECEMBER 31, ------------------------------------ 2000 1999 1998 -------- -------- -------- Segment operating income (loss): HNC FS .............................. $ 603 $ 9,935 $ 10,936 HNC IS .............................. 10,572 13,390 7,651 HNC TS and other .................... (1,709) (5,168) 700 -------- -------- -------- HNC, excluding Retek ............. 9,466 18,157 19,287 Retek ............................... (36,845) (2,318) 11,031 -------- -------- -------- Total operating income (loss) .... $(27,379) $ 15,839 $ 30,318 ======== ======== ========
A reconciliation of the operating income (loss) reported by each of our segments to our consolidated operating income (loss) is set forth below:
YEAR ENDED DECEMBER 31, --------------------------------------- 2000 1999 1998 --------- --------- --------- Segment operating income (loss) .................. $ (27,379) $ 15,839 $ 30,318 Stock-based compensation ......................... (21,670) (11,985) -- Transaction-related costs and amortization ....... (43,734) (9,158) (3,202) Expense related to spin-off of Retek ............. (48,185) -- -- Acquired in-process research and development ..... (7,601) (1,480) (6,090) Other ............................................ (1,172) -- -- --------- --------- --------- Consolidated operating income (loss) .......... (149,741) (6,784) 21,026 Interest income .................................. 12,924 6,299 6,799 Interest expense ................................. (4,231) (5,747) (4,460) Expense related to debt conversion ............... (12,676) -- -- Other expense, net ............................... (3,378) (226) (29) Minority interest in losses (income) of consolidated Subsidiaries .................................. 7,582 722 (126) --------- --------- --------- Income (loss) before income tax provision ........ $(149,520) $ (5,736) $ 23,210 ========= ========= =========
Segment depreciation expense, included in operating income, is summarized as follows: 28
YEAR ENDED DECEMBER 31, ------------------------------- 2000 1999 1998 ------- ------- ------- Segment depreciation expense: HNC FS ........................................ $ 4,533 $ 2,971 $ 2,921 HNC IS ........................................ 2,510 2,134 1,564 HNC TS and other .............................. 1,122 801 355 ------- ------- ------- HNC, excluding Retek ....................... 8,165 5,906 4,840 Retek ......................................... 3,588 2,309 1,262 ------- ------- ------- Total segment depreciation expense ......... $11,753 $ 8,215 $ 6,102 ======= ======= =======
Segment assets are summarized as follows:
DECEMBER 31, ------------------------ 2000 1999 --------- --------- Total segment assets: HNC FS ........................................ $ 96,553 $ 49,492 HNC IS ........................................ 60,106 40,491 HNC TS and other .............................. 67,003 5,872 --------- --------- HNC, excluding Retek ....................... 223,662 95,855 Retek ......................................... -- 129,099 --------- --------- Total segment assets ....................... 223,662 224,954 Corporate .................................... 295,762 291,098 Eliminations ................................. (71,683) (99,631) --------- --------- Total consolidated assets ................. $ 447,741 $ 416,421 ========= =========
Corporate assets are primarily comprised of cash and cash equivalents, marketable securities, deferred tax assets and inter-company receivables. Eliminations primarily relate to inter-company balances and investments in subsidiaries. Segment capital expenditures are summarized as follows:
YEAR ENDED DECEMBER 31, ------------------------------- 2000 1999 1998 ------- ------- ------- Segment capital expenditures: HNC FS .............................. $ 7,053 $ 4,455 $ 2,909 HNC IS .............................. 2,252 4,336 1,831 HNC TS and other .................... 3,991 1,565 407 ------- ------- ------- HNC, excluding Retek ............. 13,296 10,356 5,147 Retek ............................... 12,070 5,737 2,939 ------- ------- ------- Total capital expenditures ....... $25,366 $16,093 $ 8,086 ======= ======= =======
NOTE 13 -- STOCK COMPENSATION PLANS We apply Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for our stock-based compensation. Had compensation cost for our stock-based compensation awards been determined based on the fair value at the grant dates of awards, consistent with the method of Financial Accounting Standards Board Statement No. 123, our net 29 income (loss) and basic and diluted pro forma net income (loss) per common share would have been reduced to the pro forma amounts indicated below:
YEAR ENDED DECEMBER 31, -------------------------------------- 2000 1999 1998 ---------- --------- --------- Net income (loss): As reported ............................. $(116,418) $ (6,272) $ 10,452 Pro forma ............................... $(230,171) $(43,583) $(21,678) Basic net income (loss) per common share: As reported ............................. $ (4.08) $ (0.25) $ 0.41 Pro forma ............................... $ (8.07) $ (1.75) $ (0.84) Diluted net income (loss) per common share: As reported ............................. $ (4.08) $ (0.25) $ 0.39 Pro forma ............................... $ (8.07) $ (1.75) $ (0.85)
HNC Software Inc. Sponsored Plans We administer several employee benefit plans, both active and inactive. Our active plans include our 1995 Equity Incentive Plan, our 1995 Directors Stock Option Plan, our 1995 Employee Stock Purchase Plan, and our 1998 Stock Option Plan. Our inactive plans include our original 1987 Stock Option Plan and various plans that we acquired in conjunction with our acquisitions. Our inactive plans also include the eHNC 1999 Equity Incentive and Executive Equity Incentive Plans. As a result of a short-form merger of eHNC into HNC in July 2000, all outstanding options under eHNC plans were assumed. These assumed plans were amended to convert their respective options into HNC options as of the respective acquisition or merger dates. While subsequent to the assumption of these plans the acquired employees participated in our own stock option plans and are subject to our plans' terms and conditions, options issued prior to the acquisition or merger dates are subject to their respective plan terms and conditions. Our inactive plans are not discussed herein. For purposes of the discussion regarding our active plans below, "fair market value" means the closing price of our common stock on the Nasdaq National Market on the grant date. Our 1995 Directors Stock Option Plan ("Directors Plan"), as amended, provides for the issuance of up to 600 nonqualified stock options to our outside directors. Under the provisions of the Directors Plan, nonqualified options to purchase 25 shares of our common stock are granted to outside directors upon their respective dates of becoming members of the Board of Directors, and nonqualified options to purchase ten shares of our stock will be granted on each anniversary date. Options under the Directors Plan are to be granted at the fair market value of the stock at the grant date and vest at specific times over a four-year period. As of December 31, 2000, 255 shares remained available for future grant under this plan. Our 1995 Equity Incentive Plan ("Incentive Plan") as amended, provides for the issuance of up to 9,100 shares of our common stock in the form of nonqualified or incentive stock options, restricted stock or stock bonuses. Nonqualified stock options and restricted stock may be awarded at a price not less than 85% of the fair market value of the stock at the date of the award. Incentive stock options must be awarded at a price not less than 100% of the fair market value of the stock at the date of the award. Options granted under the Incentive Plan may have a 30 term of up to ten years. We have the discretion to provide for restrictions, and the lapse of restrictions, in respect of restricted stock awards. Options typically vest at the rate of 25% of the total grant per year over a four-year period; however, we may, at our discretion, implement a different vesting schedule with respect to any new stock option grant. At December 31, 2000, 1,172 shares remained available for future grant under this plan. Our 1998 Stock Option Plan ("1998 Plan"), as amended, provides for the issuance of up to 2,980 shares of our common stock in the form of nonqualified stock options to our employees, officers, consultants and independent advisors. Options granted under the 1998 Plan may have a term of up to ten years and typically vest at the rate of 25% of the total grant per year over a four-year period; however, we may, at our discretion, implement a different vesting schedule with respect to any new stock option grant. At December 31, 2000, 1,148 shares remained available for future grant under this plan. Our 1995 Employee Stock Purchase Plan ("Stock Purchase Plan"), as amended, provides for the issuance of a maximum of 850 shares of common stock. Each purchase period, eligible employees may designate between 2% and 10% of their cash compensation, up to legally permitted amounts, to be deducted from their compensation for the purchase of common stock under the Stock Purchase Plan. The purchase price of the shares under the Stock Purchase Plan is equal to 85% of the lesser of the fair market value per share on the first day of the twelve-month offering period or the last day of each six-month purchase period. During 2000, 1999 and 1998, 106, 115 and 68 shares of our common stock were issued under the Stock Purchase Plan at an average price of $29.55, $24.46 and $28.34 per share, respectively. As of December 31, 2000, 416 shares were reserved for future issuance under the Stock Purchase Plan. 31 Option transactions under HNC's plans during the three years ending December 31, 2000 are summarized as follows:
WEIGHTED AVERAGE EXERCISE SHARES PRICE ------ -------- Outstanding at December 31, 1997 ................. 4,591 $23.92 Options granted/exchanged ...................... 3,333 34.59 Options exercised .............................. (732) 12.12 Options canceled ............................... (718) 32.04 ------ ------ Outstanding at December 31, 1998 ................. 6,474 29.84 Options granted ................................ 3,845 33.67 Options exercised .............................. (1,916) 24.68 Options canceled ............................... (2,368) 32.11 ------ ------ Outstanding at December 31, 1999 ................. 6,035 33.03 Options granted/exchanged ...................... 3,747 69.84 Options exercised .............................. (3,227) 29.76 Options canceled ............................... (1,249) 47.57 ------ ------ Outstanding at September 29, 2000 (a) ............ 5,306 57.60 Options granted ................................ 1,559 17.46 Options exercised .............................. (98) 12.44 Options canceled ............................... (848) 10.92 ------ ------ Outstanding at December 31, 2000 ................. 5,919 12.88 ====== ======
(a) On September 29, 2000, in connection with the spin-off of Retek, we adjusted the exercise price of all outstanding stock options in accordance with the distribution ratio discussed in Note 2. The weighted average exercise price of options outstanding at September 29, 2000 after consummation of the spin-off was $11.21. The fair value of each option grant under our HNC plans was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for grants during 2000, 1999 and 1998, respectively: dividend yield of 0.0% for all three years; risk-free interest rates of 6.21%, 5.47% and 5.14%; expected volatilities of 100%, 100% and 65%; and expected lives of 4.1, 4.1 and 5.0 years. The weighted average fair value of options granted under HNC plans during 2000, 1999 and 1998 was $37.61, $23.15 and $22.17, respectively. The fair value of the employees' purchase rights issued pursuant to the Stock Purchase Plan were estimated using the Black-Scholes option pricing model with the following weighted average assumptions during 2000, 1999 and 1998, respectively: dividend yield of 0.0% for all three years; risk-free interest rates of 6.18%, 4.98% and 5.02%; expected volatilities of 100%, 100% and 65%; and an expected life of 6 months for all three years. The weighted average fair value of those purchase rights granted in 2000, 1999 and 1998 was $7.29, $16.66 and $16.25, respectively. 32 The following table summarizes information about employee stock options outstanding at December 31, 2000 under HNC's plans:
OPTIONS OUTSTANDING ----------------------------------------- OPTIONS EXERCISABLE WEIGHTED ------------------------- NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE EXERCISE PRICES 2000 LIFE (IN YEARS) PRICE 2000 PRICE - -------------------- -------------- --------------- -------- -------------- --------- $ 0.03 to $6.23 814 7.73 $5.23 126 $5.21 6.24 7.46 733 7.23 6.92 100 6.97 7.47 10.42 758 6.58 8.58 96 8.32 10.43 13.22 618 6.73 11.24 130 10.99 13.23 16.25 1,036 6.85 15.13 109 14.40 16.33 18.10 858 6.22 17.41 195 17.39 18.11 20.25 599 6.43 19.05 94 19.38 20.36 29.69 503 6.60 22.71 50 22.00 ----- ----- 0.03 29.69 5,919 6.81 12.88 900 12.73 ===== =====
Retek Inc. Sponsored Plans During 1999, Retek adopted the 1999 Equity Incentive Plan, the 1999 Director Stock Option Plan and the Employee Stock Option Exchange Program, under which options to purchase common stock in our former subsidiary Retek had been granted. During 1999, Retek also adopted the 1999 Employee Stock Purchase Plan, which provides for the issuance of Retek's common stock to eligible employee participants at a purchase price equal to 85% of the lesser of the fair market value per share on the first day of the two-year offering period and the date of purchase. As a result of our September 2000 spin-off of Retek, HNC is no longer affiliated with any Retek stock compensation plans. During the period from January 1, 2000 through the Retek spin-off date of September 29, 2000, 464 shares of Retek common stock were issued under Retek's employee stock purchase plan at an average price of $12.75 per share. No shares were issued under this plan during 1999. Option activity under Retek's option plans during 1999 and during the period from January 1, 2000 through the spin-off date, is summarized as follows:
WEIGHTED AVERAGE EXERCISE SHARES PRICE ------ -------- Outstanding at December 31, 1998 ................. -- -- Options granted ................................ 7,416 10.38 Options canceled ............................... (5) 10.00 ------ ----- Outstanding at December 31, 1999 ................. 7,411 10.38 Options granted ................................ 1,496 27.82 Options canceled ............................... (247) 19.93 ------ ----- Outstanding at September 29, 2000 (a) ............ 8,660 13.06 ====== =====
(a) As a result of the Retek spin-off, HNC has no further affiliation with Retek's plans or underlying options, including those outstanding as of the September 29, 2000 spin-off date. 33 The fair value of each option granted under Retek's plans was estimated on the date of grant using the Black-Scholes option pricing model and the following weighted average assumptions used for grants during the period from January 1, 2000 through the September 29, 2000 spin-off date and during 1999, respectively: dividend yield of 0.0% for both years; risk-free interest rates of 5.12% and 5.47%; expected volatility of 130% and 100%; and expected lives of 4.4 and 4.1 years. The weighted average fair value of options granted under Retek plans during the period from January 1, 2000 through September 29, 2000, and during 1999, was $24.49 and $7.62, respectively. The fair value of the employees' purchase rights issued pursuant to Retek's stock purchase plan in 2000 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 5.50%; expected volatility of 130%; and an expected life of 6 months. The weighted average fair value of those purchase rights granted was $8.33. Stock-Based Compensation During 2000, we recorded net stock-based compensation expense totaling $21,670, consisting of $13,762 in stock-based compensation charges attributable to our Retek spin-off, which are discussed separately below, and $7,908 in additional net compensation expense. This additional net compensation expense relates primarily to the amortization of unearned stock-based compensation of $8,772 (of which $8,266 related to Retek) and also includes additional net compensation income of $864, primarily related to the reversal of compensation expense recorded in 1999 on variable awards, as a result of a decline in the fair values of these awards during 2000. During 1999, Retek granted stock options to employees and directors to purchase Retek common stock at an exercise price of $10.00 per share when the deemed fair market value of Retek's common stock was $13.00 per share. As a result, Retek recorded unearned stock-based compensation totaling $21,886 representing the aggregate intrinsic value of the options on the date of grant. Additionally, during 2000, Retek recorded additional unearned stock-based compensation totaling $1,750 related to an employee option grant having an exercise price below the fair value of Retek's common stock on the date of grant. Amortization of Retek's unearned stock-based compensation totaled $1,908 during 1999 and $8,266 during the period from January 1, 2000 through the Retek spin-off date of September 29, 2000. Retek's unearned stock-based compensation balance of $13,255 at September 29, 2000, net of forfeiture reductions, was removed from our consolidated equity accounts in connection with the Retek spin-off. During 1999, in addition to Retek's amortization of unearned stock-based compensation as described above, we recorded stock-based compensation expense totaling $10,077. This compensation expense relates primarily to stock awards granted to former employees and non-employee consultants, of which $7,972 was calculated at intrinsic value while the remainder related to variable awards measured at fair value. The intrinsic value charge consisted primarily of a one-time charge of $6,064 related to a key employee severance agreement executed in the fourth quarter of 1999. The fair values of HNC's variable awards during 2000 and 1999 were estimated using the Black-Scholes option pricing model with the following weighted average assumptions: dividend 34 yield of 0.0% for both years; risk-free interest rate of 5.02% and 5.23% in 2000 and 1999, respectively; volatility of 100% for both years; and expected lives from four months to one year according to the vesting date and subsequent exercise period of each option grant, and our stock prices on the various grant dates as well as on December 31, 2000 and 1999. In August 2000, we accelerated the vesting of 25 percent of the outstanding stock options that would have been unvested as of the September 15, 2000 record date to afford our option holders the opportunity to participate in receipt of the Retek share dividend. As a result of this award modification, we recorded a non-cash stock-based compensation charge of $6,688 during the third quarter of 2000 in accordance with Financial Accounting Standards Board Interpretation No. 44, or FIN 44. Additionally, as a result of the proportionate option repricing in connection with the Retek spin-off, certain options failed to qualify for fixed accounting treatment under FIN 44. As a result, we recorded a one-time charge to operations of $7,074 related to the modification and cash repurchase of options in connection with the Retek spin-off. NOTE 14 -- CONTINGENCIES Various claims arising in the course of business, seeking monetary damages and other relief, are pending. We believe that these claims will not result in a material negative impact on our results of operations, liquidity or financial condition. However, the amount of the liability associated with these claims, if any, cannot be determined with certainty. We recently settled, without liability, a suit that Nestor Inc. filed against us in November 1998 in the United States District Court for the District of Rhode Island. In this suit, Nestor had alleged antitrust violations and unfair competition claims with respect to our marketing of our Falcon credit card fraud detection product. Nestor's complaint also alleged that we infringed United States patents held by Nestor and sought a declaratory judgment that a United States patent we hold relating to technology used in our Falcon products is invalid and unenforceable. In January 2000 Nestor dropped its claim of patent infringement against us and in January 2001 the case settled and Nestor's remaining claims for antitrust and unfair competition were dismissed. NOTE 15 -- SUBSEQUENT EVENT In February 2001, we announced the call for redemption of our outstanding Convertible Subordinated Notes on March 6, 2001. In March 2001, all remaining outstanding Notes were converted into 1,639 shares of our common stock at a conversion ratio of 100.2004 shares per $1,000 principal amount of Notes held. 35 NOTE 16 -- QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Summarized quarterly financial information for 2000 and 1999 is as follows:
YEAR ENDED DECEMBER 31, 2000(1)(2) --------------------------------------------------------------------- FIRST SECOND THIRD FOURTH TOTAL QUARTER QUARTER QUARTER QUARTER YEAR --------- --------- --------- --------- --------- (IN THOUSANDS) Revenues ......................................... $ 54,564 $ 67,432 $ 77,812 $ 55,076 $ 254,884 Gross Profit ..................................... 26,896 35,349 43,543 33,609 139,397 Operating loss ................................... (20,992) (30,462) (85,363) (12,924) (149,741) Net loss ......................................... (12,215) (20,145) (78,519) (5,539) (116,418) Basic net income (loss) per share (a) ............ $ (0.47) $ (0.75) $ (2.71) $ (0.17) $ (4.08) Diluted net income (loss) per share (a) ......... $ (0.47) $ (0.75) $ (2.71) $ (0.17) $ (4.08)
YEAR ENDED DECEMBER 31, 1999(3) ------------------------------------------------------------------ FIRST SECOND THIRD FOURTH TOTAL QUARTER QUARTER QUARTER QUARTER YEAR --------- --------- --------- --------- --------- (IN THOUSANDS) Revenues ......................................... $ 49,189 $ 55,933 $ 58,773 $ 52,994 $ 216,889 Gross Profit ..................................... 29,815 35,484 38,697 30,704 134,700 Operating Income (loss) .......................... 3,685 5,994 7,599 (24,062) (6,784) Net Income (loss) ................................ 2,124 3,345 3,331 (15,072) (6,272) Basic net income (loss) per share(4) ............. $ 0.08 $ 0.14 $ 0.14 $ (0.60) $ (0.25) Diluted net income (loss) per share (4) .......... $ 0.08 $ 0.13 $ 0.13 $ (0.60) $ (0.25)
(1) Results of operations in 2000 include: i) charges of $1.4 million, $5.0 million and $1.2 million related to the write-off of in-process research and development in the first, second and third quarters, respectively; ii) $12.7 million in non-recurring debt conversion expense and $48.2 million in non-recurring Retek spin-off charges in the third quarter, and iii) a $2.8 million charge relating to the write-down of our investment in Network Commerce and a $1.2 million impairment charge related to the abandonment of a lease and associated property and equipment in the fourth quarter. (2) Results of operations in 2000 exclude Retek's results of operations in the fourth quarter, as a result of our spin-off of Retek on September 29, 2000. (3) Results of operations in 1999 include a charge of $1.5 million related to the write-off of in-process research and development in the fourth quarter. (4) Net income (loss) per share is computed independently for each of the quarters presented. Therefore, the sum of the quarterly net income (loss) amounts per share do not equal the total for the year. 36 EX-99.04 7 a79278ex99-04.txt EXHIBIT 99.04 EXHIBIT 99.04 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS FOR THE QUARTERS ENDED MARCH 31, 2001 AND 2000 OVERVIEW In April 2001, we announced and began to implement a reorganization that involved realigning our internal organization from a vertical market orientation to a horizontal product platform. As a result, we changed our reportable segments beginning in the second quarter of 2001 to reflect the new method in which management primarily organizes and evaluates internal financial information to make operating decisions and assess performance. Our current reportable segments include our Efficiency, Risk and Opportunity product suites. The following discussion and analysis of our results of operations for the quarters ended March 31, 2001 and 2000 has been restated to conform to our current segment presentation. These reclassifications have no impact our consolidated results of operations for these periods, as originally reported on our Form 10-Q for the quarter ended March 31, 2001. Our revenues and operating results have varied significantly in the past and in some quarters we have experienced net losses. We expect fluctuations in our operating results to continue for the foreseeable future. As a result, we believe that investors should not rely on period-to-period comparisons of our financial results as an indication of our future performance. Further, we derive a substantial portion of our revenues from our CompAdvisor and Falcon products. Our CompAdvisor and Falcon products in the aggregate accounted for 40.3% of our total revenues in 2000. CompAdvisor accounted for 23.5% of total revenues in 2000 and Falcon accounted for 16.8% of total revenues in 2000. We expect these products will continue to account for a substantial portion of our total revenues for the foreseeable future. Our revenue will decline if the market does not continue to accept these products. 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. In addition, in the past we have acquired several companies and may continue to do so in the future. Further, in September 2000, we completed the spin-off of our former Retek subsidiary. Such transactions typically affect the comparability of our historical financial results. Acquisitions also typically generate significant continuing charges that decrease our net income, often for many fiscal periods. 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 would likely be harmed. Statements in this exhibit contain forward-looking information about our anticipated future operating expenses, our expectations for our international operations and about the assumptions and projections underlying our in-process research and development expense. Forward-looking statements are subject to risks and uncertainties. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, including, but not limited to, the following: - The timing of execution of large contracts; - The loss of any key customer; - Variations in the amount of recurring revenues; - The deferral, reduction or cancellation of customer orders or purchases; - The timing of our new product announcements and introductions and those of our competitors; - Delays in the release of final commercial versions of our products; - Changes in the mix of our distribution channels; - The amount and timing of our costs and operating expenses; - Our ability to fulfill our obligations under percentage-of-completion contracts; - Our success in completing pilot installations within contracted fee budgets; - Changes in our product offerings; - Competitive conditions in the industries we serve; - Economic conditions in our targeted markets; - Domestic and international economic conditions; - Changes in prevailing technologies; - Expenses and charges related to our acquisition of other businesses; and - Our ability under generally accepted accounting principles to recognize revenues in the quarter in which we expect to recognize those revenues. You should carefully consider these risks. Investors are cautioned not to place undue reliance on these forward-looking statements that speak only as of the date of this report. We undertake no obligation to revise or update any forward-looking statements for any reason. RESULTS OF OPERATIONS REVENUES Our revenues are comprised of license and maintenance revenues and services and other revenues. Our revenues for the first quarter of 2001, which excluded Retek, were $54.0 million. Revenues for the first quarter of 2000, which included Retek, were $54.6 million. 2 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 perpetual and short-term periodic licenses of our software is generally recognized upon delivery. Transactional fees under software license arrangements are recognized as revenue based on system usage or when fees based on system usage exceed the monthly minimum license fees. Software maintenance fees are recognized as revenue ratably over the maintenance periods. Transactional fees under network service or internal hosted software arrangements are recognized as revenue based on system usage or when fees based on system usage exceed the monthly minimum license fees. Amounts received under contracts in advance of delivery or performance are recorded as deferred revenue and are generally recognized within one year from receipt. License and maintenance revenues were $39.5 million for the first quarter of 2001, an increase of 24.1% over $31.8 million for the first quarter of 2000. Excluding Retek, whose license and maintenance revenues in the first quarter of 2000 totaled $6.4 million, HNC's license and maintenance revenues for the first quarter of 2001 increased by $14.1 million, or 55.6%, over the first quarter of 2000. Within HNC, the $14.1 million increase in license and maintenance revenues was attributable primarily to a $5.9 million increase in our Efficiency segment, a $5.0 million increase in our Risk segment and a $3.5 million increase in our Opportunity segment. The increase within our Efficiency segment was attributable primarily to increased revenues derived through the sale of our 4SCORE and RoamEx products, resulting from our acquisitions of Onyx and Systems/Link in the prior year, and to increased Connectivity revenues resulting from our acquisition of Celerity in the prior year, partially offset by a decline in CompAdvisor product revenues. The increase in our Risk segment was attributable primarily to increased revenues associated with our Falcon product and additional network revenues resulting from our acquisition of CardAlert, partially offset by a decline in MIRA product revenues. The increase within our Opportunity segment was attributable primarily to increased revenues associated with our ProfitMax products. SERVICES AND OTHER REVENUES Services and other revenues are comprised of installation and implementation revenues, remote hosted service operation 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 recognized as services are performed, which is generally within one year from receipt. Contract losses are recorded as a charge to operations in the period any losses are first identified. Installation or setup fees associated with network service and internally hosted software agreements are recognized ratably over the longer of the customer contract period or estimated life of the customer relationship. Remote hosted service fees derived from the review and repricing of customers' medical bills are recognized as revenue when the processing services are performed. 3 Services and other revenues were $14.5 million for the first quarter of 2001, a decrease of 36.3% as compared to $22.8 million for the first quarter of 2000. Excluding Retek, whose services and other revenues in the first quarter of 2000 totaled $7.5 million, HNC's services and other revenues for the first quarter of 2001 decreased by $0.7 million, or 4.8%, as compared to the first quarter of 2000. Within HNC, the $0.7 million decrease in services and other revenues was attributable primarily to a $2.2 million decline in our Efficiency segment, offset by a $1.4 million increase in our Opportunity segment. The decline in our Efficiency segment was attributable primarily to decreased revenues associated with Capstone implementations and to a decline in customer bill review volumes associated with our remote hosted service operations. The increase in our Opportunity segment was attributable primarily to an increase in Marketing Optimization revenues, resulting primarily from our acquisition of CASA in the prior year. COST OF REVENUES LICENSE AND MAINTENANCE COST OF REVENUES License and maintenance costs primarily represent our expenses for personnel engaged in customer support, travel to customer sites and documentation materials. Our license and maintenance cost of revenues are summarized as follows, both in absolute dollar amounts and as a percentage of license and maintenance revenues:
QUARTER ENDED MARCH 31, ------------------------------------------- 2001 2000 ------------------ ------------------ (IN THOUSANDS) LICENSE AND MAINTENANCE COST OF REVENUES HNC operating segments ............................ $11,451 29.0% $ 8,631 34.0% Retek operating segment ........................... -- -- 3,989 62.0% ------- ---- ------- ---- 11,451 29.0% 12,620 39.7% Stock-based compensation expense not allocated to segments ..................................... 7 0.0% 126 0.4% ------- ---- ------- ---- HNC Consolidated ................................ $11,458 29.0% $12,746 40.1% ======= ==== ======= ====
Our license and maintenance cost of revenues percentage in the first quarter of 2001 decreased by 11.1% as compared to the first quarter of 2000. This decrease was attributable primarily to a 5.0% decline within HNC, coupled with the absence of Retek in the first quarter of 2001, whose license and maintenance cost of revenues percentage was 62.0% in the first quarter of 2000. The decrease in HNC's license and maintenance cost of revenues percentage was attributable primarily to an increase in Falcon and ProfitMax revenues, having lower associated costs, and to increased revenues associated with lower-cost 4SCORE, RoamEx and Connectivity products, resulting from our prior year acquisitions of Onyx, Systems/Link and Celerity, respectively, offset in part by increased customers support costs associated with our CompAdvisor products. SERVICES AND OTHER COST OF REVENUES Services and other expenses consist of personnel and other expenses associated with providing installation and implementation services and performing development, consulting, and research development contracts, and the costs associated with hosted service operations. Our services and 4 other cost of revenues are summarized as follows, both in absolute dollars and as a percentage of services and other revenues:
QUARTER ENDED MARCH 31, ------------------------------------------- 2001 2000 ------------------ ------------------ (IN THOUSANDS) SERVICES AND OTHER COST OF REVENUES HNC operating segments .................. $10,286 70.9% $ 9,360 61.4% Retek operating segment ................. -- -- 5,688 75.5% ------- ---- ------- ---- 10,286 70.9% 15,048 66.1% Stock-based compensation expense not allocated to segments ................. -- -- 394 1.7% ------- ---- ------- ---- HNC Consolidated ...................... $10,286 70.9% $15,442 67.8% ======= ==== ======= ====
Our services and other cost of revenues percentage in the first quarter of 2001 increased by 3.1% as compared to the first quarter of 2000. This increase was attributable primarily to a 9.5% increase within HNC, offset by the absence of Retek in the first quarter of 2001, whose services and other cost of revenues percentage was 75.5% in the first quarter of 2000. The increase in HNC's cost of revenues percentage was attributable primarily to the decline in Capstone implementation revenues, which have lower associated costs, increased costs associated with Spyder contract development work performed during the first quarter of 2001 and to reduced cost efficiencies associated with the decline in remote hosted service operations bill review volumes, partially offset by an increase in lower cost Marketing Optimization development revenues. 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. Research and development expense totaled $10.9 million in the first quarter of 2001 and $17.4 million in the first quarter of 2000. Excluding Retek, whose research and development expense totaled $9.3 million in the first quarter of 2000 (including $1.3 million in stock-based compensation charges), HNC's research and development expense increased by $2.7 million, or 33.8%, from $8.1 million in the first quarter of 2000 to $10.9 million in the first quarter of 2001. The absolute dollar increase within HNC was attributable primarily to net increases in staffing and related costs to support new product development activities, including those resulting from acquisitions in 2000. 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, trade shows and promotional expenses. Sales and marketing expense totaled $10.6 million in the first quarter of 2001 and $17.2 million in the first quarter of 2000. Excluding Retek, whose sales and marketing expense totaled $9.2 million in the first quarter of 2000 (including $0.6 million in stock-based compensation charges), HNC's sales and marketing expense increased by $2.7 million, or 34.2%, from $7.9 million in the first quarter of 2000 to 5 $10.6 million in the first quarter of 2001. The absolute dollar increase within HNC was attributable primarily to increases in staffing related to the expansion of direct sales and marketing staff, including that resulting from our acquisitions in 2000. Also contributing to the increase were additional expenses associated with advertising and trade shows and other expenses to support our 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 international markets and expand our domestic sales and marketing organization and increase the breadth of our product lines. 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 insurance and professional services expenses. General and administrative expenses totaled $7.2 million in the first quarter of 2001 and $7.4 million in the first quarter of 2000. Excluding Retek, whose general and administrative expense totaled $2.6 million in the first quarter of 2000 (including $0.2 million in stock-based compensation charges), HNC's general and administrative expense increased by $2.4 million, or 49.2%, from $4.8 million in the first quarter of 2000 to $7.2 million in the first quarter of 2001. This increase included $0.8 million in additional HNC net stock-based compensation charges as compared to the first quarter of 2000 (for a further discussion regarding stock-based compensation charges, refer to the section entitled "Stock-Based Compensation Expense" appearing below). Excluding stock-based compensation charges, the absolute dollar increase at HNC are attributable primarily to additional staffing and related expenses to support a higher volume of business, including that resulting from our acquisitions in 2000. TRANSACTION-RELATED AMORTIZATION AND COSTS Transaction-related amortization and costs primarily include acquisition-related amortization during the first quarters of 2001 and 2000. Transaction-related amortization and costs increased from $4.0 million in the first quarter of 2000 to $13.7 million in the first quarter of 2001. This increase is attributable primarily to incremental intangible asset amortization charges as a result of our business acquisitions during 2000. The average amortization period and useful life for these intangible assets is approximately 3.5 years. IN-PROCESS RESEARCH AND DEVELOPMENT EXPENSE In-process research and development expense was $1.4 million in the first quarter of 2000, related to a one-time charge recorded in connection with our acquisition of CASA. No such charges were recorded during the first quarter of 2001, as we did not consummate any acquisitions in this quarter. INTEREST INCOME Interest income totaled $2.6 million in the first quarter of 2001 and $3.5 million in the first quarter of 2000. The quarter over quarter decline in interest income is attributable primarily to 6 lower average cash and investment balances during the first quarter of 2001 as compared to the first quarter of 2000. INTEREST EXPENSE Interest expense totaled $0.1 million in the first quarter of 2001 and $1.2 million in the first quarter of 2000. The majority of our interest expense during each of these periods relates to our convertible subordinated notes. The decline in interest expense in the first quarter of 2001 as compared to the first quarter of 2000 is attributable primarily to the conversion of $83.6 million of our convertible subordinated notes into common stock during the third quarter of 2000, and to a lesser degree the conversion of the remaining $16.4 million of such notes in the first quarter of 2001, whereas the outstanding convertible note balance during the full first quarter of 2000 was $100.0 million. INCOME TAXES The provision (benefit) for income taxes was $8.2 million for the first quarter of 2001 and $(4.4) million for the first quarter of 2000. The provision for the first quarter of 2001, as compared to the benefit for the first quarter of 2000, is attributable primarily to the significant increase in non-deductible acquisition-related amortization expense in the first quarter of 2001, resulting from our acquisitions during 2000. The provision (benefit) for income taxes is based on our estimates of the effective tax rates for the respective full fiscal years. STOCK-BASED COMPENSATION EXPENSE Within our statement of operations, stock-based compensation charges (income) have been classified as follows for the first quarters in 2001 and 2000:
QUARTERS ENDED MARCH 31, ------------------------ 2001 2000 ------- ------- (IN THOUSANDS) License and maintenance ........ $ 7 $ 126 Services and other ............. -- 394 Research and development ....... 36 1,205 Sales and marketing ............ 15 581 General and administrative ..... 128 (389) ------- ------- $ 186 $ 1,917 ======= =======
Stock-based compensation expense recorded during the first quarter of 2001 totaled $186. This expense included a one-time charge associated with an employee option award modification, along with the amortization of unearned stock-based compensation during the quarter. Net stock-based compensation expense for the first quarter in 2000 totaled $1,917. This net compensation expense included $2,630 related to Retek's amortization of unearned stock-based compensation, offset by net compensation income related to stock-based awards of $713 at HNC. The net compensation income at HNC related primarily to the reversal of compensation expense recorded in 1999 on variable awards, as a result of a decline in the fair values of these awards during the first quarter of 2000, offset by the amortization of unearned stock-based compensation during the quarter. 7 SEGMENT CONTRIBUTION MARGIN (LOSS) The following section summarizes the primary reasons for fluctuations in segment contribution margin, conforming to segment data for the quarters ended March 31, 2001 and 2000 as reported in Exhibit No. 99.05 to this Report on Form 8-K: Segment contribution margin for our Efficiency segment increased from $7.5 million for the quarter ended March 31, 2000 to $12.1 million for the quarter ended March 31, 2001, and as a percentage of segment revenues increased from 33.6% to 45.5%. The absolute dollar increase was attributable primarily to increased segment revenues, as previously discussed herein, as direct segment operating expenses remained relatively flat. The segment contribution margin percentage increase was attributable primarily to increased sales of higher margin products acquired, including RoamEx, 4SCORE and Connectivity products, and the decline in Capstone implementation revenues, which have lower associated direct segment costs, partially offset by increased customer support costs associated with our CompAdvisor products and reduced cost efficiencies associated with the decline in remote hosted service operations bill review volumes. Segment contribution margin for our Risk segment increased from $10.0 million for the quarter ended March 31, 2000 to $12.8 million for the quarter ended March 31, 2001, and as a percentage of segment revenues decreased from 70.5% to 69.0%. The absolute dollar increase was attributable to increased segment revenues, as previously discussed herein, offset by an increase in direct segment operating expenses. The segment contribution margin percentage decrease was attributable primarily to increased Spyder contract development work, which has relatively higher associated direct segment costs, as well as increased research and development spending on Risk segment products. Segment contribution margin for our Opportunity segment increased from $0.6 million for the quarter ended March 31, 2000 to $4.3 million for the quarter ended March 31, 2001, and as a percentage of segment revenues increased from 21.6% to 55.9%. The absolute dollar increase was attributable to increased segment revenues, as previously discussed herein, offset by an increase in direct segment operating expenses. The segment contribution margin percentage increase was attributable primarily to increased ProfitMax and Marketing Optimization revenues, which had lower associated direct segment costs. The increase in higher segment contribution margin Marketing Optimization revenues resulted primarily from the acquisition of CASA in March 2000. Direct segment losses for our Other segment decreased from $1.1 million for the quarter ended March 31, 2000 to $0.7 million for the quarter ended March 31, 2001, and as a percentage of segment revenues decreased from negative 81.9% to negative 64.0%. The absolute dollar decline was attributable to a slight decline in segment revenues offset by a decline in direct segment operating expenses. The decrease in direct segment operating expenses and loss percentage was attributable primarily to reductions in direct segment costs related to Intelligent Response products. 8 EX-99.05 8 a79278ex99-05.txt EXHIBIT 99.05 EXHIBIT 99.05 SEGMENT DATA FOR THE QUARTERS ENDED MARCH 31, 2001 AND 2000 In April 2001, we announced and began to implement a reorganization that involved realigning our internal organization from a vertical market orientation to a horizontal product platform. As a result, our reportable segments were changed to reflect the new method in which management primarily organizes and evaluates internal financial information to make operating decisions and assess performance, based upon the product suites of our Critical Action Technology Platform (formerly our Customer Insight platform). The following segment information for the quarters ended March 31, 2001 and 2000 has been revised as supplemental information to conform to our current segment presentation. Our Critical Action Technology Platform includes our Efficiency, Risk and Opportunity product suites. Additionally, as presented herein, our "Other" segment category includes our Advanced Technology Solutions group, which primarily conducts research and development for the United States government and other internally funded projects, as well as other miscellaneous products. Retek, which we spun-off to stockholders effective September 29, 2000, is also presented separately below. The accounting policies of our operating segments are the same as those described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2000. We do not identify or allocate our assets by operating segment. Accordingly, segment asset information is not disclosed. Segment revenues and segment contribution margins for the periods indicated are as follows (unaudited):
QUARTERS ENDED MARCH 31, ----------------------- 2001 2000 -------- -------- (IN THOUSANDS) EFFICIENCY SUITE Total revenues ................................... 26,558 22,230 Direct segment operating expenses(1) ............. (14,488) (14,754) -------- -------- Segment contribution margin ...................... $ 12,070 $ 7,476 ======== ======== RISK SUITE Total revenues ................................... 18,555 14,152 Direct segment operating expenses(1) ............. (5,749) (4,169) -------- -------- Segment contribution margin ...................... $ 12,806 $ 9,983 ======== ======== OPPORTUNITY SUITE Total revenues ................................... 7,720 2,838 Direct segment operating expenses(1) ............. (3,408) (2,225) -------- -------- Segment contribution margin ...................... $ 4,312 $ 613 ======== ======== OTHER Total revenues ................................... 1,137 1,380 Direct segment operating expenses(1) ............. (1,864) (2,510) -------- -------- Segment contribution margin ...................... $ (727) $ (1,130) ======== ======== TOTAL SEGMENT CONTRIBUTION MARGIN ................ $ 28,461 $ 16,942 ======== ======== Reconciliation to operating loss: Total segment contribution margin ................ $ 28,461 $ 16,942 Indirect operating expenses(2) ................... (24,771) (15,935) Retek operating loss, excluding non-cash and non-recurring charges included below ........ -- (14,695) Stock-based compensation expense ................. (186) (1,917) Transaction-related amortization and costs ....... (13,690) (3,965) In-process research and development .............. -- (1,422) -------- -------- TOTAL OPERATING LOSS ............................. $(10,186) $(20,992) ======== ========
- ---------- (1) Direct segment operating expenses include direct costs such as direct labor costs related to product research and development, sales, and marketing activities, direct support and installation costs, and other product-specific costs of sales. Direct costs reflect only direct controllable expenses associated with each segment's line of business. (2) Indirect operating expenses consist of costs not directly attributable to a segment, such as general and administrative expenses, corporate marketing expenses, depreciation and amortization, facilities expenses, information technology overhead costs, and other indirect, non-product specific costs. 2 EX-99.06 9 a79278ex99-06.txt EXHIBIT 99.06 EXHIBIT 99.06 HNC REPORTS FOURTH QUARTER AND FISCAL 2001 RESULTS DILUTED OPERATIONAL NET INCOME PER SHARE FOR FISCAL 2001 INCREASES BY 25% OVER FISCAL 2000 SAN DIEGO, JANUARY 23, 2002 -- HNC Software Inc. (Nasdaq: HNCS) announced today its financial results for the fourth quarter and fiscal year ended December 31, 2001. On September 29, 2000, HNC distributed to its stockholders all of its shares of its former subsidiary, Retek Inc. Accordingly, unlike its fiscal year ended December 31, 2000, HNC's financial results for its fiscal year ended December 31, 2001, do not include or reflect Retek's operations. HNC PRO FORMA RESULTS Revenues for the fourth quarter of 2001 were $54.6 million. Revenues for fiscal 2001 were $226.7 million, representing an increase of 16 percent over revenues of $195.0 million excluding Retek for fiscal 2000. Diluted operational net income per share for the fourth quarter of 2001 was $0.07 (see footnotes 4 and 5 on the following table entitled, "Selected Pro Forma Financial Data, Excluding Retek"). Diluted operational net income per share for fiscal 2001 was $0.45, representing an increase of 25 percent over diluted operational net income per share for fiscal 2000 excluding Retek of $0.36 (see footnotes 6, 7, 8 and 9 on the following table entitled, "Selected Pro Forma Financial Data, Excluding Retek"). HNC ACTUAL CONSOLIDATED RESULTS HNC Reports Fourth Quarter 2001 Results/page 2 Revenues for the fourth quarter of 2001 were $54.6 million. Revenues for fiscal 2001 were $226.7 million. Diluted net loss for the fourth quarter of 2001 was $8.0 million, or $0.23 per share. Diluted net loss for fiscal 2001 was $36.5 million, or $1.06 per share. "HNC's fourth quarter illustrated a continued slowdown in IT spending both in the US and overseas. Despite this pullback, we saw strong and steady business from our existing base of blue-chip customers. Additionally, we are fortunate to have a flexible business model that allows businesses to opt for payment on either a "pay-as-you-go" or a one time "up-front" model. In these tight economic times, many of our customers have appreciated the ability to forego large up-front fees and have chosen the pay-as-you-go or recurring option," said John Mutch, chief executive officer, HNC Software. "In the fourth quarter of 2001, we continued to make steady progress developing the Critical Action Technology Platform, which we believe will be the type of business analytics foundation companies will be looking for when IT spending increases." HNC will host a live Webcast conference call regarding fourth quarter 2001 operating results on Wednesday, January 23, 2002, at 2 p.m. Pacific Daylight Time. All are welcome to join the Webcast, which can be accessed through the Investor Relations section of HNC's Web site: www.hnc.com. During the conference call HNC executives will review several topics including, but not limited to, HNC's fourth quarter of 2001 and fiscal year 2001 operating results, and its growth strategy and vision, acquisition strategy, product roadmap and recent product introductions. HNC also expects the call to discuss global market expansion and market penetration, industry trends, and financial business model and future revenue and earnings guidance. A recording of the Webcast will be available for 10 days after the event on HNC's Web site: www.hnc.com. ABOUT HNC SOFTWARE INC. HNC is a leading provider of high-end analytic and decision management software that enables global companies to manage customer interactions by converting data and customer transactions into real time recommendations. HNC's proven software empowers Global 2000 HNC Reports Fourth Quarter 2001 Results/page 3 companies in the financial services, insurance, telecommunications and other industries to make millions of the right mission-critical customer decisions designed to increase revenues and decrease risk. For more information, visit www.hnc.com. This press release contains forward-looking statements about HNC's business model, technology platform and other events and circumstances that have not yet occurred. Forward-looking statements may be identified by words such as "will," "expects," "believes," "anticipates" or "plans" or other statements indicating a future tense. Investors should be aware that actual results may differ materially from HNC's expectations in forward-looking statements, due to numerous risks and uncertainties about the future. HNC will not necessarily update the information in this press release or in its conference call if any forward-looking statement later turns out to be inaccurate. Risks and uncertainties that may affect HNC's future results and performance and lead to fluctuations in its financial results and revenue compared to expectations include, but are not limited to, the following: timing of contract acceptances by customers changes of recurring fee based agreements to one time fixed fee-based agreements; changes in the percentage of HNC's revenues that are paid on a recurring transaction fee basis the status of HNC's relationships with its customers, particularly larger customers; developments in the financial services, insurance and telecommunications industries, including consolidation and trends in IT spending; the financial, accounting and business affects of HNC's acquisitions of other companies, business, or assets; HNC's success in integrating companies, businesses and assets it has acquired or may in the future acquire and in managing potentially increased expenses arising from acquisitions; intense competition and pricing pressures, particularly in the software market; HNC's ability to maintain or increase its profit margins; the impact of the current economic environment on the willingness of HNC's customers' to make capital purchases or licenses; HNC's ability to correctly anticipate market trends and customers' needs and develop and implement successful strategies that are responsive to these trends and needs; HNC's ability to maintain high reliability for its server-based Web services; HNC's ability to maintain successful business relationships with strategic partners and other third parties that are important to HNC's success; HNC's ability to adapt and expand its product, service and content offerings for the Internet and other environments; the costs of implementing HNC's strategy; changes in its product lines and product strategies; uncertainty as to the timing and availability for future products and services; future market growth and upgrade rates for HNC's software products; the impact of government regulatory actions on HNC's ability to sell and implement its products; HNC's ability to leverage its existing customer base to cross-sell complementary products and sell customers multiple products; the retention and motivation of HNC's employees; and results for HNC's international operations. Additional information about factors that could affect future results and events is included in the reports that HNC files with the Securities and Exchange Commission, including its annual report on Form 10-K for its fiscal year ended December 31, 2000. HNC Reports Fourth Quarter 2001 Results/page 4 SELECTED FINANCIAL DATA
QUARTERS ENDED FISCAL YEARS ENDED DECEMBER 31, DECEMBER 31, -------------------------- -------------------------- 2000 2001 2000 2001 --------- --------- --------- --------- Revenues $ 55,076 $ 54,551 $ 254,884 $ 226,670 Operating loss $ (12,827) $ (12,101) $(149,741) $ (42,523) Basic and diluted net loss per share $ (0.17) $ (0.23) $ (4.08) $ (1.06)
SELECTED PRO FORMA FINANCIAL DATA, EXCLUDING RETEK (1) (UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE DATA) The following table sets forth selected financial data for the Company on a pro forma basis, excluding Retek. Please see footnotes (1) through (9) to this information for reconciliations between pro forma and GAAP bases for the information presented.
QUARTERS ENDED FISCAL YEAR ENDED DECEMBER 31, DECEMBER 31, ---------------------------- ----------------------------- 2000 2001 2000 2001 ---------- ---------- ---------- ----------- Revenues $55,076 $54,551 $194,969 $226,670 Operating income, before non-cash and non-recurring charges $ 3,966(2) $ 2,696(4) $ 9,187(6) $ 19,638(8) Diluted operational net income per share $ 0.12(3) $ 0.07(5) $ 0.36(7) $ 0.45(9)
(1) On September 29, 2000, HNC spun off its former subsidiary Retek Inc. to HNC's stockholders by means of a dividend of all shares of Retek owned by HNC. Thus, Retek's operating results were included in HNC's financial results through September 29, 2000, but were not included in HNC's financial results for the quarter and fiscal year ended December 31, 2001. For purposes of comparability, the above pro forma financial data for the fiscal year ended December 31, 2000 illustrates the financial results of HNC (subject to the computations and exclusions explained below), excluding Retek's financial results for such periods. (2) Computed by excluding $283 of stock-based compensation charges, $13,627 of transaction-related amortization and costs, $1,711 of Retek spin-off charges and $1,172 of restructuring and impairment charges. (3) Based on: (a) diluted operational net income of $4,178, computed as operating income before non-cash and non-recurring charges of $3,966 plus other net income of $2,719, fully taxed at a 37.5 percent tax rate, divided by (b) weighted average shares of 36,130, computed as 32,228 shares used in computing diluted net loss per share plus 3,902 shares associated with weighted average options, ESPP shares and convertible subordinated notes, assuming conversion. (4) Computed by excluding $58 of stock-based compensation charges and $14,739 of transaction-related amortization and costs. (5) Based on: (a) diluted operational net income of $3,078, computed as operating income before non-cash and non-recurring charges of $2,696 plus other net income of $2,229, fully taxed at a 37.5 percent tax rate, divided by (b) weighted average shares of 41,961, computed as 35,370 shares used in computing diluted net income per share plus 6,591 shares associated with weighted average options, ESPP shares and convertible subordinated notes, assuming conversion. (6) Computed by excluding $13,154 of stock-based compensation charges, $38,697 of transaction-related amortization and costs, $3,601 of in-process research and development charges, $48,185 of Retek spin-off charges and $1,172 of restructuring and impairment charges. (7) Based on: (a) diluted operational net income of $12,199, computed as operating income before non-cash and non-recurring charges of $9,187 plus other net income of $10,331, fully taxed at a 37.5 percent tax rate, divided by (b) weighted average shares of 33,610, computed as 28,529 shares used in computing diluted net income per share plus 5,081 shares associated with weighted average options, ESPP shares and convertible subordinated notes, assuming conversion. (8) Computed by excluding $476 of stock-based compensation charges, $56,556 of transaction-related amortization and costs, $487 of in-process research and development charges and $4,642 of restructuring and impairment charges. (9) Based on: (a) diluted operational net income of $17,188, computed as operating income before non-cash and non-recurring charges of $19,638 plus other net income of $7,863, fully taxed at a 37.5 percent tax rate, divided by (b) weighted average shares of 38,582, computed as 34,509 shares used in computing diluted net loss per share plus 4,073 shares associated with weighted average options, ESPP shares and convertible subordinated notes, assuming conversion. HNC Reports Fourth Quarter 2001 Results/page 5 HNC SOFTWARE INC. CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT PER SHARE DATA)
DECEMBER 31, DECEMBER 31 2001 2000 ----------- ----------- ASSETS Current assets: Cash, cash equivalents and marketable securities available for sale $ 217,910 $ 114,300 Accounts receivable, net 38,969 43,856 Deferred income taxes 22,279 15,045 Other current assets 10,656 8,402 --------- --------- Total current assets 289,814 181,603 Marketable securities available for sale 95,815 48,453 Equity investments 9,219 14,719 Property and equipment, net 23,785 20,826 Goodwill, net 75,720 96,810 Intangible assets, net 42,942 47,522 Deferred income taxes 34,761 33,844 Other assets 5,970 3,964 --------- --------- Total assets $ 578,026 $ 447,741 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities $ 29,716 $ 38,675 Deferred revenue 8,807 9,876 --------- --------- Total current liabilities 38,523 48,551 Other liabilities $ 1,684 $ 259 Convertible Subordinated Notes 150,000 16,357 --------- --------- Total liabilities 190,207 65,167 --------- --------- 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; 35,432 and 32,286 shares issued and outstanding, respectively 35 32 Common stock in treasury at cost -- 49 and 49 shares, respectively (3,251) (3,251) Paid-in capital 531,666 499,705 Accumulated deficit (140,660) (104,209) Notes receivable from stockholders - (9,049) Unearned stock-based compensation (238) (577) Accumulated other comprehensive income (loss) 267 (77) --------- --------- Total stockholders' equity 387,819 382,574 --------- --------- Total liabilities and stockholders' equity $ 578,026 $ 447,741 ========= =========
HNC Reports Fourth Quarter 2001 Results/page 6 HNC SOFTWARE INC. UNAUDITED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE FOURTH QUARTERS ENDED DECEMBER 30, 2000 AND 2001 (IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTER ENDED DECEMBER 30, -------------------------- 2000 2001 -------- -------- Revenues: License and maintenance $ 39,870 $ 40,172 Services and other 15,206 14,379 -------- -------- Total revenues 55,076 54,551 Operating expenses: License and maintenance 9,921 10,644 Services and other 11,546 11,150 Research and development 10,518 11,889 Sales and marketing 11,196 11,868 General and administrative 7,929 6,304 -------- -------- Operating income (loss) before non-cash and non- recurring charges 3,966 2,696 Non-cash and non-recurring charges: Stock-based compensation 283 58 Transaction-related amortization and costs 13,627 14,739 Expense related to spin-off of Retek subsidiary 1,711 - Restructuring and impairment charges 1,172 - -------- -------- Operating income (loss) (12,827) (12,101) Other income (expense): Other income, net 2,719 2,229 Write-down of equity investments (2,750) - Interest expense related to convertible debt (220) (2,159) -------- -------- Income (loss) before income tax provision (benefit) (13,078) (12,031) Income tax provision (benefit) (7,540) (4,012) -------- -------- Net income (loss) $ (5,538) $ (8,019) ======== ======== Earnings per share: Basic and diluted net loss per common share $ (0.17) $ (0.23) ======== ======== Shares used in computing basic and diluted net loss per common share 32,228 35,370 ======== ========
HNC Reports Fourth Quarter 2001 Results/page 7 HNC SOFTWARE INC. UNAUDITED PRO FORMA AND CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2000 AND 2001 (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, 2000 --------------------------------------------- YEAR ENDED DISTRIBUTION DECEMBER 31, AS REPORTED OF RETEK PRO FORMA 2001 ----------- ------------ --------- ----------- Revenues: License and maintenance $ 166,063 $ (35,229) $ 130,834 $ 168,626 Services and other 88,821 (24,686) 64,135 58,044 --------- --------- --------- --------- Total revenues 254,884 (59,915) 194,969 226,670 Operating expenses: License and maintenance 51,725 (15,058) 36,667 44,676 Services and other 63,762 (19,349) 44,413 42,465 Research and development 65,553 (26,197) 39,356 45,587 Sales and marketing 66,416 (28,236) 38,180 44,503 General and administrative 34,807 (7,641) 27,166 29,801 --------- --------- --------- --------- Operating income (loss) before non-cash and non- recurring charges (27,379) 36,566 9,187 19,638 Non-cash and non-recurring charges: Stock-based compensation 21,670 (8,516) 13,154 476 Transaction-related amortization and costs 43,734 (5,037) 38,697 56,556 In-process research and development 7,601 (4,000) 3,601 487 Expense related to spin-off of Retek subsidiary 48,185 - 48,185 - Restructuring and impairment charges 1,172 - 1,172 4,642 --------- --------- --------- --------- Operating income (loss) (149,741) 54,119 (95,622) (42,523) Other income (expense): Other income, net 11,827 (1,496) 10,331 7,863 Interest expense related to convertible debt (3,762) - (3,762) (3,171) Write-down of equity investments (2,750) - (2,750) (4,893) Expense related to debt conversion (12,676) - (12,676) - Minority interest in losses (income) of consolidated subsidiary 7,582 (7,582) - - --------- --------- --------- --------- Income (loss) before income tax provision (benefit) (149,520) 45,041 (104,479) (42,724) Income tax provision (benefit) (33,102) 16,488 (16,614) (6,272) --------- --------- --------- --------- Net income (loss) $(116,418) $ 28,553 $ (87,865) $ (36,452) ========= ========= ========= ========= Earnings per share: Basic and diluted net loss per common share $ (4.08) $ (3.08) $ (1.06) ========= ========= ========= Shares used in computing basic and diluted net loss per common share 28,529 28,529 34,509 ========= ========= =========
-----END PRIVACY-ENHANCED MESSAGE-----