-----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, FX7XFeibTwLoucX7XQWNAKPX9ZCmqFyValeDQqbXdRjm+7sLCyBktNWatm8uwCwi tPEgRAjjjMNv1SucP/yY3A== 0000936392-98-000327.txt : 19980227 0000936392-98-000327.hdr.sgml : 19980227 ACCESSION NUMBER: 0000936392-98-000327 CONFORMED SUBMISSION TYPE: S-3/A PUBLIC DOCUMENT COUNT: 8 FILED AS OF DATE: 19980226 SROS: NASD 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: S-3/A SEC ACT: SEC FILE NUMBER: 333-46419 FILM NUMBER: 98550816 BUSINESS ADDRESS: STREET 1: 5930 CORNERSTONE CT W CITY: SAN DIEGO STATE: CA ZIP: 92121-3728 BUSINESS PHONE: 6195468877 MAIL ADDRESS: STREET 1: 5930 CORNERSTONE CT WEST CITY: SAN DIEGO STATE: CA ZIP: 92121-3728 S-3/A 1 AMENDMENT #1 TO FORM S-3 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 26, 1998 REGISTRATION NO. 333-46419 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 1 TO FORM S-3 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ HNC SOFTWARE INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 0-26146 33-0248788 (STATE OR OTHER JURISDICTION OF (COMMISSION FILE NUMBER) (I.R.S. EMPLOYER IDENTIFICATION NO.) INCORPORATION)
------------------------ 5930 CORNERSTONE COURT WEST SAN DIEGO, CALIFORNIA 92121 (619) 546-8877 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) ROBERT L. NORTH PRESIDENT AND CHIEF EXECUTIVE OFFICER HNC SOFTWARE INC. 5930 CORNERSTONE COURT WEST SAN DIEGO, CALIFORNIA 92121 (619) 546-8877 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ COPIES TO: LAIRD H. SIMONS, III, ESQ. JOHN A. FORE, ESQ. KENNETH A. LINHARES, ESQ. KATHLEEN B. BLOCH, ESQ. KATHERINE TALLMAN SCHUDA, ESQ. STEPHEN KIM, ESQ. FENWICK & WEST LLP WILSON SONSINI GOODRICH & ROSATI TWO PALO ALTO SQUARE PROFESSIONAL CORPORATION PALO ALTO, CALIFORNIA 94306 650 PAGE MILL ROAD (650) 494-0600 PALO ALTO, CALIFORNIA 94304 (650) 493-9300
------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. If the only securities being registered on this Form are being offered pursuant to dividend or interest reinvestment plans, please check the following box. [ ] If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] _________ If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] _________ If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] ------------------------ CALCULATION OF REGISTRATION FEE - ----------------------------------------------------------------------------------------------------------------------- TITLE OF EACH CLASS PROPOSED MAXIMUM PROPOSED MAXIMUM OF SECURITIES AMOUNT TO BE OFFERING PRICE AGGREGATE OFFERING AMOUNT OF TO BE REGISTERED REGISTERED PER SHARE PRICE REGISTRATION FEE - ----------------------------------------------------------------------------------------------------------------------- % Convertible Subordinated Notes due 2003...................... $100,000,000(1) 100%(2) $100,000,000(2) $29,500.00 - ----------------------------------------------------------------------------------------------------------------------- Common Stock, par value $0.001...... (3) N/A N/A N/A - ----------------------------------------------------------------------------------------------------------------------- Common Stock, par value $0.001...... 2,415,000(4) (5) (5) $24,127.04 - ----------------------------------------------------------------------------------------------------------------------- Total Registration Fee $53,627.04(6) -----------------------------------------
(1) Includes $10,000,000 in principal amount of Notes that the Underwriters have the option to purchase to cover over-allotments, if any. (2) Estimated solely for the purposes of calculating the amount of the registration fee, pursuant to Rule 457 under the Securities Act. (3) Such indeterminate number of shares of Common Stock as are issuable upon conversion of the Notes. (4) Includes 315,000 shares of Common Stock that the Underwriters have the option to purchase to cover over-allotments, if any. (5) Estimated solely for the purpose of calculating the amount of the registration fee, pursuant to Rule 457(c) under the Securities Act, based on the average price of the Common Stock on the Nasdaq National Market on February 9, 1998 for the 1,725,000 shares covered by the filing on February 17, 1998 and the closing price of February 25, 1998 for the incremental 690,000 shares covered by this Amendment. (6) Of the total fee, $42,917.25 has been paid and $10,709.79 is paid herewith. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. ================================================================================ 2 EXPLANATORY NOTE This Registration Statement consists of two separate prospectuses. There is a prospectus relating to Convertible Subordinated Notes to be issued and sold by the Registrant. There is also a prospectus relating to Common Stock to be sold by the Registrant and certain stockholders of the Registrant. 3 Information contained herein is subject to completion or amendment. A registration statement relating to these securities has been filed with the Securities and Exchange Commission. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This prospectus shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such jurisdiction. SUBJECT TO COMPLETION, DATED FEBRUARY 26, 1998 LOGO - -------------------------------------------------------------------------------- U.S. $90,000,000 % CONVERTIBLE SUBORDINATED NOTES DUE 2003 - -------------------------------------------------------------------------------- Interest on the Notes is payable on March 1 and September 1 of each year, commencing September 1, 1998. The Notes will mature on March 1, 2003. The Notes will be convertible into Common Stock, par value $.001 per share (the "Common Stock"), of HNC Software Inc., a Delaware corporation ("HNC" or the "Company"), at any time prior to the close of business on the maturity date, unless previously redeemed or repurchased, at a conversion price of $ share (equivalent to a conversion rate of approximately shares per $1,000 principal amount of Notes), subject to adjustment in certain circumstances. See "Description of Notes -- Conversion." The Common Stock is listed on the Nasdaq National Market under the symbol "HNCS." The last reported sale price of the Common Stock on the Nasdaq National Market on February 25, 1998 was $32 11/16 per share. See "Price Range of Common Stock." The Notes are not redeemable prior to March 6, 2001. On or after March 6, 2001, the Notes may be redeemed at the option of the Company, in whole or from time to time in part, at the redemption prices set forth herein plus accrued interest. See "Description of Notes -- Optional Redemption." In the event of a Fundamental Change (as defined), each Holder of Notes may require the Company to repurchase its Notes, in whole or in part, for cash, at the repurchase prices set forth herein plus accrued interest. See "Description of Notes -- Repurchase at Option of Holders Upon a Fundamental Change." The Notes are general unsecured obligations of the Company and are subordinated in right of payment to all existing and future Senior Indebtedness (as defined) of the Company and effectively subordinated to all indebtedness and other liabilities of the Company's subsidiaries. As of December 31, 1997, the Company had no indebtedness outstanding that would have constituted Senior Indebtedness, and the Company's subsidiaries had indebtedness and other liabilities outstanding aggregating approximately $254,000 (excluding intercompany liabilities and liabilities of a type not required to be reflected as liabilities on the balance sheets of such subsidiaries in accordance with generally accepted accounting principles). The Indenture will not restrict the incurrence of additional Senior Indebtedness by the Company or the incurrence of other indebtedness and liabilities by the Company or its subsidiaries. FOR INFORMATION CONCERNING CERTAIN RISK FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS, SEE "RISK FACTORS" COMMENCING ON PAGE 5. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
PRICE TO UNDERWRITING PROCEEDS TO PUBLIC(1) DISCOUNT(2) COMPANY(3) Per Note 100% $ $ Total(3) $90,000,000 $ $
(1) Plus accrued interest, if any, from , 1998. (2) The Company has agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended. See "Underwriting." (3) Before deducting expenses estimated at $100,000, payable by the Company. (4) The Company has granted to the Underwriters an option for 30 days to purchase up to an additional $10,000,000 aggregate principal amount of Notes solely to cover over-allotments, if any. If such option is exercised in full, the total Price to Public, Underwriting Discount and Proceeds to Company will be $ , $ and $ , respectively. See "Underwriting." The Notes offered hereby are offered by the Underwriters subject to prior sale, when, as and if delivered to and accepted by them, and subject to approval of certain legal matters by counsel and certain other conditions. The Underwriters reserve the right to withdraw, cancel or modify such offer and to reject orders in whole or in part. Delivery of the Notes offered hereby to the Underwriters is expected to be made in New York, New York on or about , 1998. DEUTSCHE MORGAN GRENFELL BANCAMERICA ROBERTSON STEPHENS SALOMON SMITH BARNEY The date of this Prospectus is , 1998. 4 AVAILABLE INFORMATION HNC is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance therewith, files reports, proxy statements and other information with the Securities and Exchange Commission (the "Commission"). Such reports, proxy statements and other information can be inspected and copied at the public reference facilities maintained by the Commission at Room 1024, 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549, and at the Commission's following Regional Offices: 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and Seven World Trade Center, 13th Floor, New York, New York 10048. Copies of such material can be obtained at prescribed rates from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549. The Commission maintains a World Wide Web site that contains reports, proxy statements and other information regarding registrants that file electronically with the Commission. The address of the site is http://www.sec.gov. The Company's Common Stock is quoted on the Nasdaq National Market and reports, proxy statements and other information concerning the Company also may be inspected at the offices of Nasdaq Operations, 1735 K Street, N.W., Washington, D.C. 20006. The Company has filed with the Commission a Registration Statement on Form S-3 (the "Registration Statement") under the Securities Act of 1933, as amended (the "Securities Act"), with respect to the securities offered by this Prospectus. This Prospectus, which forms a part of the Registration Statement, does not contain all of the information set forth in the Registration Statement, certain parts of which have been omitted in accordance with the rules and regulations of the Commission. For further information with respect to the Company and the securities offered hereby, reference is made to the Registration Statement, including the exhibits filed or incorporated by reference in the Registration Statement. Statements made in this Prospectus about any contract or other document are not necessarily complete and in each instance in which a copy of such contract is filed with, or incorporated by reference in, the Registration Statement as an exhibit, reference is made to such copy, and each such statement shall be deemed qualified in all respects by such reference. Copies of the Registration Statement may be inspected, without charge, at the offices of the Commission, or obtained at prescribed rates from the Public Reference Section of the Commission at the address set forth above. INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE The following documents that HNC has previously filed with the Commission are hereby incorporated herein by reference: (a) The Company's Annual Report on Form 10-K for the year ended December 31, 1997, as amended; and (b) The description of the Company's Common Stock contained in the Company's registration statement on Form 8-A filed with the Commission on May 26, 1995. All documents filed by the Company pursuant to Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act after the date of this Prospectus and prior to the termination of the offering covered by this Prospectus shall be deemed to be incorporated by reference in this Prospectus and to be a part hereof from the date of filing of such documents. Any statement contained in any document incorporated by reference herein shall be deemed to be modified or superseded for purposes of this Prospectus to the extent that a statement contained herein or in any other subsequently filed document that also is or is deemed to be incorporated by reference herein, modifies or supersedes such statement. Any statement so modified or superseded shall not be deemed, except as so modified or superseded, to constitute a part of this Prospectus. The Company will provide without charge, upon written or oral request of any person to whom this Prospectus is delivered, a copy of any or all of the documents that have been or may be incorporated by reference in this Prospectus (other than exhibits to such documents that are not specifically incorporated by reference into such documents). Requests for such copies should be directed to HNC at 5930 Cornerstone Court West, San Diego, California 92121-3728, Attention: Raymond V. Thomas (telephone number (619) 546-8877). ------------------------ CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE NOTES OR COMMON STOCK, INCLUDING BY ENTERING STABILIZING BIDS, IMPOSING PENALTY BIDS OR OTHERWISE. SUCH ACTIVITIES, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. FOR A DISCUSSION OF THESE ACTIVITIES, SEE "UNDERWRITING." IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS (AND SELLING GROUP MEMBERS, IF ANY) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE "UNDERWRITING." 2 5 PROSPECTUS SUMMARY The following summary should be read in conjunction with and is qualified in its entirety by the more detailed information, including "Risk Factors" and the consolidated financial statements and notes thereto, appearing elsewhere in this Prospectus or incorporated by reference in this Prospectus. THE COMPANY HNC develops, markets and supports predictive software solutions for leading service industries. These predictive software solutions employ proprietary neural-network predictive decision engines, profiles, traditional statistical modeling, business models, expert rules and context vectors to convert existing data and business experiences into meaningful recommendations and actions. Just as manufacturing organizations have implemented manufacturing resource planning software to automate routine transactions, leading service industries such as the healthcare/insurance, financial services and retail industries are using predictive software solutions to improve profitability, competitiveness and customer satisfaction. The Company's objective is to be the leading supplier of predictive software solutions by leveraging its core computational intelligence technology across a series of product lines targeted at specific service industries. In the healthcare/insurance industry, the Company's products are used to automate workers' compensation bill review and loss reserving, detect and prevent workers' compensation fraud and increase workers' compensation payor and provider effectiveness. In the financial services industry, the Company's products are used to detect and prevent credit card fraud, manage the profitability of credit card portfolios and automate lending decisions and residential property valuations. In the retail industry, the Company's products address inventory control, merchandise management, demand forecasting and private label credit card fraud. The Company markets most of its predictive software solutions as an ongoing service that includes software licenses, decision model updates, application consulting and on-line or on-site support and maintenance. The Company's customers include many of the leading companies in each of its target markets, including Concentra Managed Care Inc., CIGNA Corp. and CNA Financial Corporation in the healthcare/insurance industry, First Data Resources, Inc., Household International Inc. and MBNA Corp. in the financial services industry, and the Computer City division of Tandy Corp., Caldor Corp. and Hills Department Stores Inc. in the retail industry. The Company was founded in 1986 under the laws of California and was reincorporated in June 1995 under the laws of Delaware. The Company's principal executive offices are located at 5930 Cornerstone Court West, San Diego, California 92121-3728, and its telephone number is (619) 546-8877. In this Prospectus, the terms "HNC" and the "Company" each refer to HNC Software Inc., a Delaware corporation, and its consolidated subsidiaries unless the context otherwise requires. SUMMARY CONSOLIDATED FINANCIAL INFORMATION (IN THOUSANDS, EXCEPT RATIO AND PER SHARE DATA)
YEAR ENDED DECEMBER 31, ------------------------------------------------ 1993 1994 1995 1996 1997 ------- ------- ------- ------- -------- STATEMENT OF INCOME DATA:(1) Total revenues................................................ $16,167 $29,838 $43,704 $71,439 $113,735 Operating income.............................................. 1,034 2,881 5,082 9,659 23,040 Net income.................................................... 875 3,142 6,077 11,893 17,565 Basic net income per common share(2).......................... 0.02 0.28 0.38 0.50 0.72 Diluted net income per common share(2)........................ 0.02 0.17 0.28 0.47 0.68 Pro forma net income(3)....................................... 641 2,137 4,534 9,731 15,417 Basic pro forma net income per common share(3)................ 0.64 Diluted pro forma net income per common share(3).............. 0.60 Shares used in computing basic net income per common share and basic pro forma net income per common share................. 8,591 8,642 15,195 23,552 24,275 Shares used in computing diluted net income per common share and diluted pro forma net income per common share........... 9,289 18,142 21,510 25,363 25,681 OTHER DATA: Ratio of earnings to fixed charges(4)......................... 3.00x 4.87x 6.99x 12.15x 26.51x
DECEMBER 31, 1997 --------------------------- ACTUAL AS ADJUSTED(5) -------- -------------- BALANCE SHEET DATA: Cash, cash equivalents and investments available for sale............................ $ 42,946 $130,146 Working capital...................................................................... 74,303 161,503 Total assets......................................................................... 119,877 207,077 Total stockholders' equity........................................................... 103,860 103,860
- --------------- (1) The summary consolidated financial information gives retroactive effect to the acquisitions of Risk Data Corporation ("Risk Data"), Retek Distribution Corporation, now known as Retek Information Systems("Retek") and CompReview, Inc. ("CompReview") for all periods presented, accounted for as poolings of interests. (2) The computations of basic net income per common share for 1993, 1994 and 1995 include reductions of consolidated net income in the amounts of $717,000, $717,000 and $348,000, respectively, related to the accretion of dividends on mandatorily redeemable convertible Preferred Stock, which converted into Common Stock upon the closing of the Company's initial public offering on June 26, 1995. The computation of diluted net income per common share for 1993 does not include the assumed conversion of all outstanding shares of mandatorily redeemable convertible Preferred Stock into 7,675,000 shares of Common Stock or an increase to net income per common share related to the elimination of dividend accretion on such Preferred Stock as the impact would be antidilutive. (3) Pro forma net income and net income per common share reflect a provision for taxes on the income of CompReview, which was a subchapter S corporation prior to its acquisition by HNC, as if CompReview had been subject to corporate income taxes as a C corporation for all periods presented. (4) The ratio of earnings to fixed charges has been computed by dividing earnings available for fixed charges (earnings before income taxes plus fixed charges less capitalized interest) by fixed charges (interest expense plus capitalized interest and the portion of rental expense which represents interest). (5) Adjusted to reflect the sale of the Notes offered hereby and the receipt of the net proceeds therefrom. 3 6 THE OFFERING Securities Offered......... $90,000,000 principal amount of % Convertible Subordinated Notes due 2003 (the "Notes") ($100,000,000 principal amount of Notes if the over-allotment option is exercised in full). Interest Payment Dates..... March 1 and September 1, commencing September 1, 1998. Conversion................. The Notes will be convertible into Common Stock at any time prior to the close of business on the maturity date, unless previously redeemed or repurchased, at a conversion price of $ share (equivalent to a conversion rate of approximately shares per $1,000 principal amount of Notes), subject to adjustment. Subordination.............. The Notes are subordinated in right of payment to all existing and future Senior Indebtedness (as defined) of the Company and effectively subordinated to all indebtedness and other liabilities of the Company's subsidiaries. As of December 31, 1997, the Company had no indebtedness outstanding that would have constituted Senior Indebtedness and the Company's subsidiaries had outstanding indebtedness and other liabilities outstanding aggregating approximately $254,000 (excluding intercompany liabilities and liabilities of a type not required to be reflected as liabilities on the balance sheets of such subsidiaries in accordance with generally accepted accounting principles). The Indenture will not restrict the incurrence of additional Senior Indebtedness by the Company or the incurrence of other indebtedness and liabilities by the Company or its subsidiaries. Optional Redemption........ The Notes are not redeemable by the Company prior to March 6, 2001. On or after March 6, 2001, the Notes may be redeemed at the option of the Company, in whole or from time to time in part, at the redemption prices set forth herein plus accrued interest. Repurchase at Option of Holders Upon a Fundamental Change..................... In the event of a Fundamental Change (as defined), each Holder of Notes may require the Company to repurchase its Notes, in whole or in part, for cash at the repurchase prices set forth herein, subject to adjustment in certain events as described herein, plus accrued interest. Use of Proceeds............ The proceeds of the Notes will be used for general corporate purposes, including working capital, and potentially to repurchase outstanding shares of the Company's Common Stock or to acquire complementary businesses, products or technologies. See "Use of Proceeds." ------------------------ ProfitMax(R) is a registered trademark of the Company. CRLink(TM), CompCompare(TM), ProviderCompare(TM), PMA Advisor(TM), VeriComp(TM), MIRA(TM), Falcon(TM), Falcon Export(TM), Falcon Select(TM), Falcon Debit(TM), Falcon Retail(TM), Falcon Sentry(TM), Eagle(TM), Capstone(TM), Capstone for Payment Cards(TM), Capstone for Consumer Lending(TM), Capstone for Mortgage Lending(TM), ProfitMax Bankruptcy(TM), AREAS(TM), Retek Merchandising System(TM), Retek Data Warehouse(TM), Active Retail Intelligence(TM), Retek Demand Forecasting(TM), Falcon Retail(TM), MatchPlus(TM), SelectCast(TM), SelectResponse(TM) and SelectResource(TM) are trademarks of the Company. All other trademarks or trade names referred to in this Prospectus are the property of their respective owners. 4 7 RISK FACTORS This Prospectus (including without limitation the following Risk Factors) contains forward-looking statements (within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act) regarding the Company and its business, financial condition, results of operations and prospects. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this Prospectus. Additionally, statements concerning future matters such as the development of new products, enhancements or technologies, possible changes in legislation and other statements regarding matters that are not historical are forward-looking statements. Although forward-looking statements in this Prospectus reflect the good faith judgment of the Company's management, such statements can only be based on facts and factors currently known by the Company. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and actual results and outcomes may differ materially from the results and outcomes discussed in the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include without limitation those discussed below as well as those discussed elsewhere in this Prospectus and in any documents that are incorporated into this Prospectus by reference. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Prospectus. The Company undertakes no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Prospectus. Readers are urged to carefully review and consider the various disclosures made by the Company in this Prospectus and in the Company's Annual Report on Form 10-K for the year ended December 31, 1997, as amended, filed with the Commission, which attempts to advise interested parties of the risks and factors that may affect the Company's business, financial condition and results of operations and prospects. POTENTIAL FLUCTUATIONS IN OPERATING RESULTS. The Company's revenues and operating results have varied significantly in the past and may do so in the future. Because the Company's expense levels are based in part on its expectations regarding future revenues and in the short term are fixed to a large extent, the Company may be unable to adjust its spending in time to compensate for any unexpected revenue shortfall. Factors affecting operating results include market acceptance of the Company's products; the relatively large size and small number of customer orders that may be received during a given period; customer cancellation of long-term contracts yielding recurring revenues or customers' ceasing their use of Company products for which the Company's fees are usage based; the length of the Company's sales cycle; the Company's ability to develop, introduce and market new products and product enhancements; the timing of new product announcements and introductions by the Company and its competitors; changes in the mix of distribution channels; changes in the level of operating expenses; the Company's ability to achieve progress on percentage-of-completion contracts; the Company's success in completing certain pilot installations for contracted fees; competitive conditions in the industry; domestic and international economic conditions; and market conditions in the Company's targeted markets. In addition, as a result of recently issued guidance on software revenue recognition, license agreements entered into during a quarter may not meet the Company's revenue recognition criteria. Therefore, even if the Company meets or exceeds its forecast of aggregate licensing and other contracting activity, it is possible that the Company's revenues would not meet expectations. Furthermore, the Company's operating results may be affected by factors unique to certain of its product lines. For example, the Company derives a substantial and increasing portion of its revenues from its retail products, which are generally priced as "perpetual" license transactions in which the Company receives a one-time license fee. The Company recognizes these fees as revenue upon delivery of the software and acceptance by the customer. Thus, failure to complete a perpetual license transaction during a fiscal quarter would have a disproportionate adverse impact on the Company's operating results for that quarter. 5 8 The Company expects fluctuations in its operating results to continue for the foreseeable future. Accordingly, the Company believes that period-to-period comparisons of its financial results should not be relied upon as an indication of future performance. The Company may not be able to maintain profitability on a quarterly or annual basis in the future. Due to all of the foregoing factors, it is possible that in some future quarter the Company's operating results will be below the expectations of public market analysts and investors. In that event, the price of the Company's Common Stock and, in turn, the market price of the Notes, would likely be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." LENGTHY AND UNPREDICTABLE SALES CYCLE. Due in part to the mission-critical nature of certain of the Company's applications, potential customers perceive high risk in connection with adoption of the Company's products. As a result, customers have been cautious in making decisions to acquire the Company's products. In addition, because the purchase of the Company's 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 affect key operations. For these and other reasons, the sales cycle associated with the purchase of the Company's products is typically lengthy, unpredictable and subject to a number of significant risks over which the Company has little or no control, including customers' budgetary constraints and internal acceptance reviews. The sales cycle associated with the licensing of the Company's 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, the Company's ability to forecast the timing and amount of specific sales is limited. A lost or delayed sale could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Sales and Marketing." ACQUISITIONS. Between August 1996 and November 1997, the Company acquired three businesses. In August 1996, the Company acquired Risk Data, a company that develops, markets and supports proprietary software decision products for use in the insurance industry. In November 1996, the Company acquired Retek, a company that develops, markets and supports management decision software products for retailers and their vendors. In November 1997, the Company acquired CompReview, a company that develops, markets and supports a software product and related services designed to assist in the management and containment of the medical costs of workers' compensation and automobile accident medical claims. The Company believes that its future growth depends, in part, upon the success of these and possible future acquisitions. There can be no assurance that the Company will successfully identify, acquire on favorable terms or integrate such businesses, products, services or technologies. The Company may in the future face increased competition for acquisition opportunities, which may inhibit the Company's ability to consummate suitable acquisitions and increase the costs of completing such acquisitions. The acquisitions of Risk Data, Retek and CompReview, as well as other potential future acquisitions, will require the Company to successfully manage and integrate such acquired businesses, which may be located in diverse geographic locations. Acquiring other businesses also requires the Company to successfully develop and market products to new industries and markets with which the Company may not be familiar. It also requires the Company to coordinate (and possibly change) the diverse operating structures, policies and practices of the acquired companies and to integrate the employees of the acquired companies into the Company's organization and culture. Failure of the Company to successfully integrate and manage acquired businesses, to retain their employees, and to successfully address new industries and markets associated with such acquired businesses, would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, although the acquisitions of Risk Data, Retek and CompReview have been accounted for as poolings of interests, future acquisitions may be accounted for as purchases, resulting in potential charges that may adversely affect the Company's earnings. 6 9 Additional acquisitions may also involve the issuance of shares of the Company's stock to owners of acquired businesses, resulting in dilution in the percentage of the Company's stock owned by other stockholders. See "Business -- HNC's Strategy." RISKS ASSOCIATED WITH MANAGING GROWTH. In recent years, the Company has experienced changes in its operations that have placed significant demands on the Company's administrative, operational and financial resources. The growth in the Company's customer base and expansion of its product functionality, together with its acquisition of other businesses and their employees, have challenged and are expected to continue to challenge the Company's management and operations, including its sales, marketing, customer support, research and development and finance and administrative operations. The Company's future performance will depend in part on its ability to successfully manage change, both in its domestic and international operations, and to adapt its operational and financial control systems, if necessary, to respond to changes in its business and to facilitate the integration of acquired businesses with the Company's operations. The failure of the Company's management to effectively respond to and manage growth could have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE ON EMERGING TECHNOLOGIES AND MARKETS. The market for predictive software solutions is still emerging. The rate at which businesses have adopted the Company's products has varied significantly by market and by product within each market, and the Company expects to continue to experience such variations with respect to its target markets and products in the future. The Company has introduced products for the healthcare/insurance, financial services and retail markets. The Company has recently announced several new products, including PMAdvisor, VeriComp, SelectCast, SelectResponse and SelectResource. To date, none of these products has achieved any significant degree of market acceptance, and there can be no assurance that such products will ever be widely accepted. Although businesses in the Company's target markets have recognized the advantages of using predictive software solutions to automate the decision-making process, many have developed decision automation systems internally rather than licensing them from outside vendors. There can be no assurance that the markets for the Company's products will continue to develop or that the Company's products will be widely accepted, if at all. If the markets for the Company's new or existing products fail to develop, or develop more slowly than anticipated, the Company's sales would be negatively impacted, which would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Emerging Market Opportunities." RISKS ASSOCIATED WITH TECHNOLOGICAL CHANGE AND DELAYS IN DEVELOPING NEW PRODUCTS. The market for the Company's predictive software solutions for service industries is characterized by rapidly changing technology and improvements in computer hardware, network operating systems, programming tools, programming languages, operating systems and database technology. The Company's success will depend upon its ability to continue to develop and maintain competitive technologies, enhance its 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. For example, the rapid growth of the Internet environment creates new opportunities, risks and uncertainties for businesses, such as the Company, which develop software solutions that now may have to be designed to operate in Internet, intranet and other on-line environments. The Company may not be able to develop and market, on a timely basis, or at all, product enhancements or new products that respond to changing technologies. The Company has 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. Any significant delay in the completion of new 7 10 products, or the failure of such products, if and when installed, to achieve any significant degree of market acceptance, would have a material adverse effect on the Company's business, financial condition and results of operations. Any failure by the Company to anticipate or to respond adequately to changing technologies, or any significant delays in product development or introduction, could cause customers to delay or decide against purchases of the Company's products and would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Technology" and "-- Research and Development." PRODUCT CONCENTRATION. The Company currently has one product or product line in each of its three target markets that accounts for a majority of the Company's total revenues from that market. These products in the aggregate accounted for 60.0%, 59.1% and 57.9% of the Company's total revenues in 1995, 1996 and 1997, respectively. In the healthcare/insurance market, the Company's revenues from its CRLink product accounted for 29.8%, 24.6% and 23.0% of the Company's total revenues in 1995, 1996 and 1997, respectively, and are expected to account for a substantial portion of the Company's total revenues for the foreseeable future. Continued market acceptance of CRLink will be affected by future product enhancements and competition. Decline in demand for, or use of, CRLink, whether as a result of competition, simplification of state workers' compensation fee schedules, changes in the overall payment system or regulatory structure for workers' compensation claims, technological change, an inability to obtain or use state fee schedule or claims data, saturation of market demand, industry consolidation or otherwise, could result in decreased revenues from CRLink, which could have a material adverse effect on the Company's business, financial condition and results of operations. Further, revenues from the Retek Merchandising System ("RMS"), a retail management product, accounted for 2.2%, 13.6% and 18.9% of the Company's total revenues in 1995, 1996 and 1997, respectively, and are expected to continue to account for a substantial portion of the Company's revenues in the foreseeable future. Continued market acceptance of RMS will be affected by the quality and timely introduction of future product enhancements and competition. Decline in demand for, or use of, RMS as a result of continued entry into the retail inventory management market by vendors that may have significantly greater resources and a broader customer base than the Company could result in decreased revenues from RMS, which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, decline in demand for RMS, as a result of technological change, saturation of market demand, industry consolidation or otherwise would have a material adverse effect on the Company's business, financial condition and results of operations. Revenues from the Company's Falcon product line for credit card fraud detection for financial institutions accounted for 28.0%, 20.9% and 16.0% of the Company's total revenues in 1995, 1996 and 1997, respectively, and are expected to continue to account for a substantial portion of the Company's total revenues in the foreseeable future. Continued market acceptance of the Falcon product line will be affected by the quality and timely introduction of future product enhancements and competition. In addition, it is possible that patterns of credit card fraud may change in a manner that the Falcon product line would not detect and that other methods of credit card fraud prevention may reduce customers' needs for the Falcon product line. As a result of increasing saturation of market demand for the Falcon product line, the Company may also need to rely increasingly on international sales to maintain or increase Falcon revenue levels. Furthermore, Falcon customers are banks and related financial institutions. Accordingly, the Company's future success depends upon the capital expenditure budgets of such customers and the continued demand by such customers for Falcon products. The financial services industry tends to be cyclical in nature, which may result in variations in demand for the Company's products. In addition, there has been and continues to be consolidation in the financial services industry, which in some cases has lengthened the sales cycle and may lead to reduced demand for the Company's products. Decline in demand for, or use of, Falcon, whether as a result of competition, technological change, change in fraud patterns, the cyclical nature of the financial services industry, saturation of market demand, fluctuations in interest rates, industry consolidation, reduction in capital spending or otherwise, could have a 8 11 material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Markets and Products." DEPENDENCE ON DATA. The development, installation and support of the Company's credit card fraud control and profitability management, loan underwriting, home valuation and certain healthcare/insurance products require periodic model updates. The Company must develop or obtain a reliable source of sufficient amounts of current and statistically relevant data to analyze transactions and update its models. For example, in the electronic payments market, the data required by the Company are collected privately and maintained in proprietary databases. As a result, the Company and its Falcon and ProfitMax customers enter into agreements pursuant to which customers agree to provide the data the Company requires to analyze transactions, report results and build new fraud detection and profitability models. For its AREAS home valuation product, the Company obtains data from commercial databases on available terms and conditions. Many of the Company's healthcare/insurance products use historical workers' compensation claims data obtained from customers. CRLink also uses data from state workers' compensation fee schedules adopted by state regulatory agencies, and certain third parties have asserted copyright interests in such data. In most cases, such data must be periodically updated and refreshed to enable the Company's predictive software products to continue to work effectively. In addition, the development of new and enhanced products also depends to a significant extent on the availability of sufficient amounts of statistically relevant data to enable the Company to develop models. For example, to expand the geographic coverage of its AREAS product, the Company would be required to develop or obtain data on home sales in each county for which AREAS is marketed. There can be no assurance that the Company will be able to continue to obtain adequate amounts of statistically relevant data on a timely basis, in the required formats or on reasonable terms and conditions, whether from customers or commercial suppliers. Any such failure by the Company to obtain required data when it is needed, for a reasonable price and on reasonable terms, could have a significant negative impact on existing product performance, new product development and product pricing which could in turn have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Customer Service and Support." COMPETITION. The market for predictive software solutions for service industries is intensely competitive and subject to rapid change. Competitors, many of which have substantially greater financial resources than the Company, vary in size and in the scope of the products and services they offer. The Company encounters competition from a number of sources, including (i) other application software companies, (ii) management information systems departments of customers and potential customers, including banks, insurance companies and retailers, (iii) third-party professional services organizations, including without limitation, consulting divisions of public accounting firms, (iv) hardware suppliers that bundle or develop complementary software, (v) network and service providers that seek to enhance their value-added services, (vi) neural-network tool suppliers and (vii) managed care organizations. In the healthcare/insurance market, the Company has experienced competition primarily from National Council on Compensation Insurance ("NCCI"), Corporate Systems and CSC Incorporated. In the workers' compensation and medical cost administration market, the Company has experienced competition from MediCode, Inc. ("MediCode"), Medata, Inc. and Embassy Software with regard to software licensing, and Intracorp and Corvel Corporation in the service bureau operations market. Additionally, the Company has faced competition from Automatic Data Processing, Inc. ("ADP") in the automobile accident medical claims market. In the financial services market, the Company has experienced competition from Fair, Isaac & Co., Inc., Cogensys (a subsidiary of Policy Management Systems Corporation), Federal National Mortgage Association ("Fannie Mae"), Federal Home Loan Mortgage Corporation ("Freddie Mac"), International Business Machines Corporation ("IBM"), Nestor, Inc., NeuralTech Inc., Neuralware Inc., PMI Mortgage Services Co., VISA International and others. In the retail market, the Company has experienced competition from JDA Software Group, Inc., SAP AG, PeopleSoft, Inc., IBM, Manugistics Group, Inc. and others. The 9 12 Company expects to experience additional competition from other established and emerging companies, as well as other technologies. For example, the Company's Falcon product competes against other methods of preventing credit card fraud, such as card activation 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, reduced gross margins and loss of market share, any of which could materially adversely affect the Company's business, financial condition and results of operations. The Company believes that most of its products are currently priced at a premium when compared to its competitors' products. The market for the Company's products is highly competitive, and the Company expects that it will face increasing pricing pressures from its current competitors and new market entrants. In particular, increased competition could reduce or eliminate such premiums and cause further price reductions. In addition, such competition could adversely affect the Company's ability to obtain new long-term contracts and renewals of existing long-term contracts on terms favorable to the Company. Any reduction in the price of the Company's products could materially adversely affect the Company's business, financial condition and results of operations. Some of the Company's current, and many of the Company's potential, competitors have significantly greater financial, technical, marketing and other resources than the Company. 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 the Company. 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 the Company's prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly gain significant market share. Also, the Company relies upon its customers to provide data, expertise and other support for the ongoing updating of the Company's models. The Company's customers, most of which have significantly greater financial and marketing resources than the Company, may compete with the Company in the future or otherwise discontinue their relationships with or support of the Company. There can be no assurance that the Company will be able to compete successfully against current and future competitors or that competitive pressures faced by the Company will not materially adversely affect its business, financial condition and results of operations. See "Business -- Competition." RISKS ASSOCIATED WITH RECRUITING AND RETAINING QUALIFIED PERSONNEL. The Company's success depends to a significant degree upon the continued service of members of the Company's senior management and other key research, development, sales and marketing personnel. Accordingly, the loss of any of the Company's senior management or key research, development, sales or marketing personnel could have a material adverse effect on the Company's business, financial condition and results of operations. Only a small number of employees have employment agreements with the Company, and there can be no assurance that such agreements will result in the retention of these employees for any significant period of time. In addition, the untimely loss of a member of the management team or a key employee of a business acquired by the Company could have a material adverse effect on the Company's business, financial condition and results of operations, particularly if such loss occurred before the Company has had adequate time to familiarize itself with the operating details of that business. In the past, the Company has experienced difficulty in recruiting a sufficient number of qualified sales and technical employees. In addition, competitors may attempt to recruit the Company's key employees. There can be no assurance that the Company will be successful in attracting, assimilating and retaining such personnel. The failure to attract, assimilate and retain key personnel could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Employees" and "Management." 10 13 CUSTOMER CONCENTRATION. Product licenses to First Data Resources, Inc. ("First Data"), the largest provider of credit card charge receipt processing services to banks, accounted for 8.7%, 8.6% and 7.6% of the Company's total revenues in 1995, 1996 and 1997, respectively. The Company has licensed First Data to provide its customers with access to the Company's ProfitMax product pursuant to a license agreement entered into in January 1996 (the "ProfitMax Contract"). The Company's revenues under the ProfitMax Contract represented approximately one-quarter of the Company's revenues from First Data in 1997. In late January 1998, First Data asserted that certain restrictive covenants under the ProfitMax Contract violated certain intellectual property laws. First Data also asserted that the existence of such restrictions made the ProfitMax Contract at least temporarily unenforceable and that First Data is therefore not obligated to pay the Company license fees due under the ProfitMax Contract. The Company disputed First Data's claim, released and waived the above-mentioned restrictive covenants in the ProfitMax Contract and gave First Data written notice that the Company intended to terminate the ProfitMax Contract pursuant to its terms unless First Data cured its failure to pay the delinquent license fees in a timely manner. Currently, First Data and the Company are working to resolve their dispute regarding the ProfitMax Contract by negotiating a new agreement; however, there can be no assurance that such an agreement will be reached or that the terms of such an agreement would be as favorable to HNC as its existing contractual arrangements with First Data. If no such agreement can be reached and First Data maintains its current position, it is possible that litigation or arbitration could ensue, which would likely result in a loss of anticipated revenue to the Company under the ProfitMax Contract and possibly other agreements between the Company and First Data, which could have a material adverse effect on the Company's business, financial condition and results of operation. See "Business -- Sales and Marketing." RISKS ASSOCIATED WITH INTERNATIONAL SALES. In 1995, 1996 and 1997, international operations and export sales (including sales in Canada) represented 12.6%, 17.7% and 16.8% of the Company's total revenues, respectively. The Company intends to continue to expand its operations outside the United States and to enter additional international markets, including by adding sales and support offices in Europe and Japan, which will require significant management attention and financial resources. For certain more mature products, such as Falcon, the Company may need to increase international sales in order to continue to expand the product's customer base. The Company has committed and continues to commit significant time and development resources to customizing certain of its products for selected international markets and to developing international sales and support channels. There can be no assurance that the Company's efforts to develop products, databases and models for targeted international markets or to develop additional international sales and support channels will be successful. The failure of such efforts, which can entail considerable expense, could have a material adverse effect on the Company's business, financial condition and results of operations. International sales are subject to 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. The Company's international sales are currently denominated predominantly in United States dollars and a small portion are denominated in British pounds sterling. An increase in the value of the United States dollar relative to foreign currencies could make the Company's products more expensive, and therefore potentially less competitive, in foreign markets. In the future, to the extent the Company's international sales are denominated in local currencies, foreign currency translations may contribute to significant fluctuations in the Company's business, financial condition and results of operations. If for any reason exchange or price controls or other restrictions on foreign currencies are imposed, the Company's business, financial condition and results of operations could be materially adversely affected. See "Business -- Sales and Marketing." 11 14 RISKS ASSOCIATED WITH CHANGING REGULATORY ENVIRONMENT. The Company's customers are subject to a number of government regulations and certain other industry standards with which the Company's products must comply. For example, the Company's financial services products are affected by Regulation B promulgated under the Equal Credit Opportunity Act, by regulations governing the extension of credit to consumers and by Regulation E promulgated under the Electronic Fund Transfers Act governing the transfer of funds from and to consumer deposit accounts, as well as VISA and MasterCard electronic payment standards. In the mortgage services market, the Company's products are affected by regulations such as Fannie Mae and Freddie Mac regulations for conforming loans, Uniform Standards of Professional Appraisal Practice and appraisal standards for federally insured institutions under the Financial Institutions Reform, Recovery and Enforcement Act. In addition, recent regulatory initiatives have restricted the availability of bank and credit bureau data, reflecting a consumer privacy trend that could limit the Company's ability to obtain or use certain credit-related information. It is also possible that insurance-related regulations may in the future apply to the Company's healthcare/insurance products. 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, and such changes, if adopted, might adversely affect the Company's healthcare/insurance business. In addition, if state-mandated workers' compensation laws or regulations or state workers' compensation fee schedules are simplified, such changes would diminish the need for, and the benefit provided by, the CRLink product. Changes in workers' compensation laws or regulations could also adversely affect the Company's healthcare/insurance products by making them obsolete, or by requiring extensive changes in these products to reflect new workers' compensation rules. To the extent that the Company sells new products targeted to markets that include regulated industries and businesses, the Company's products will need to comply with these additional regulations. Any failure of the Company's products to comply with existing or new regulations and standards could result in legal action against the Company or its customers by regulatory authorities or by third parties, including actions seeking civil or criminal penalties, injunctions against the Company's use of data or civil damages, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company may also be liable to its customers for failure of its products to comply with such regulatory requirements. Furthermore, changes to these regulations and standards or the adoption of new regulations or standards that affect the Company's products could affect the performance of such products and have a material adverse effect on the Company's business, financial condition and results of operations. PROTECTION OF INTELLECTUAL PROPERTY. The Company relies on a combination of patent, copyright, trademark and trade secret laws and confidentiality procedures to protect its proprietary rights. The Company currently owns seven issued United States patents and has four United States patent applications pending. The Company has applied for additional patents for its Falcon technology in Canada, Europe and Japan and for its MIRA product in Australia, Canada and Europe. There can be no assurance that patents will be issued with respect to pending or future patent applications or that the Company's patents will be upheld as valid or will prevent the development of competitive products. The Company seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. As part of its confidentiality procedures, the Company generally enters into invention assignment and proprietary information agreements with its employees and independent contractors and nondisclosure agreements with its distributors, corporate partners and licensees, and limits access to and distribution of its 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 the Company's products or technology without authorization, or to develop similar technology independently. In addition, to ensure that customers will not be adversely affected by an interruption in the Company's business, the Company places source code for certain of its products into escrow, which may increase the likelihood of misappropriation or other misuse of the 12 15 Company's intellectual property. Moreover, effective protection of intellectual property rights may be unavailable or limited in certain foreign countries in which the Company has done and may do business. Also, the Company has developed technologies under research projects conducted under agreements with various United States Government agencies or subcontractors to such agencies. Although the Company has acquired certain commercial rights to such technologies, the United States Government typically retains ownership of certain intellectual property rights and licenses in the technologies developed by the Company under such contracts, and in some cases can terminate the Company's rights in such technologies if the Company fails to commercialize them on a timely basis. In addition, under certain United States Government contracts, the results of the Company's research may be made public by the government, which could limit the Company's competitive advantage with respect to future products based on such research. See "Business -- Intellectual Property and Other Proprietary Rights." INFRINGEMENT OF PROPRIETARY RIGHTS. In the past, the Company has received communications from third parties asserting that Company trademarks infringed such other parties' trademarks, none of which has resulted in litigation or losses to the Company. Given the Company's ongoing efforts to develop and market new technologies and products, the Company may receive communications from third parties asserting that the Company's products infringe, or may infringe, their intellectual property rights. If as a result of any such claims the Company were precluded from using certain technologies or intellectual property rights, licenses to such disputed third-party technology or intellectual property rights might not be available on reasonable commercial terms, if at all. Furthermore, the Company may initiate claims or litigation against third parties for infringement of the Company's proprietary rights or to establish the validity of the Company's proprietary rights. Litigation, either as plaintiff or defendant, could result in significant expense to the Company and divert the efforts of the Company's technical and management personnel from productive tasks, whether or not such litigation is resolved in favor of the Company. In the event of an adverse ruling in any such litigation, the Company might be required to pay substantial damages, discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to infringing technology, and the court might invalidate the Company's patents, trademarks or other proprietary rights. In the event of a successful claim against the Company and the failure of the Company to develop or license a substitute technology, the Company's business, financial condition and results of operations would be materially and adversely affected. As the number of software products increases and the functionality of these products further overlaps, the Company believes that software developers may become increasingly subject to infringement claims. Any such claims, with or without merit, can be time consuming and expensive to defend and could materially and adversely affect the Company's business, financial condition and results of operations. See "Business -- Intellectual Property and Other Proprietary Rights." RISK OF PRODUCT DEFECTS AND PRODUCT LIABILITY. Software products as complex as those offered by the Company often contain undetected errors or failures when first introduced or as new versions are released. In addition, to the extent that the Company may have to develop new products that operate in new environments, such as the Internet, the possibility for program errors and failures may increase due to factors such as the use of new technologies or the need for more rapid product development that is characteristic of the Internet market. Despite pre-release testing by the Company and by current and potential customers, there still may be errors in new products, even after commencement of commercial shipments. The occurrence of such errors could result in delay in, or failure to achieve, market acceptance of the Company's products, which could have a material adverse effect on the Company's business, financial condition and results of operations. Although the Company's license agreements with its customers typically contain provisions designed to limit the Company's exposure to potential product liability claims, it is possible that such limitation of liability provisions may not be effective as a result of existing or future laws or unfavorable judicial decisions. Because the Company's products are used in business-critical 13 16 applications, any errors or failures in such products may give rise to substantial product liability claims, which could have a material adverse effect on the Company's business, financial condition and results of operations. VOLATILITY OF PRICE OF NOTES AND COMMON STOCK. The Company's Common Stock has experienced significant price volatility and such volatility may recur in the future. Factors such as announcements of the introduction of new products by the Company or its competitors, acquisitions of businesses or products by the Company, quarter-to-quarter variations in the Company's operating results and the gain or loss of significant orders, as well as market conditions in the technology and emerging growth company sectors, may have a significant impact on the market price of the Company's Common Stock and, in turn, the market price of the Notes. Further, the stock market has experienced extreme volatility that has particularly affected the market prices of securities of many technology companies and that often has been unrelated or disproportionate to the operating performance of such companies. These market fluctuations may adversely affect the price of the Notes and the Common Stock. The trading prices of many technology companies' stocks, including the Company's Common Stock, reflect price/earnings ratios substantially above historical norms. The trading price of the Company's Common Stock may not remain at or near its current level, which, in turn, would materially and adversely affect the market price of the Notes. See "Price Range of Common Stock." YEAR 2000 COMPLIANCE. Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than two years, computer systems and/or software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. Significant uncertainty exists in the software industry concerning the potential effects associated with such compliance. The Company anticipates that it will need to devote resources in the next two years to modify its CRLink product to properly process dates beyond December 31, 1999. The Company expects that the cost of making these modifications and distributing the modified product to existing customers will be approximately $500,000. These modifications and the resources that the Company expects to devote to such modifications may divert management and engineering attention from, or delay the development and introduction of, new products and enhancements to existing products. The inability of the Company to complete such modifications successfully and on a timely basis, or the inability of the Company to devote sufficient resources to continuing updates and enhancements to the CRLink product, could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to correct or patch their current software systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase software products such as those offered by the Company, which could result in a material adverse effect on the Company's business, financial condition and results of operations. FACTORS INHIBITING TAKEOVER. The Board of Directors is authorized to issue up to 4,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock, while providing 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 the outstanding voting stock of the Company. The Company has no current plans to issue shares of Preferred Stock. In addition, Section 203 of the Delaware General Corporation Law restricts certain business combinations with any "interested stockholder" as defined by such statute. The statute may have the effect of delaying, deferring or preventing a change in control of the Company. The repurchase option upon a "fundamental change" feature of 14 17 the Notes may in certain circumstances make more difficult or discourage a takeover of the Company and, thus, the removal of incumbent management. See "Description of the Notes -- Repurchase at Option of Holders Upon a Fundamental Change." LEVERAGE; SUBORDINATION AND ABSENCE OF FINANCIAL COVENANTS. In connection with the sale of the Notes, the Company will incur $90.0 million in indebtedness ($100.0 million if the over-allotment option is exercised in full) which will result in a ratio of long-term debt to total capitalization at December 31, 1997 of approximately 46.4% on an as adjusted basis (49.1% if the over-allotment option is exercised in full). As a result of this indebtedness, the Company will have substantial principal and interest obligations. The degree to which the Company will be leveraged could materially and adversely affect the Company's ability to obtain financing for working capital, acquisitions or other purposes and could make the Company more vulnerable to industry downturns and competitive pressures. The Company's ability to meet its debt service obligations will be dependent upon the Company's future performance, which will be subject to financial, business and other factors affecting the operation of the Company, many of which are beyond its control. The Notes will be unsecured and subordinated in right of payment in full to all Senior Indebtedness of the Company. As a result of such subordination, in the event of bankruptcy, liquidation or reorganization of the Company or certain other events, the assets of the Company will be available to pay obligations on the Notes only after all Senior Indebtedness has been paid in full in cash, and there may not be sufficient assets remaining to pay amounts due on any or all of the Notes then outstanding. As a significant portion of the Company's consolidated operations is conducted through subsidiaries, the cash flow and the consequent ability to service debt of the Company, including the Notes, is partially dependent upon the earnings of such subsidiaries and the distribution of those earnings, or upon loans or other payments of funds by those subsidiaries, to the Company. Such subsidiaries are separate and distinct legal entities, and have no obligation, contingent or otherwise, to pay any amounts due pursuant to the Notes or to make any funds available therefor, whether by dividends, distributions, loans or other payments. In addition, the payment of dividends or distributions and the making of loans and advances to the Company by any such subsidiaries may be subject to statutory or contractual restrictions, and may be contingent upon the earnings of those subsidiaries and subject to various business considerations. Any right of the Company to receive assets of subsidiaries upon their liquidation or reorganization (and the consequent right of the Holders of the Notes to participate in these assets) would be effectively subordinated to the claims of that subsidiary's creditors (including trade creditors), except to the extent that the Company is itself recognized as a creditor of such subsidiary, in which case the claims of the Company would still be subordinate to any security interests in the assets of such subsidiary and any indebtedness of such subsidiary senior to that held by the Company. As of December 31, 1997, the Company had no indebtedness outstanding that would have constituted Senior Indebtedness and the Company's subsidiaries had indebtedness and other liabilities outstanding aggregating approximately $254,000 (excluding intercompany liabilities and liabilities of a type not required to be reflected as liabilities on the balance sheets of such subsidiaries in accordance with generally accepted accounting principles) to which the Notes would have been effectively subordinated. The Indenture will not limit the amount of additional indebtedness, including Senior Indebtedness, which the Company can create, incur, assume or guarantee, nor will the Indenture limit the amount of indebtedness which any subsidiary of the Company can create, incur, assume or guarantee. The Company anticipates that from time to time it and its subsidiaries will incur additional indebtedness, including Senior Indebtedness. In addition, the Indenture does not contain any financial covenants or restrictions on the payment of dividends by the Company or the issuance or repurchase of securities by the Company, and contains no covenants or other provisions to afford protection to holders of the Notes in the event of a highly leveraged transaction or a change in control of the Company except to the extent described under 15 18 "Description of Notes -- Subordination" and "-- Repurchase at Option of Holders Upon a Fundamental Change." DISCRETIONARY USE OF PROCEEDS OF OFFERING. The principal purpose of this offering is to increase the Company's capital base and financial flexibility. The Company expects to use the net proceeds principally for general corporate purposes, including working capital, potentially to repurchase outstanding shares of the Company's stock or to acquire complementary businesses, products or technologies. As a consequence, the Company's management will have the ability to allocate the net proceeds of this offering at its discretion. There can be no assurance that the proceeds will be utilized in a manner that the Holders of Notes deem optimal or that the proceeds can or will be invested to yield a significant return upon the completion of this offering. Upon completion of this offering, the Company will have more than $130.1 million of cash, cash equivalents and short-term investments (based on balances at December 31, 1997, and assuming no exercise of the Underwriters' over-allotment option and after deducting the estimated underwriting discount and estimated offering expenses payable by the Company), substantially all of which will be invested in short-term, interest-bearing, investment-grade obligations for an indefinite period of time. See "Use of Proceeds." LIMITATIONS ON REPURCHASE OF NOTES. Upon a Fundamental Change (as defined), each Holder of Notes will have certain rights, at the Holder's option, to require the Company to repurchase all or a portion of such Holder's Notes. If a Fundamental Change were to occur, there can be no assurance that the Company would have or be able to obtain sufficient funds to pay the repurchase price for all Notes tendered by the Holders thereof. The Company's existing credit agreement contains, and any future credit agreements or other agreements relating to other indebtedness (including Senior Indebtedness) to which the Company becomes a party may contain, restrictions and provisions that prohibit the Company from repurchasing or redeeming any Notes or provide that a Fundamental Change would constitute an event of default thereunder. In the event that a Fundamental Change occurs at a time when the Company is prohibited from repurchasing or redeeming Notes, the Company could seek the consent of its lenders to the repurchase of Notes or could attempt to refinance the borrowings that contain such prohibition. If the Company does not obtain such a consent or repay such borrowings, the Company would remain prohibited from repurchasing or redeeming Notes. In such case, the Company's failure to repurchase tendered Notes would constitute an Event of Default under the Indenture, which may, in turn, constitute a further default under the terms of other indebtedness that the Company may enter into from time to time, including under any Senior Indebtedness. In such circumstances, the subordination provisions in the Indenture would likely prohibit the repurchase of the Notes. See "Description of Notes -- Repurchase at Option of Holders upon a Fundamental Change." ABSENCE OF PUBLIC MARKET FOR THE NOTES. The Notes are a new issue of securities for which there is currently no public market. There can be no assurance that an active trading market will develop or be maintained for the Notes. If a market for the Notes does develop, the Notes may trade at a discount from their initial offering price, depending upon prevailing interest rates, the market for similar securities, the performance of the Company, the market price for the Company's Common Stock and other factors. 16 19 USE OF PROCEEDS The net proceeds to the Company from the issuance and sale of the Notes offered hereby are estimated to be $87.2 million ($96.9 million if the Underwriters' over-allotment option is exercised in full), after deducting the estimated underwriting discount and estimated offering expenses. The Company expects to use the net proceeds for working capital and other general corporate purposes. The Company has not allocated any specific portion of the net proceeds to such purposes and management will have the ability to allocate such proceeds at its discretion. A portion of the net proceeds may be used to repurchase shares of the Company's Common Stock from time to time in the open market. A portion of the net proceeds may also be used to acquire or invest in complementary businesses or products or otherwise to obtain the right to use complementary technologies or data. From time to time, in the ordinary course of business, the Company evaluates potential acquisitions of such businesses, products, technologies or data. The Company has no present understandings, commitments or agreements with respect to any material acquisition of businesses, products, technologies or data. Pending use of the net proceeds, the Company intends to invest such funds in short-term, interest-bearing, investment-grade securities. See "Risk Factors -- Discretionary Use of Proceeds of Offering." PRICE RANGE OF COMMON STOCK The Company's Common Stock has been traded on the Nasdaq National Market since June 1995 under the symbol "HNCS." The following table sets forth for the periods indicated the high and low sales prices of the Common Stock. Prior to June 1995, there was no established public trading market for the Common Stock. All prices have been adjusted to give effect to a two-for-one stock split effected in the form of a stock dividend paid in April 1996.
HIGH LOW ---- ---- 1996: First Quarter.................................... $38 3/4 $18 1/4 Second Quarter................................... 51 31 1/4 Third Quarter.................................... 47 1/2 20 3/4 Fourth Quarter................................... 45 1/4 26 1/4 1997: First Quarter.................................... $36 3/4 $23 1/4 Second Quarter................................... 42 3/8 18 1/4 Third Quarter.................................... 43 5/8 33 3/4 Fourth Quarter................................... 43 1/2 30 1998: First Quarter (through February 25, 1998)........ $43 $32 9/16
On February 25, 1998, the last reported sale price of the Common Stock on the Nasdaq National Market was $32 11/16 per share. As of February 13, 1998, there were approximately 186 holders of record of the Common Stock. DIVIDEND POLICY The Company has never declared or paid any cash dividends on its capital stock. The Company currently anticipates that it will retain all future earnings for use in its business and does not anticipate paying any cash dividends in the foreseeable future. The Company's bank credit agreement prohibits the Company from declaring or paying any cash dividends without the bank's consent. 17 20 CAPITALIZATION The following table sets forth the capitalization of HNC at December 31, 1997 and as adjusted to give effect to the sale by the Company of the Notes offered hereby.
DECEMBER 31, 1997 ------------------------ ACTUAL AS ADJUSTED -------- ----------- (IN THOUSANDS) % Convertible Subordinated Notes due 2003....................... $ -- $ 90,000 -------- -------- Stockholders' equity: Preferred stock, $0.001 par value -- 4,000,000 shares authorized: no shares issued or outstanding.................. -- -- Common stock, $0.001 par value -- 50,000,000 shares authorized: 24,537,550 shares issued and outstanding(1).................. 25 25 Paid-in capital................................................. 95,919 95,919 Unrealized loss on investments available for sale............... (2) (2) Foreign currency translation adjustment......................... (111) (111) Retained earnings............................................... 8,029 8,029 -------- -------- Total stockholders' equity................................... 103,860 103,860 -------- -------- Total capitalization.................................... $103,860 $ 193,860 ======== ========
- --------------- (1) Excludes the shares reserved for issuance upon conversion of the Notes, 4,591,133 shares of Common Stock subject to stock options outstanding at December 31, 1997 at a weighted average exercise price of $23.92 per share and an additional 393,075 shares of Common Stock reserved for issuance under the Company's stock option and stock purchase plans at such date. In February 1998, the Company adopted a nonqualified stock option plan and reserved 1,000,000 shares of Common Stock for issuance thereunder. The Underwriters are concurrently offering 2,100,000 shares of the Company's Common Stock, of which 20,000 shares will be issued and sold by the Company. The net proceeds from such sale will not be material. 18 21 SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data as of December 31, 1996 and 1997 and for each of the years in the three-year period ended December 31, 1997 have been derived from HNC's Consolidated Financial Statements included elsewhere in this Prospectus, which have been audited by Price Waterhouse LLP, independent accountants, as indicated in their report thereon appearing elsewhere herein. The selected consolidated financial data as of December 31, 1994 and 1995 and for the year ended December 31, 1994 have been derived from separate audited financial statements for HNC and CompReview not included herein. The selected consolidated financial data as of and for the year ended December 31, 1993 have been derived from separate financial data for HNC and CompReview not included herein. The data set forth below are qualified in their entirety by reference to, and should be read in conjunction with, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and related notes thereto included elsewhere in this Prospectus.
YEAR ENDED DECEMBER 31, ------------------------------- 1995 1996 1997 ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF INCOME DATA(1): Revenues: License and maintenance..................................................... $24,561 $48,890 $89,643 Installation and implementation............................................. 4,648 6,691 10,702 Contracts and other......................................................... 9,146 11,128 7,772 Service bureau.............................................................. 5,349 4,730 5,618 -------- ------- ------- Total revenues....................................................... 43,704 71,439 113,735 -------- ------- ------- Operating expenses: License and maintenance..................................................... 7,903 13,725 19,937 Installation and implementation............................................. 1,425 2,714 5,174 Contracts and other......................................................... 6,894 7,694 5,438 Service bureau.............................................................. 3,025 3,365 4,320 Research and development.................................................... 6,998 13,808 21,151 Sales and marketing......................................................... 7,276 11,923 22,049 General and administrative.................................................. 5,101 8,551 12,626 -------- ------- ------- Total operating expenses............................................. 38,622 61,780 90,695 -------- ------- ------- Operating income.............................................................. 5,082 9,659 23,040 Interest and other income..................................................... 912 2,178 2,003 Interest expense.............................................................. (428) (478) (81) Minority interest in income of consolidated subsidiary........................ -- -- (43) -------- ------- ------- Income before income tax (benefit) provision......................... 5,566 11,359 24,919 Income tax (benefit) provision................................................ (511) (534) 7,354 -------- ------- ------- Net income........................................................... $ 6,077 $11,893 $17,565 ======== ======= ======= Earnings per share: Basic net income per common share(2)........................................ $ 0.38 $ 0.50 $ 0.72 ======== ======= ======= Diluted net income per common share(2)...................................... $ 0.28 $ 0.47 $ 0.68 ======== ======= ======= Unaudited pro forma data(3): Income before income tax provision.......................................... $ 5,566 $11,359 $24,919 Income tax provision........................................................ 1,032 1,628 9,502 -------- ------- ------- Net income........................................................... $ 4,534 $ 9,731 $15,417 ======== ======= ======= Basic pro forma net income per common share(3).............................. $ 0.64 ======= Diluted pro forma net income per common share(3)............................ $ 0.60 ======= Shares used in computing basic net income per common share and unaudited basic pro forma net income per common share....................................... 15,195 23,552 24,275 ======== ======= ======= Shares used in computing diluted net income per common share and unaudited diluted pro forma net income per common share............................... 21,510 25,363 25,681 ======== ======= =======
19 22
YEAR ENDED DECEMBER 31, ------------------------------------------------ 1993 1994 1995 1996 1997 ------- ------- ------- ------- -------- (IN THOUSANDS, EXCEPT RATIO AND PER SHARE DATA) ADDITIONAL STATEMENT OF INCOME DATA:(1) Total revenues............................... $16,167 $29,838 $43,704 $71,439 $113,735 Operating income............................. 1,034 2,881 5,082 9,659 23,040 Net income................................... 875 3,142 6,077 11,893 17,565 Basic net income per common share(2)......... 0.02 0.28 0.38 0.50 0.72 Diluted net income per common share(2)....... 0.02 0.17 0.28 0.47 0.68 Pro forma net income(3)...................... 641 2,137 4,534 9,731 15,417 Basic pro forma net income per common share(3)................................... 0.64 Diluted pro forma net income per common share(3)................................... 0.60 Shares used in computing unaudited basic net income per common share and basic pro forma net income per common share................ 8,591 8,642 15,195 23,552 24,275 Shares used in computing unaudited diluted net income per common share and diluted pro forma net income per common share.......... 9,289 18,142 21,510 25,363 25,681 OTHER DATA: Ratio of earnings to fixed charges(4)........ 3.00x 4.87x 6.99x 12.15x 26.51x
DECEMBER 31, ------------------------------------------------ 1993 1994 1995 1996 1997 ------- ------- ------- ------- -------- (IN THOUSANDS) BALANCE SHEET DATA: Cash, cash equivalents and investments available for sale......................... $ 4,679 $ 7,827 $44,975 $34,849 $ 42,946 Total assets................................. 10,944 20,663 63,113 98,293 119,877 Long-term obligations, less current portion.................................... 367 917 1,373 264 63 Mandatorily redeemable convertible preferred stock...................................... 12,452 13,169 -- -- --
- --------------- (1) The selected consolidated financial data gives retroactive effect to the acquisitions of Risk Data, Retek and CompReview for all periods presented, accounted for as poolings of interests. (2) The computations of basic net income per common share for 1993, 1994 and 1995 include reductions of consolidated net income in the amounts of $717,000, $717,000 and $348,000, respectively, related to the accretion of dividends on mandatorily redeemable convertible Preferred Stock, which converted into Common Stock upon the closing of the Company's initial public offering on June 26, 1995. The computation of diluted net income per common share for 1993 does not include the assumed conversion of all outstanding shares of mandatorily redeemable convertible Preferred Stock into 7,675,000 shares of Common Stock or an increase to net income per common share related to the elimination of dividend accretion on such Preferred Stock as the impact would be antidilutive. (3) Pro forma net income and net income per common share reflect a provision for taxes on the income of CompReview, which was a subchapter S corporation prior to its acquisition by HNC, as if CompReview had been subject to corporate income taxes as a C corporation for all periods presented. (4) The ratio of earnings to fixed charges has been computed by dividing earnings available for fixed charges (earnings before income taxes plus fixed charges less capitalized interest) by fixed charges (interest expense plus capitalized interest and the portion of rental expense that represents interest). 20 23 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Prospectus (including without limitation the following section regarding Management's Discussion and Analysis of Financial Condition and Results of Operations) contains forward-looking statements (within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act) regarding the Company and its business, financial condition, results of operations and prospects. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this Prospectus. Additionally, statements concerning future matters such as the development of new products, enhancements or technologies, possible changes in legislation and other statements regarding matters that are not historical are forward-looking statements. Although forward-looking statements in this Prospectus reflect the good faith judgment of the Company's management, such statements can only be based on facts and factors currently known by the Company. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include without limitation those discussed in "Risk Factors" as well as those discussed elsewhere in this Prospectus and in any documents that are incorporated into this Prospectus by reference. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Prospectus. The Company undertakes no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Prospectus. Readers are urged to carefully review and consider the various disclosures made by the Company in this Prospectus and in the Company's Annual Report on Form 10-K for the year ended December 31, 1997, as amended, filed with the Commission, which attempts to advise interested parties of the risks and factors that may affect the Company's business, financial condition, results of operations and prospects. OVERVIEW HNC develops, markets and supports predictive software solutions for leading service industries. These predictive software solutions employ proprietary neural-network predictive decision engines, profiles, traditional statistical modeling, business models, expert rules and context vectors to convert existing data and business experiences into meaningful recommendations and actions. HNC was founded in 1986 to provide software tools and contracted technology services using neural-network technology. In August 1996, HNC completed its acquisition of Risk Data in a transaction accounted for as a pooling of interests. Risk Data is based in Irvine, California and develops, markets and supports proprietary software decision products for use in the insurance industry. In 1996, HNC formed Aptex Software Inc. ("Aptex"), a majority-owned subsidiary located in San Diego, California that develops, markets and supports electronic text analysis technology in products designed for the Internet and other environments. In November 1996, HNC completed its acquisition of Retek in a transaction accounted for as a pooling of interests. Retek is based in Minneapolis, Minnesota and develops, markets and supports software products that provide merchandise management and other management tools to retailers and their vendors. In November 1997, the Company completed its acquisition of CompReview, in a transaction accounted for as a pooling of interests. CompReview is located in Costa Mesa, California and develops, markets and supports a software product and related services designed to assist in the management and containment of the medical costs of workers' compensation and automobile accident medical claims. CompReview provides its product and services primarily to insurance companies, managed care organizations, third party administrators and large self-insured employers. The Company anticipates that from time to time it 21 24 will consider acquisitions of other businesses in order to expand the markets served by the Company and to acquire complementary technologies, products and personnel. See "Risk Factors -- Acquisitions" and "Business -- HNC's Strategy." After giving retroactive effect to the Company's acquisitions of Risk Data, Retek and CompReview, HNC experienced compound annual growth in total revenues of 63% from 1993 through 1997. See "Risk Factors -- Risks Associated with Managing Growth." This revenue growth resulted primarily from increased license fees for the Retek Merchandising System, CRLink, Falcon, MIRA and ProfitMax products and, to a lesser extent, from increased license fees for the Active Retail Intelligence, Retek Data Warehouse, PMAdvisor, CompCompare, Capstone and AREAS products. Because of the long sales and development cycle associated with the Company's products, the Company has not received significant revenues to date from the SelectCast, SelectResponse, SelectResource, VeriComp or PMAdvisor products. See "Risk Factors -- Lengthy and Unpredictable Sales Cycle." The Company markets most of its predictive software solutions as an ongoing service that includes software licenses, decision model updates, application consulting and on-line or on-site support and maintenance. The Company's pricing for the CRLink, Falcon, MIRA, ProfitMax, AREAS, PMAdvisor, CompCompare and ProviderCompare products typically includes an annual or monthly usage fee and a one to seven year contract commitment. In 1995, 1996 and 1997, annual license and maintenance revenues from these contracts represented 61.2%, 56.1% and 55.2% of the Company's total revenues, respectively. The Company's revenues and operating results have varied significantly in the past and may do so in the future. Because the Company's expense levels are based in part on its expectations regarding future revenues and in the short term are fixed to a large extent, the Company may be unable to adjust its spending in time to compensate for any unexpected revenue shortfall. Factors affecting operating results include market acceptance of the Company's products; the relatively large size and small number of customer orders that may be received during a given period; customer cancellation of long-term contracts yielding recurring revenues or customers' ceasing their use of Company products for which the Company's fees are usage based; the length of the Company's sales cycle; the Company's ability to develop, introduce and market new products and product enhancements; the timing of new product announcements and introductions by the Company and its competitors; changes in the mix of distribution channels; changes in the level of operating expenses; the Company's ability to achieve progress on percentage-of-completion contracts; the Company's success in completing certain pilot installations for contracted fees; competitive conditions in the industry; domestic and international economic conditions; and market conditions in the Company's targeted markets. In addition, as a result of recently issued guidance on software revenue recognition, license agreements entered into during a quarter may not meet the Company's revenue recognition criteria. Therefore, even if the Company meets or exceeds its forecast of aggregate licensing and other contracting activity, it is possible that the Company's revenues would not meet expectations. Furthermore, the Company's operating results may be affected by factors unique to certain of its product lines. For example, the Company derives a substantial and increasing portion of its revenues from its retail products, which are generally priced as "perpetual" license transactions in which the Company receives a one-time license fee. The Company recognizes these fees as revenue upon delivery of the software and acceptance by the customer. Thus, failure to complete a perpetual license transaction during a fiscal quarter could have a disproportionate adverse impact on the Company's operating results for that quarter. The Company expects fluctuations in its operating results to continue for the foreseeable future. Accordingly, the Company believes that period-to-period comparisons of its financial results should not be relied upon as an indication of future performance. The Company may not be able to maintain profitability on a quarterly or annual basis in the future. Due to all of the foregoing factors, it is possible that in some future quarter the Company's operating results will be below the expectations of public market analysts and investors. In that event, the price of the Company's 22 25 Common Stock and, in turn, the market price of the Notes, would likely be materially adversely affected. RESULTS OF OPERATIONS The Company's statements of income for all periods presented give retroactive effect to the acquisitions of Risk Data, Retek and CompReview in August 1996, November 1996 and November 1997, respectively, each of which was accounted for as a pooling of interests. Total Revenues The Company's revenues are comprised of license and maintenance revenues, installation and implementation revenues, contracts and other revenues and service bureau revenues. Total revenues increased by 63.5% to $71.4 million in 1996 and by 59.2% to $113.7 million in 1997. International operations and export sales represented 12.6%, 17.7% and 16.8% of total revenues in 1995, 1996 and 1997, respectively. The retail product line currently has more sales in international markets than the healthcare/insurance and financial services product lines combined. The Company believes that international sales represent a significant opportunity for revenue growth and expects international sales to increase as a percent of total revenue. License and Maintenance Revenues. The Company's license and maintenance revenues are derived from annual license fees, monthly license fees, perpetual license fees and annual maintenance fees. The Company typically licenses many of its products for an annual or monthly usage fee under long-term contracts that include software licenses, decision model updates, application consulting, and on-line or on-site support and maintenance. The Company's revenue from periodic software license and maintenance agreements is generally recognized ratably over the respective license or agreement periods. Revenue from certain short-term periodic software license and maintenance agreements with guaranteed minimum license fees is recognized as related services are performed. Transactional fees are recognized as revenue based on system usage or when fees based on system usage exceed the monthly minimum license fees. Revenue from perpetual licenses of the Company's software for which there are no significant continuing obligations and collection of the related receivables is probable is recognized on delivery of the software and acceptance by the customer. Recently issued guidance on software revenue recognition could lead to unanticipated changes in the Company's revenue recognition practices. See "Risk Factors -- Potential Fluctuations in Operating Results" and "-- New Accounting Pronouncements." License and maintenance revenues increased by 99.1% to $48.9 million in 1996 and by 83.4% to $89.6 million in 1997. The increase from 1995 to 1996 was due primarily to the growth of license fees in all markets, particularly from the Retek Merchandising System, CRLink and Falcon, and, to a lesser extent, MIRA and CompCompare. The increase from 1996 to 1997 was due primarily to the growth of license fee revenues from the Retek Merchandising System and CRLink. Also contributing to the increase were increased license fees from other retail products, such as ARI and Retek Data Warehouse, financial services products such as Falcon, ProfitMax and Capstone, and other healthcare/insurance products, such as PMAdvisor and MIRA. Installation and Implementation Revenues. Revenues from software installations and implementations are generally recognized as the services are performed using the percentage of completion method based on costs incurred to date compared to total estimated costs at completion. Amounts received in advance of performance under the contracts are recorded as deferred revenue and are generally recognized within one year from receipt. Installation and implementation revenues increased by 44.0% to $6.7 million in 1996 and by 59.9% to $10.7 million in 1997. Substantially all of the increase from 1995 to 1996 was due primarily to growth in the installations of Retek Data Forecasting as this product moved 23 26 from development into production. The increase from 1996 to 1997 was due primarily to growth in the installations of Capstone and ProfitMax. Contracts and Other Revenues. Contracts and other revenues are derived primarily from new product development contracts with commercial customers and research contracts with the United States Government. The Company typically contracts with one or two commercial partners for pilot development and installation of its new products and with the United States Government for additional research funds. Revenues from contract services are generally recognized as the services are performed using the percentage of completion method based on costs incurred to date compared to total estimated costs at completion. Revenue from hardware product sales, which is included in contracts and other revenue, is recognized upon shipment to the customer. Contracts and other revenues increased by 21.7% to $11.1 million in 1996 and decreased by 30.2% to $7.8 million in 1997. The increase in 1996 was primarily the result of greater revenues from commercial new product pilot installation contracts with customers in support of the Company's development of ProfitMax, SelectCast, Falcon Sentry and Capstone. The decrease in 1997 was primarily the result of products such as ProfitMax, Retek Data Forecasting and Capstone moving from development into production. During 1997, the Company had fewer new product development projects and new product pilot installations than during 1996. There can be no assurance that any of these product development projects or pilot installations will be successful or be completed within anticipated time schedules or that the customers who serve as pilot installation sites will be satisfied with these products or agree to license them. If the Company's new product development efforts are unsuccessful, are not completed on a timely basis or are not well received by pilot customers, the Company may be compelled to delay or discontinue the release of production versions of these products or bear increased expense to bring these pilot products to market, either of which would have a material adverse effect on the Company's business, financial condition and results of operations. Service Bureau Revenues. Service bureau revenues are derived from the Company's service bureau operations, which provide CRLink's functionality to customers that do not wish to obtain a license, that use this service until they can implement their own internal CRLink operation or that use this service when their volumes peak to high levels. Service bureau customers typically subscribe for services under month-to-month agreements. Service bureau fees are recognized as revenue when the processing services are performed. Service bureau revenues decreased by 11.6% to $4.7 million in 1996 and increased by 18.8% to $5.6 million in 1997. The decrease in 1996 was primarily a result of the significant increase in license revenues as the Company's sales efforts were focused on licensing CRLink to customers rather than marketing service bureau services. The increase in 1997 was primarily due to an increase in the number of customers utilizing service bureau operations. Gross Margin The following table sets forth the gross margin for each of the Company's revenue categories for each of the comparison periods.
YEARS ENDED DECEMBER 31, ------------------------ 1995 1996 1997 ---- ---- ---- License and maintenance........................... 67.8% 71.9% 77.8% Installation and implementation................... 69.3 59.4 51.7 Contracts and other............................... 24.6 30.9 30.0 Service bureau.................................... 43.4 28.9 23.1
24 27 License and Maintenance Gross Margin. License and maintenance costs primarily represent the Company's expenses for personnel engaged in customer support, travel to customer sites and documentation materials. The Company's gross margin on license and maintenance revenues was 67.8%, 71.9% and 77.8% in 1995, 1996 and 1997, respectively. In 1996, the improvement in gross margin was the result of the Company's ability to move from price discounts for early adopters of its products to full pricing for products sold to subsequent customers as well as a higher volume of international licenses, which generate relatively higher margins than domestic operations due, in part, to lower overhead expenses as a result of less corporate infrastructure. Gross margin improved in 1997 due primarily to license fees increasing at a higher rate than the costs associated with providing these licenses. This increase was primarily attributable to increased pricing producing higher margins in the retail and healthcare/insurance markets. Installation and Implementation Gross Margin. Installation and implementation costs consist primarily of personnel-related costs, travel and equipment. The Company's gross margin on installation and implementation revenues was 69.3%, 59.4% and 51.7% in 1995, 1996 and 1997, respectively. In 1996, the decrease in the gross margin was due primarily to new installations of Retek Data Forecasting, which have substantially lower margins than installations of Falcon products, which represented a majority of installations in 1995. Gross margin decreased in 1997 due primarily to an increase in Capstone implementations, which have substantially lower margins than implementations of Falcon products. Contracts and Other Gross Margin. Contracts and other costs consist primarily of personnel-related costs. The Company's gross margin on contracts and other revenues was 24.6%, 30.9% and 30.0% in 1995, 1996 and 1997, respectively. The improvement in gross margin during 1996 was due primarily to the Company's increased ability to better price its new pilot projects. The slight decrease in gross margin for 1997 was due to the decrease in new product development contracts, while government projects with substantially lower margins remained relatively constant in absolute dollars. Service Bureau Gross Margin. Service bureau costs consist primarily of the personnel and facilities costs of operating the service bureaus. The Company's gross margin on service bureau revenues was 43.4%, 28.9% and 23.1% in 1995, 1996 and 1997, respectively. The decrease in 1996 was a result of the loss of a customer in early 1996 for which the Company was able to recognize higher than usual margins during 1995. The decrease in 1997 was attributable to an increase in fixed costs and in labor costs required to support the service bureau business that outpaced the increase in revenue. This was the result of a more static customer base and higher fixed costs associated with the infrastructure necessary to run the service bureau operation. Other Operating Expenses Research and Development Expenses. Research and development expenses consist primarily of salaries and other personnel-related expenses, subcontracted development services, depreciation for development equipment and supplies. Research and development expenses increased from $7.0 million in 1995 to $13.8 million in 1996 and to $21.2 million in 1997, representing 16.0%, 19.3% and 18.6% of total revenues in 1995, 1996 and 1997, respectively. Research and development expenses increased in absolute dollars due to the development costs associated with new releases of several products in the retail and financial services product lines. The increased research and development expenses in absolute dollars and as a percentage of revenues in 1996 was primarily the result of greater staffing to support more new product development programs, primarily for ProfitMax, Capstone, CompCompare, ProviderCompare and the Retek Merchandising System. The 1996 costs also included the initial product development costs of the Company's Aptex business unit, which did not have a significant impact on revenues. Statement of Financial Accounting Standards No. 86, "Ac- 25 28 counting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," requires capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on the Company's product development process, technological feasibility is not established until completion of a working model. Costs incurred by the Company between completion of the working model and the point at which a product is ready for general release have been insignificant. As a result, no significant software development costs were capitalized through December 31, 1997. The Company anticipates that research and development expenses will increase in dollar amount and could increase as a percentage of total revenues for the foreseeable future. Sales and Marketing Expenses. Sales and marketing expenses consist primarily of salaries and benefits, commissions, travel, entertainment and promotional expenses. Sales and marketing expenses increased from $7.3 million in 1995 to $11.9 million in 1996 and to $22.0 million in 1997, representing 16.6%, 16.7% and 19.4% of total revenues in 1995, 1996 and 1997, respectively. The increases were primarily a result of increased staffing as the Company built its direct sales and marketing staff, opened sales offices in Japan and in several locations in Europe, and increased expenses for trade shows, advertising and other marketing programs. The Company expects sales and marketing expenses to continue to increase for the foreseeable future. Such expenses could also increase as a percentage of total revenues as the Company continues to develop a direct sales force in Europe and other international markets, expand its domestic sales and marketing organization and increase the breadth of its product lines. General and Administrative Expenses. General and administrative expenses consist primarily of personnel costs for finance, contract administration, human resources and general management, as well as acquisition, insurance and professional services expenses. General and administrative expenses increased from $5.1 million in 1995 to $8.6 million in 1996 and to $12.6 million in 1997, representing 11.7%, 10.3% and 9.8% of total revenues, respectively. General and administrative expenses included $1.2 million of acquisition expenses related to the acquisitions of Risk Data and Retek in 1996 and $1.4 million of acquisition expenses primarily related to the acquisition of CompReview in 1997. Excluding acquisition expenses, general and administrative expenses were $5.1 million, $7.4 million and $11.2 million in 1995, 1996 and 1997, respectively. The primary reason for these increases in absolute dollars was increased staffing to support the Company's growth and additional expenses associated with being a public company. Operating Income The above factors resulted in operating income of $5.1 million, constituting 11.6% of total revenues in 1995, $9.7 million, constituting 13.5% of total revenues in 1996, and $23.0 million, constituting 20.3% of total revenues in 1997. The Company does not expect that operating income will continue to increase significantly as a percentage of total revenues. Other Income (Expense) Net Interest and other income, net of interest expense, increased from $484,000 in 1995 to $1.7 million in 1996 and to $1.9 million in 1997. The increase in 1996 was primarily attributable to increased interest income in 1996 from higher cash and investment balances, which consisted primarily of the proceeds from the Company's initial public offering in June 1995 and secondary public offering in December 1995. The increase in 1997 was primarily due to a decrease in interest expense of approximately $397,000 primarily related to the repayment of Risk Data's bank notes payable during the third quarter of 1996, offset by a decrease in interest income of approximately $165,000. 26 29 Income Tax (Benefit) Provision The income tax benefit of $511,000 in 1995 was primarily attributable to the recognition of a $2.2 million deferred tax asset based on anticipated future utilization of all of the Company's remaining net operating loss carryforwards and research and development credit carryforwards. The income tax benefit of $534,000 in 1996 was primarily attributable to the recognition of a $2.7 million deferred tax asset based on anticipated future utilization of all of the remaining net operating loss carryforwards and research and development credit carryforwards relating to Risk Data and Retek. That deferred tax asset had previously been offset by a valuation allowance. The Company released the valuation allowance during the fourth quarter of 1996, based upon management's assessment that it was more likely than not that the Company would realize the asset in future periods. The 1997 income tax provision of $7.4 million, or 29.5% of pre-tax income, was lower than 1997 taxes at statutory rates primarily as a result of CompReview's subchapter S corporation status prior to the acquisition, which resulted in most of CompReview's tax liability being borne by its former stockholders. As of the date of the acquisition, CompReview's tax status was changed to C corporation. In the future, the Company expects that the effective tax rate will be reflective of the tax rate of other California-based companies. 27 30 SELECTED PRO FORMA QUARTERLY OPERATING RESULTS The following table presents unaudited pro forma quarterly financial information for each of the eight quarters in the period ended December 31, 1997. This information has been derived from the Company's unaudited financial statements. Pro forma net (loss) income reflects a provision for taxes on the income of CompReview, which was a subchapter S corporation prior to its acquisition by HNC, as if CompReview had been subject to corporate income taxes as a C corporation for all periods presented. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, have been included to present fairly the quarterly results. See "Risk Factors -- Potential Fluctuations in Operating Results" and "-- Lengthy and Unpredictable Sales Cycle."
THREE MONTHS ENDED -------------------------------------------------------------------------------- 1996 1997 --------------------------------------- -------------------------------------- MAR. 31 JUN. 30 SEPT. 30 DEC. 31 MAR. 31 JUN. 30 SEPT. 30 DEC. 31 ------- ------- -------- ------- ------- ------- -------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF INCOME DATA:(1) Revenues: License and maintenance................... $ 8,479 $11,163 $ 13,831 $15,417 $18,331 $22,311 $ 23,705 $25,296 Installation and implementation........... 1,200 1,214 1,399 2,878 1,946 2,188 3,069 3,499 Contracts and other....................... 2,979 3,051 2,784 2,314 2,726 1,805 1,671 1,570 Service bureau............................ 1,219 1,269 1,101 1,141 1,069 1,289 1,544 1,716 ------- ------- ------- ------- ------- ------- ------- ------- Total revenues...................... 13,877 16,697 19,115 21,750 24,072 27,593 29,989 32,081 ------- ------- ------- ------- ------- ------- ------- ------- Operating expenses: License and maintenance................... 3,180 3,120 3,689 3,736 3,994 5,036 4,957 5,950 Installation and implementation........... 589 597 560 968 801 1,251 1,499 1,623 Contracts and other....................... 2,071 1,938 1,860 1,825 1,850 1,454 1,111 1,023 Service bureau............................ 932 947 749 737 864 919 1,203 1,334 Research and development.................. 2,440 3,352 3,748 4,268 4,431 4,930 6,015 5,775 Sales and marketing....................... 2,485 2,981 3,041 3,416 4,553 5,233 5,691 6,572 General and administrative................ 1,829 1,961 2,351 2,410 2,459 2,768 3,142 4,257 ------- ------- ------- ------- ------- ------- ------- ------- Total operating expense............. 13,526 14,896 15,998 17,360 18,952 21,591 23,618 26,534 ------- ------- ------- ------- ------- ------- ------- ------- Operating income............................ 351 1,801 3,117 4,390 5,120 6,002 6,371 5,547 Interest income, net........................ 452 406 384 458 429 481 538 431 ------- ------- ------- ------- ------- ------- ------- ------- Income before pro forma income tax provision (benefit)..................... 803 2,207 3,501 4,848 5,549 6,483 6,909 5,978 Pro forma income tax provision (benefit).... 934 1,119 1,138 (1,563) 2,115 2,475 2,623 2,289 ------- ------- ------- ------- ------- ------- ------- ------- Pro forma net (loss) income............... $ (131) $ 1,088 $ 2,363 $ 6,411 $ 3,434 $ 4,008 $ 4,286 $ 3,689 ======= ======= ======= ======= ======= ======= ======= ======= AS A PERCENTAGE OF TOTAL REVENUES: Revenues: License and maintenance................... 61.1% 66.8% 72.3% 70.9% 76.2% 80.9% 79.1% 78.9% Installation and implementation........... 8.6 7.3 7.3 13.2 8.1 7.9 10.2 10.9 Contracts and other....................... 21.5 18.3 14.6 10.6 11.3 6.5 5.6 4.9 Service bureau............................ 8.8 7.6 5.8 5.3 4.4 4.7 5.1 5.3 ------- ------- ------- ------- ------- ------- ------- ------- Total revenues...................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 ------- ------- ------- ------- ------- ------- ------- ------- Operating expenses: License and maintenance................... 22.9 18.7 19.3 17.2 16.6 18.2 16.5 18.5 Installation and implementation........... 4.3 3.6 3.0 4.4 3.3 4.5 5.0 5.0 Contracts and other....................... 14.9 11.6 9.7 8.4 7.7 5.3 3.7 3.2 Service bureau............................ 6.7 5.7 3.9 3.4 3.6 3.3 4.0 4.2 Research and development.................. 17.6 20.1 19.6 19.6 18.4 17.9 20.1 18.0 Sales and marketing....................... 17.9 17.8 15.9 15.7 18.9 19.0 19.0 20.5 General and administrative................ 13.2 11.7 12.3 11.1 10.2 10.0 10.5 13.3 ------- ------- ------- ------- ------- ------- ------- ------- Total operating expense............. 97.5 89.2 83.7 79.8 78.7 78.2 78.8 82.7 ------- ------- ------- ------- ------- ------- ------- ------- Operating income............................ 2.5 10.8 16.3 20.2 21.3 21.8 21.2 17.3 Interest income, net........................ 3.3 2.4 2.0 2.1 1.8 1.7 1.8 1.3 ------- ------- ------- ------- ------- ------- ------- ------- Income before pro forma income tax provision (benefit)..................... 5.8 13.2 18.3 22.3 23.1 23.5 23.0 18.6 Pro forma income tax provision (benefit).... 6.7 6.7 5.9 (7.2) 8.8 9.0 8.7 7.1 ------- ------- ------- ------- ------- ------- ------- ------- Pro forma net (loss) income............... (0.9)% 6.5% 12.4% 29.5% 14.3% 14.5% 14.3% 11.5% ======= ======= ======= ======= ======= ======= ======= =======
- --------------- (1) The above table gives retroactive effect to the acquisitions of Risk Data, Retek and CompReview for all periods presented, accounted for as poolings of interests. 28 31 LIQUIDITY AND CAPITAL RESOURCES The $21.0 million of net cash provided by operating activities in 1997 represented net income before depreciation and amortization of approximately $22.4 million, further increased by a decrease in deferred income taxes of $6.9 million and offset by an increase in accounts receivable of $11.1 million. Net cash used in investing activities was $7.7 million in 1997 primarily due to $9.6 million expended for property and equipment during 1997, including $6.0 million for computer equipment to support the increased staffing across the Company, and $1.9 million for furniture and fixtures primarily related to the relocation of the Company's Minneapolis facility, offset by approximately $1.9 million of proceeds from sales and maturities of investments available for sale net of purchases of such investments. Net cash used in financing activities was $3.2 million in 1997 primarily due to $6.8 million in distributions to the former CompReview stockholders offset by $4.0 million in net proceeds from issuances of common stock. As of December 31, 1997, the Company had $42.9 million in cash, cash equivalents and investments. The Company believes that its current cash, cash equivalents and investments available for sale balances, together with the net proceeds from the sale of the Notes, borrowings under its credit facility and net cash provided by operating activities, will be sufficient to meet its working capital and capital expenditure requirements for at least the next 12 months. The credit facility will not be available following issuance of the Notes unless the Company obtains an appropriate consent or amendment from the bank. A portion of the Company's cash could be used to repurchase shares of the Company's Common Stock from time to time in the open market. Management intends to invest the Company's cash in excess of current operating requirements in short-term, interest-bearing, investment-grade securities. A portion of the Company's cash could also be used to acquire or invest in complementary businesses or products or otherwise to obtain the right to use complementary technologies or data. From time to time, in the ordinary course of business, the Company evaluates potential acquisitions of such businesses, products, technologies or data. The Company has no present understandings, commitments or agreements with respect to any material acquisition of businesses, products, technologies or data. YEAR 2000 COMPLIANCE The Company anticipates that it will need to devote resources in the next two years to modify its CRLink product to properly process dates beyond December 31, 1999. The Company expects that the cost of making these modifications and distributing the modified product to existing customers will be approximately $500,000. These modifications and the resources that the Company expects to devote to such modifications may divert management and engineering attention from, or delay the development and introduction of, new products and enhancements to existing products. The inability of the Company to complete such modifications successfully and on a timely basis, or the inability of the Company to devote sufficient resources to continuing updates and enhancements to the CRLink product, could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to correct or patch their current software systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase software products such as those offered by the Company, which could result in a material adverse effect on the Company's business, financial condition and results of operations. NEW ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130 ("FAS 130"), "Reporting Comprehensive Income," which the Company is required to adopt for 1998. This statement will require the Company to report in the financial statements, in addition to net income, comprehensive income and its 29 32 components including foreign currency items and unrealized gains and losses on certain investments in debt and equity securities. Upon adoption of FAS 130, the Company is also required to reclassify financial statements for earlier periods provided for comparative purposes. The adoption of FAS 130 will not have a significant impact on the Company's consolidated financial statement disclosures. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and Related Information," which the Company is required to adopt for its 1998 annual financial statements. This statement establishes standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. Under FAS 131, operating segments are to be determined consistent with the way that management organizes and evaluates financial information internally for making operating decisions and assessing performance. The Company has not determined the impact of the adoption of this new accounting standard on its consolidated financial statement disclosures. In October 1997, the American Institute of Certified Public Accountants issued Statement of Position No. 97-2 ("SOP 97-2"), "Software Revenue Recognition," which the Company is required to adopt for agreements entered into with customers beginning in 1998. This statement provides guidance for software revenue recognition matters primarily from a conceptual level and does not include specific implementation guidance. Based on its reading and interpretation of SOP 97-2, the Company believes that the adoption of SOP 97-2 will not have a significant impact on its financial statements; however, detailed implementation guidelines for this standard have not yet been issued. Once issued, such detailed implementation guidelines could lead to unanticipated changes in the Company's current revenue recognition practices, and such changes could be material to the Company's financial statements. 30 33 BUSINESS HNC develops, markets and supports predictive software solutions for leading service industries. These predictive software solutions employ proprietary neural-network predictive decision engines, profiles, traditional statistical modeling, business models, expert rules and context vectors to convert existing data and business experiences into meaningful recommendations and actions. Just as manufacturing organizations have implemented manufacturing resource planning ("MRP") software to automate routine transactions, leading service industries such as the health-care/insurance, financial services and retail industries are using predictive software solutions to improve profitability, competitiveness and customer satisfaction. INDUSTRY BACKGROUND Today's competitive business environment has forced many service companies to increase business efficiency while improving their flexibility and responsiveness to changing market conditions. Businesses continually seek new ways to make better decisions by collecting and analyzing data. Consequently, service companies have made, and continue to make, significant investments in computer systems designed to gather and electronically store ever increasing amounts of data. In most cases, these computerized systems automate manual tasks and activities, resulting in the conversion of significant amounts of corporate data from paper to electronic form. However, these systems generally do not synthesize data in ways that help businesses make better real-time decisions. Historically, the development of predictive software solutions was inhibited by the lack of computing standards and effective computational intelligence techniques. The emergence of client-server standards, including relational database management systems, the Windows operating system and network communications protocols, has fostered the increased transmission and dissemination of electronically stored data within and among businesses. MRP software systems were developed to automate production, accounting, human resources and distribution transactions for primarily manufacturing organizations. These systems manage and store large amounts of diverse business information, providing continuous and simultaneous availability of information to geographically dispersed employees, customers and suppliers. However, MRP systems generally do not provide businesses with the functionality and flexibility needed to utilize this data to simulate operations and make real-time decisions and recommendations in diverse and rapidly changing business environments. Several service industries have a particular need to leverage large volumes of real-time transactional and operational data in order to address systemic issues that have historically affected profitability, competitiveness and customer satisfaction. These industries and issues include: - HEALTHCARE/INSURANCE INDUSTRY. Workers' compensation fraud and abuse is currently receiving widespread attention in the healthcare/insurance industry. Conning & Co. recently estimated that 10%-25% of the dollar amount of filed workers' compensation claims in the United States are fraudulent. This translates to more than $5 billion lost each year to workers' compensation fraud. - FINANCIAL SERVICES INDUSTRY. Based on reports from Visa and Mastercard, Faulkner & Gray estimates that United States credit card credit losses and chargeoffs were $18 billion in 1996. - RETAIL INDUSTRY. Rapid changes in consumer buying patterns have caused merchants to place increased emphasis on predicting consumer demand and managing retail inventories. The change from mass to individual retail marketing has multiplied the number of promotional offers and stock-keeping units ("SKUs") required to address market opportunities. 31 34 The U.S. Department of Commerce estimates that the inventory carrying costs for retail inventories nationwide were $316 billion at the end of March 1997. Historically, many companies in the healthcare/insurance, financial services and retail industries have developed specialized in-house applications to address these issues. Such applications are generally designed to access large volumes of operational and transactional data stored on mainframe computers. However, such systems are expensive, costly to support and maintain, and do not offer flexible and enterprise-wide access to data. Furthermore, most of these systems are not designed to meet the need for real-time recommendations and actions. The widespread adoption of distributed client-server computing has provided organizations with a much greater ability to access and manipulate stored information but also has created the need for third-party vendors of packaged applications software solutions that provide the same degree of functionality and reliability as traditional in-house applications. These vendors are able to provide a higher degree of functionality and reliability than traditional in-house applications by combining the domain knowledge from their customers and partners with expertise in computational intelligence and client-server technologies. THE HNC SOLUTION HNC's predictive software solutions enable leading service industries, such as the healthcare/insurance, financial services and retail industries, to analyze and act upon operational and transactional data in real time. The Company's products provide the following benefits: Core predictive software technology. The Company's software includes a variety of computational intelligence technologies such as proprietary neural-network predictive decision engines, profiles, traditional statistical modeling, business models, expert rules and context vectors that can be customized to specific business applications. Neural networks can be adapted to changing environments and applications quickly and have proven to be accurate and effective in real-time operating environments. The Company's decision engine also includes a user-defined rule-based technology. The neural networks and rulebases are delivered through software that allows the Company's products to adapt to many customer-specific business needs without extensive custom programming. Adaptable functions include workflow queuing management, policy and procedure guidelines, input data modification, flexible graphical user interface ("GUI") display, decision criteria and report formats. Quick payback for customers. The Company's software solutions are designed for quick customer payback. The Company typically installs its products in two to six months, and customer payback periods for installation and first year usage fees are typically less than one year. Payback is rapid because the software products address applications that have a significant profit impact. HNC personnel focus not only on the technical integration, but also on delivering direct benefits to the customer throughout the service contract period. Transaction-based, real-time decision capability. HNC's software can operate in real time, providing an immediate, situation-specific response to each customer transaction. For example, the Falcon system for credit/debit card fraud detection can monitor millions of transactions each day, identify fraudulent transactions in progress and permit the card issuing bank to withhold an authorization before the perpetrator completes a purchase. The Falcon system differs from traditional modeling implementations, which operate in a batch or off-line mode on a collection of historical transactions. Flexible client-server solutions. HNC's solutions can be integrated into a customer's existing environment or architecture. The Company's products are available on industry-standard, client-server platforms, including Windows and UNIX clients, NetWare, Windows NT, UNIX and CICS servers and IBM, Oracle, Sybase and Informix databases. HNC's application products represent a complete software solution, including decision models, deployment software, communications interfaces and GUIs. The Company also supplies systems integration, ongoing performance 32 35 analysis, model rebuilding and application consulting services to help ensure ongoing success for the customer. The Company believes that this flexible combination of products, services and deployment platforms represents an advance that enables successful predictive software system deployment in many mission-critical applications. Turnkey, customized and user-developed model options. The choice of data source is important to customers because data are the fundamental building blocks used to create accurate predictive models. HNC provides various models built on industry-specific or customer-specific data to meet individual application requirements. Customers and data suppliers provide the Company with historical transaction data for turnkey models, trend analyses and product updates. This combination of proprietary turnkey (from data and individual consumer profiles), customized and user-developed models allows the Company to offer products that solve a broad range of predictive application problems. HNC'S STRATEGY HNC's objective is to be the leading supplier of predictive software solutions by leveraging its core computational intelligence technology across a series of product families targeted at specific service industries. The Company's strategy for achieving this objective contains the following key elements: Maintain and strengthen HNC's position at the core of its customers' applications infrastructure. Customers rely heavily on HNC's predictive software solutions to anticipate and react to rapidly changing business conditions. The Company's core computational intelligence technology serves as a platform upon which service businesses can deploy and combine the Company's products to manage and respond to operational and transactional data in real time. Therefore, HNC attempts to establish a strong position within the applications infrastructure of its customers. For example, the Company's first predictive solution product, Falcon, is a credit/debit card fraud detection system for monitoring individual credit card accounts. By adapting the core technology developed for Falcon, the Company later introduced ProfitMax, a transaction-based, real-time credit authorization system that manages the profitability of credit card portfolios. The Company believes that the opportunity exists for similar penetration within each of its core vertical markets, including opportunities such as retail banking within the financial services industry. As another example, the Company's context vectoring technology could profile visitors to a financial institution's Web site and send proactive direct e-mails regarding financial products. Leverage core predictive technologies to enter new market segments. Historically, the Company has applied its core predictive technology to the domain knowledge of companies it has acquired to introduce new products. For example, in August 1996, HNC acquired Risk Data, a developer of decision systems in the workers' compensation industry. By combining Risk Data's industry expertise with HNC's fraud detection technology, HNC is developing a VeriComp module that applies predictive technology to employer fraud in the workers' compensation industry. In addition, the Company is evaluating opportunities in other data-intensive industries, such as telecommunications, where predictive software may have the ability to improve business performance and profitability. Earn recurring revenues through long-term contracts. The Company markets most of its predictive software solutions as an ongoing service that includes software licenses, decision model updates, application consulting and on-line or on-site support and maintenance. Since many of the Company's applications are enhanced by periodic model updates, customers derive significant value from the Company's ongoing services. In addition, the mission-critical nature of many of HNC's predictive software solutions creates customer demand for long-term support commitments. Accordingly, the Company's customers typically pay for this package of software and service with a monthly usage fee and a three to seven year contract commitment. 33 36 Use strategic relationships to support direct distribution. In each of its primary markets, the Company uses strategic relationships with system integrators and third-party service providers to support its direct distribution efforts. These partners provide varying levels of distribution support, from lead generation to resale of the Company's products. The Company maintains such strategic relation\ships with Electronic Data Systems ("EDS"), Intracorp and Marsh McLennan, Inc. in healthcare/insurance, First Data and EDS in financial services, and Andersen Consulting and KPMG Peat Marwick LLP in retail. Growth through acquisitions. The Company acquired Risk Data, Retek and CompReview in 1996 and 1997, thereby significantly expanding its product offerings in its target markets. On January 30, 1998, the Company signed a definitive agreement to acquire Practical Control Systems Technologies, Inc. ("PCS"), a distribution center management software vendor based in Cincinnati, Ohio, subject to the satisfaction of certain closing conditions and the approval of PCS' shareholders. The Company expects to continue to review acquisitions of businesses, products and technologies as a means to expand its product offerings for existing and new target markets. 34 37 MARKETS AND PRODUCTS HNC has a broad family of predictive software products that provide specific solutions for each of the healthcare/insurance, financial services and retail markets. Revenues from each of the Company's three target markets accounted for more than one-quarter of the Company's total revenues in 1997. Revenues from three products, CRLink, Retek Merchandising System and Falcon, accounted for 57.9% of the Company's total revenues in 1997. See "Risk Factors -- Product Concentration." Healthcare/Insurance HNC offers and is developing products in the healthcare/insurance market. These products are targeted to insurance carriers, insurance providers, managed care organizations, state insurance funds, third-party administrators and large, self-insured employers. HNC has developed predictive software solutions that address 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. These solutions, CRLink, MIRA, CompCompare, ProviderCompare, PMAdvisor and VeriComp, allow users the ability to reduce fraud losses and streamline operations. HNC HEALTHCARE/INSURANCE INDUSTRY PRODUCTS ================================================================================
PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------- CRLink CRLink operates as the bill review engine that links all of the critical components of an effective cost containment program to help clients control the cost of workers' compensation, personal injury and other casualty risks. - ------------------------------------------------------------------------------------------------------- MIRA MIRA uses statistical predictive methods to automatically determine workers' compensation loss reserves based on historical data gathered from insurance carriers, third-party administrators and state insurance funds throughout the United States. - ------------------------------------------------------------------------------------------------------- CompCompare CompCompare enables clients to compare claims costs or the effectiveness of managed care programs by using benchmarking data from HNC's proprietary workers' compensation database. - ------------------------------------------------------------------------------------------------------- ProviderCompare ProviderCompare is a physician profiling product that provides on-line access to HNC's proprietary workers' compensation database. ProviderCompare enables clients to generate a detailed comparative analysis, such as treatment costs, among providers within the same specialty. - ------------------------------------------------------------------------------------------------------- PMAdvisor PMAdvisor enables claim payors to verify that the number of visits and type of treatment for claims involving physical medicine (primarily chiropractic and physical therapy) are appropriate for the diagnosis and severity of the injury and to identify chiropractic and physical therapy claims that exceed appropriate treatment guidelines. - ------------------------------------------------------------------------------------------------------- VeriComp VeriComp is a workers' compensation claimant system designed to assist in identifying claimant behavior that is likely to indicate the presence of fraud or abuse. - -------------------------------------------------------------------------------------------------------
Financial Services The increasing volume of electronic financial transactions requires mission-critical decision-making in real time for applications such as credit card charge authorization, that carry a substantial risk of consumer and merchant fraud. HNC's Falcon and ProfitMax product lines are targeted at bank and private label card issuers and payment processors. Falcon employs a client/server architecture that consists of an interface into the customer's legacy system, a decision engine, a cardholder profile database, a case management database and a fraud workstation. 35 38 HNC estimates that loan underwriting costs in the United States currently exceed $2.5 billion each year. Competitive pressures including cost reduction, rapid loan approval and the growth of on-line banking have compelled lenders to turn to software solutions that can automate loan origination in order to lower costs, improve customer service and provide remote access to lending services. HNC's predictive software solutions for the loan origination markets, Capstone and AREAS, allow lenders such as banks and private label card issuers, home equity lenders, auto lenders and mortgage lenders to automate the loan approval decision process. HNC FINANCIAL SERVICES INDUSTRY PRODUCTS ================================================================================
PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------- Falcon Product Line - ------------------------ Falcon Falcon products are neural network-based solutions that examine Falcon Expert transaction, cardholder and merchant data to detect a wide range of Falcon Select credit and debit card fraud. Using predictive software techniques, Falcon Debit Falcon captures relationships and patterns that often are missed by Falcon Retail traditional methods of detecting suspicious transactions. Falcon Sentry Eagle - ------------------------------------------------------------------------------------------------------- Capstone Product Line - ------------------------ Capstone for Payment Capstone is an intelligent, high-performance new account decision Cards processing solution. Based on expert rules, Capstone allows users to Capstone for automate lending decisions and design, test, implement and track Consumer Lending lending policies. Capstone for Mortgage Lending - ------------------------------------------------------------------------------------------------------- ProfitMax Product Line - ------------------------ ProfitMax ProfitMax provides transaction-based, real-time authorization and ProfitMax Bankruptcy action decisions from within a complete infrastructure for managing the profitability of credit card portfolios. ProfitMax uses neural networks, expert rules and HNC's cardholder behavior profiling technology to analyze the expected profitability of each account in an issuer's portfolio using the issuer's definition of financial profit. ProfitMax Bankruptcy uses the basic ProfitMax structure to predict the likelihood of cardholder bankruptcy even before the cardholder is delinquent. - ------------------------------------------------------------------------------------------------------- AREAS AREAS automated property valuation software uses neural networks and other computational intelligence to provide an objective prediction of the current market value of residential property. - -------------------------------------------------------------------------------------------------------
Retail Although retailers have made significant investments in customer information, point-of-sale and quick-response ordering systems, these applications often do not include the forecasting ability required to maximize profitability and respond to competition through timely "in-store" replenishment, electronic networking and quick response initiatives. HNC has developed a group of products that effectively addresses inventory control, merchandise management and financial control management. These software solutions allow retailers to build forecasting and marketing models to carry out day-to-day buying and selling activities, thereby reducing carrying costs for inventories and improving purchasing, promotion and logistics efficiencies. The target markets for the Company's retail products are department stores, mass merchandisers and specialty retail chains in multi-store and multi-warehouse environments with gross sales in excess of $200 million. 36 39 HNC RETAIL INDUSTRY PRODUCTS ================================================================================
PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------- Retek Merchandising The Retek Merchandising System provides inventory control, merchandise System management and financial control and addresses the definition and management of merchandise at the SKU level and reporting and financial control through stock ledgers. - ------------------------------------------------------------------------------------------------------- Retek Data Warehouse Retek Data Warehouse provides the transaction infrastructure needed for retailers to plan, buy, move, sell and pay for their merchandise. - ------------------------------------------------------------------------------------------------------- Active Retail Active Retail Intelligence identifies performance exceptions and Intelligence recommends the appropriate corrective action. - ------------------------------------------------------------------------------------------------------- Retek Demand Retek Demand Forecasting provides forecasts to retailers' supply chain Forecasting planning allocation and replenishment functions and uses predictive causal techniques with automated forecasting and multi-dimensional on-line analysis. - ------------------------------------------------------------------------------------------------------- Falcon Retail Falcon Retail provides proactive detection of private label card application and transaction fraud. - -------------------------------------------------------------------------------------------------------
EMERGING MARKET OPPORTUNITIES The Company's experience and technology capabilities in the healthcare/insurance, financial services and retail markets often lead to new product ideas and concepts. The Company also evaluates new market opportunities that arise through its commercial and government contract work. As contracts are completed, the end products are evaluated for commercialization. For example, contracts for the Advanced Research Projects Agency, United States Army Research Laboratory, United States Air Force, Office of Naval Research, DataTimes Corporation and Tracor Applied Sciences, Inc. generated a context-based text analysis technology called MatchPlus. This core text analysis technology has been under development at HNC for the last four years for Department of Defense applications. During 1996, the Company formed Aptex to commercialize HNC's MatchPlus text analysis technology for emerging markets. Aptex has developed a strategic partnership with InfoSeek Corporation, an Internet search and navigation service, to deliver products using this text analysis technology to the Internet market. To date, three new Internet products have been launched: SelectCast, SelectResponse and SelectResource. Substantially all of the Company's revenues in recent years have been attributable to sales of predictive software solutions and services, and these products and services are currently expected to continue to account for a substantial amount of the Company's future revenues. The market for predictive software solutions is still emerging. The rate at which businesses have adopted the Company's products has varied significantly by market and by product within each market, and the Company expects to continue to experience such variations with respect to its target markets and products in the future. The Company has introduced products for the healthcare/insurance, financial services and retail markets. The Company has recently announced several new products, including PMAdvisor, VeriComp, SelectCast, SelectResponse and SelectResource. To date, none of these products has achieved any significant degree of market acceptance, and there can be no assurance that such products will ever be widely accepted. Although businesses in the Company's target markets have recognized the advantages of using predictive software solutions to automate the decision-making process, many have developed decision automation systems internally rather than licensing them from outside vendors. There can be no assurance that the markets for the Company's products will continue to develop or that the Company's products will be widely accepted, if at all. If the markets for the Company's new or existing products fail to develop, or develop more slowly than anticipated, the Company's sales would be negatively impacted, which would have a material adverse effect on the Company's business, financial condition and results of operations. 37 40 CUSTOMER SERVICE AND SUPPORT A high level of continuing maintenance, service and support is critical to maintaining the performance of the Company's predictive software solutions. Service and support are also essential to the Company's objective of developing long-term relationships with, and obtaining recurring revenues from, customers. The Company's service and support activities are related to system installation, performance validation and ongoing consultation on the optimal use of HNC products. Model and Rule Updates. Most HNC product license agreements include periodic data, model and/or rule updates to maintain system performance. HNC technical personnel generally assist the customer with installation of updates. The Company makes commitments to update models and rules at varying intervals, from fixed times (such as quarterly and annually) to unscheduled times, provided the customer has met its commitments to provide data to HNC. Education. The Company offers comprehensive education and training programs to its customers. The Company provides on-site training services associated with many of its products. Fees for education and training services are generally included in usage-priced products, but may be charged separately in other cases. Consulting. The Company's consultants are available to work with customers' user application groups and information systems organizations. Customers that buy consulting services are usually planning large implementations or want to optimize performance of the Company's products in their operating environments. Fees for consulting are generally included in usage-priced products, but may be charged separately in other cases. PRICING The Company generally establishes prices in one of two ways: usage-based fees and fixed-fee licenses with maintenance. The Company generally employs usage-based pricing for its healthcare/insurance products, Falcon, ProfitMax and AREAS. Under the usage-based pricing structure, HNC generally provides a fixed-term software license, software maintenance, model updates (in the case of HNC-supplied models) and ongoing consulting services in exchange for recurring revenue based on usage. Usage-based term contracts typically include annual price index adjustments. In 1995, 1996 and 1997, annual license and maintenance revenues from these contracts represented 61.2%, 56.1% and 55.2% of the Company's total revenues, respectively. The Company generally employs fixed-fee license pricing for Capstone and all of the Company's retail products except Falcon Retail. Under the fixed-fee license pricing structure, the Company generally licenses the product for the customer's internal use on a perpetual basis. In most cases, the user can separately contract for maintenance services on an annual basis. The Company typically offers early adopter pricing for its usage-based products to customers that agree to be part of pilot or other early product life cycle installations. Early adopter pricing might include reduced-fee perpetual licenses, reduced-fee services or both. The Company often contracts for installation services associated with its predictive software solutions. The Company provides user-specific proposals priced at either fixed-fee levels or on a time and materials basis. In nearly all cases, travel expenses are billed separately at cost. The Company offers contract consulting services. Because of the complexity associated with predictive software solutions, users often request that HNC help them to develop models or analyze problems. Also, the Company from time to time accepts engagements not associated with current product offerings in order to become more familiar with a new application area and determine the potential for new product development. Although consulting services are included with many of the Company's usage-based products, customers may request additional consulting, often associated with custom modeling. 38 41 SALES AND MARKETING The Company sells and markets its software and services in North America and internationally through its direct sales organization, joint marketing and distribution agreements. The Company's worldwide sales and marketing organization consisted of 125 employees as of December 31, 1997. The domestic sales staff is based at the Company's corporate headquarters in San Diego and in United States field offices in California, Colorado, Connecticut, Georgia, Minnesota, New York, Pennsylvania, Texas and Virginia. Internationally, the Company has field sales offices in Australia, Canada, France, Germany, Japan, Singapore, South Africa and the United Kingdom. To support its sales force, the Company conducts comprehensive marketing programs, which include direct mail, public relations, advertising, seminars, trade shows and ongoing customer communication programs. The sales staff is generally product-based, and each representative is assigned a geographic territory. The Company has licensed First Data and EDS to act as service bureaus to provide an alternate channel of distribution for end-users to utilize the Falcon product to process credit card receipts for banks and other credit card issuers. The Company generally assists its service bureau partners in the sales effort, often employing the Company's direct sales force in the process. Company sales representatives earn a commission for service bureau sales in their territory. These service bureaus pay the Company monthly usage fees based on the volume of transactions processed for such credit card issuers. Product licenses to First Data, the largest provider of credit card charge receipt processing services to banks, accounted for 8.7%, 8.6% and 7.6% of the Company's total revenues in 1995, 1996 and 1997, respectively. The Company has licensed First Data to provide its customers with access to the Company's ProfitMax product pursuant to the ProfitMax Contract entered into in January 1996. The Company's revenues under the ProfitMax Contract represented approximately one-quarter of the Company's revenues from First Data in 1997. In late January 1998, First Data asserted that certain restrictive covenants under the ProfitMax Contract violated certain intellectual property laws. First Data also asserted that the existence of such restrictions made the ProfitMax Contract at least temporarily unenforceable and that First Data is therefore not obligated to pay the Company license fees due under the ProfitMax Contract. The Company disputed First Data's claim, released and waived the above-mentioned restrictive covenants in the ProfitMax Contract and gave First Data written notice that the Company intended to terminate the ProfitMax Contract pursuant to its terms unless First Data cured its failure to pay the delinquent license fees in a timely manner. Currently, First Data and the Company are working to resolve their dispute regarding the ProfitMax Contract by negotiating a new agreement. First Data has resumed making license fee payments on a delayed basis, and HNC has agreed to extend the date for First Data to pay past due license fees until mid-April 1998. Although HNC expects to reach a new agreement with First Data that will resolve the pending dispute, there can be no assurance that such an agreement will be reached or that the terms of such an agreement would be as favorable to HNC as its existing contractual arrangements with First Data. If no such agreement can be reached and First Data maintains its current position, it is possible that litigation or arbitration could ensue, which would likely result in a loss of anticipated revenue to the Company under the ProfitMax Contract and possibly other agreements between the Company and First Data, which could have a material adverse effect on the Company's business, financial condition and results of operation. The Company also uses representative agents for certain products in certain territories outside of North America. The Company has agents covering Australia, Austria, France, Germany, Italy, New Zealand, Spain and Switzerland. In 1995, 1996 and 1997, international operations and export sales (includes sales in Canada) represented 12.6%, 17.7% and 16.8% of the Company's total revenues, respectively. International sales result primarily from Falcon product sales and sales of retail products. The Company intends to continue to expand its operations outside the United States and to enter additional international markets, including by adding sales and support offices in Europe and Japan, which will require significant management attention and financial resources. The Company has committed and continues to commit significant time and development resources 39 42 to customizing certain of its products for selected international markets and to developing international sales and support channels. There can be no assurance that the Company's efforts to develop products, databases and models for targeted international markets or to develop additional international sales and support channels will be successful. The failure of such efforts, which can entail considerable expense, could have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Risks Associated with International Sales." International sales are subject to 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. The Company's international sales are currently denominated predominantly in United States dollars and a small portion are denominated in British pounds sterling. An increase in the value of the United States dollar relative to foreign currencies could make the Company's products more expensive, and therefore potentially less competitive, in foreign markets. In the future, to the extent the Company's international sales are denominated in local currencies, foreign currency translations may contribute to significant fluctuations in the Company's business, financial condition and results of operations. If for any reason exchange or price controls or other restrictions on foreign currencies are imposed, the Company's business, financial condition and results of operations could be materially adversely affected. Due in part to the mission-critical nature of certain of the Company's applications, potential customers perceive high risk in connection with adoption of the Company's products. As a result, customers have been cautious in making decisions to acquire the Company's products. In addition, because the purchase of the Company's 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 affect key operations. For these and other reasons, the sales cycle associated with the purchase of the Company's products is typically lengthy, unpredictable and subject to a number of significant risks over which the Company has little or no control, including customers' budgetary constraints and internal acceptance reviews. The sales cycle associated with the licensing of the Company's 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, the Company's ability to forecast the timing and amount of specific sales is limited. A lost or delayed sale could have a material adverse effect on the Company's business, financial condition and results of operations. TECHNOLOGY The Company seeks to develop innovative products by combining industry and application knowledge with its core neural-network technology to address specific market needs. The Company's systems also employ rule-based technology to implement customer strategy, policy and procedures. These technologies are incorporated in computer software and hardware architectures, including client-server hardware, relational databases and object-oriented programming. The Company intends to continue to develop state-of-the-art technologies to enhance its current products and broaden development opportunities. Neural-Network Technology. Neural networks have predictive power that can be improved with experience as the historical database increases in size. The term "neural network" refers to a family of nonlinear, statistical modeling techniques, sometimes called "computational intelligence." These techniques distinguish themselves through a process of automated "learning" or "training" that replaces the time-consuming manual techniques of traditional nonlinear, statistical modeling. The neural-network architecture itself consists of groups of "processing elements," or equations with several inputs and a single output. The output of each element becomes either the 40 43 input to another element or part of the dependent output. Each input receives a "weight" or value, in the equation, which is adjusted during the training process. The actual result from each training record is compared with the answer from the neural network, and the weights are adjusted to reduce the error between the two. This process can become computationally intensive, as millions of training data records must be processed hundreds or thousands of times. HNC has developed proprietary high-speed and parallel-processor boards to accelerate training and execution of its neural-network software. The Company believes that the rapid model development afforded by its technology provides a competitive advantage in the development of predictive software solutions. Rule-Based Technology. The Company's systems also employ rule-based technology to implement customer strategy, policy and procedures. The rules are implemented as part of predictive processes. The Company believes that its combination of neural networks and rule bases in a single decision engine represents a significant competitive advantage over more traditional approaches to decision automation. Context Vector Technology. Context vector technology that originated at HNC and is being commercialized at Aptex is a way to explore, analyze and model unstructured textual data. Context vector technology automatically discovers the underlying structure of free form symbolic data. This structure enables modeling from data elements previously considered impossible to include in predictive software applications. Context vector technology also models behavior. Just as relationships are discovered in unstructured data, observing electronic transaction behavior identifies patterns. Compatibility predictions can be made between information, behavior, people and products. When combined with other HNC technologies, such as neural networks and rule-based systems, the Company believes that context vectors can improve the performance of existing applications while opening new market opportunities. Context vector technology has been demonstrated to increase banner advertising click rates on the Internet, automate e-mail responses and discover unknown relationships in credit card transaction data. The Company's success depends upon its ability to enter new markets by successfully developing new products for such markets on a timely and cost-effective basis. The Company's products often require customer data for decision model development and system installation. As a result, completion of new products (particularly new products for markets not previously served by the Company) may be delayed while the Company extracts sufficient amounts of statistically relevant data and develops the models. During this development process, the Company relies on its potential customers in the new market to provide data and to help train Company personnel in the use and meaning of the data in the specific industry. These relationships also assist the Company in establishing a market presence and credibility in the new market. These potential customers, most of which have significantly greater financial and marketing resources than the Company, may compete with the Company in the future or otherwise discontinue their relationships with or support of the Company, either during development of the Company's products or thereafter. The failure by the Company to obtain adequate third-party support for new product development would have a material adverse effect on the Company's ability to enter new markets and, consequently, on the Company's business, financial condition and results of operations. See "Risk Factors -- Risks Associated with Technological Change and Delays in Developing New Products." RESEARCH AND DEVELOPMENT The Company believes that its future success depends in part on its ability to maintain and improve its core technologies, enhance its existing products and develop new products that meet an expanding range of markets and customer requirements. The Company intends to expand its existing product offerings and to introduce new predictive software solutions. In the development of new products and enhancements to existing products, the Company uses its own tools extensively. Until 1996, the Company relied primarily on internal development of its products. Based on timing and cost considerations, however, the Company has acquired, and in the future 41 44 may consider acquiring, technology or products from third parties. For example, the Company acquired technology and products in connection with its acquisitions of Risk Data and Retek in 1996 and CompReview in 1997. The Company performs all quality assurance and develops documentation internally. The Company intends to continue to support industry standard operating environments, client-server architectures and network protocols. The Company's 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 HNC predictive software solutions. The marketing services organization is responsible for authoring and updating all user documentation and other publications. See "Risk Factors -- Risks Associated with Technological Change and Delays in Developing New Products." The Company strategically targets its long-term research projects. In addition to funds allocated by the Company for research, HNC receives research contracts from a range of commercial sources and the United States Government. Government and commercial contract customers have included the Advanced Research Projects Agency, United States Air Force, Office of Naval Research and Tracor Applied Sciences, Inc. The Company believes that these contracts augment its ability to maintain existing technologies and investigate new technologies that may or may not become part of its products. The United States Government typically retains certain intellectual property rights and licenses in the technologies the Company develops under research contracts directly or indirectly sponsored by the government, and in some cases can terminate the Company's rights in such technologies if the Company fails to commercialize them on a timely basis. Historically, these contracts have not resulted in development of products contributing to the Company's revenues in the fiscal year in which the research contract is performed, or in the subsequent fiscal year. The market for the Company's predictive software solutions for service industries is characterized by rapidly changing technology and improvements in computer hardware, network operating systems, programming tools, programming languages, operating systems and database technology. The Company's success will depend upon its ability to continue to develop and maintain competitive technologies, enhance its 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. For example, the rapid growth of the Internet environment creates new opportunities, risks and uncertainties for businesses, such as the Company, which develop software solutions that now may have to be designed to operate in Internet, intranet and other on-line environments. The Company may not be able to develop and market, on a timely basis, or at all, product enhancements or new products that respond to changing technologies. The Company has 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. Any significant delay in the completion of new products, or the failure of such products, if and when installed, to achieve any significant degree of market acceptance, would have a material adverse effect on the Company's business, financial condition and results of operations. Any failure by the Company to anticipate or to respond adequately to changing technologies, or any significant delays in product development or introduction, could cause customers to delay or decide against purchases of the Company's products and would have a material adverse effect on the Company's business, financial condition and results of operations. 42 45 INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS The Company relies on a combination of patent, copyright, trademark and trade secret laws and confidentiality procedures to protect its proprietary rights. The Company currently owns seven issued United States patents and has four United States patent applications pending. The Company has applied for additional patents for its Falcon technology in Canada, Europe and Japan and for its MIRA product in Australia, Canada and Europe. There can be no assurance that patents will be issued with respect to pending or future patent applications or that the Company's patents will be upheld as valid or will prevent the development of competitive products. The Company seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. As part of its confidentiality procedures, the Company generally enters into invention assignment and proprietary information agreements with its employees and independent contractors and nondisclosure agreements with its distributors, corporate partners and licensees, and limits access to and distribution of its 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 the Company's products or technology without authorization, or to develop similar technology independently. In addition, to ensure that customers will not be adversely affected by an interruption in the Company's business, the Company places source code for certain of its products into escrow, which may increase the likelihood of misappropriation or other misuse of the Company's intellectual property. Moreover, effective protection of intellectual property rights may be unavailable or limited in certain foreign countries in which the Company has done and may do business. Also, the Company has developed technologies under research projects conducted under agreements with various United States Government agencies or subcontractors to such agencies. Although the Company has acquired certain commercial rights to such technologies, the United States Government typically retains ownership of certain intellectual property rights and licenses in the technologies developed by the Company under such contracts, and in some cases can terminate the Company's rights in such technologies if the Company fails to commercialize them on a timely basis. In addition, under certain United States Government contracts, the results of the Company's research may be made public by the government, which could limit the Company's competitive advantage with respect to future products based on such research. In the past, the Company has received communications from third parties asserting that Company trademarks infringe such other parties' trademarks, none of which has resulted in litigation or losses to the Company. Given the Company's ongoing efforts to develop and market new technologies and products, the Company may receive communications from third parties asserting that the Company's products infringe, or may infringe, their intellectual property rights. If as a result of any such claims the Company were precluded from using certain technologies or intellectual property rights, licenses to such disputed third-party technology or intellectual property rights might not be available on reasonable commercial terms, if at all. Furthermore, the Company may initiate claims or litigation against third parties for infringement of the Company's proprietary rights or to establish the validity of the Company's proprietary rights. Litigation, either as plaintiff or defendant, could result in significant expense to the Company and divert the efforts of the Company's technical and management personnel from productive tasks, whether or not such litigation is resolved in favor of the Company. In the event of an adverse ruling in any such litigation, the Company might be required to pay substantial damages, discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to infringing technology, and the court might invalidate the Company's patents, trademarks or other proprietary rights. In the event of a successful claim against the Company and the failure of the Company to develop or license a substitute technology, the Company's business, financial condition and results of operations would be materially and adversely affected. As the number of software products increases and the functionality of these products further overlaps, the Company believes that software developers may become increasingly subject to 43 46 infringement claims. Any such claims, with or without merit, can be time consuming and expensive to defend and could materially and adversely affect the Company's business, financial condition and results of operations. COMPETITION The market for predictive software solutions for service industries is intensely competitive and subject to rapid change. Competitors, many of which have substantially greater financial resources than the Company, vary in size and in the scope of the products and services they offer. The Company encounters competition from a number of sources, including (i) other application software companies, (ii) management information systems departments of customers and potential customers, including banks, insurance companies and retailers, (iii) third party professional services organizations, including without limitation, consulting divisions of public accounting firms, (iv) hardware suppliers that bundle or develop complementary software, (v) network and service providers that seek to enhance their value-added services, (vi) neural-network tool suppliers and (vii) managed care organizations. In the healthcare/insurance market, the Company has experienced competition primarily from NCCI, Corporate Systems and CSC Incorporated. In the workers' compensation and medical cost administration market, the Company has experienced competition from MediCode, Medata, Inc. and Embassy Software with regard to software licensing, and Intracorp and Corvel Corporation in the service bureau operations market. Additionally, the Company has faced competition from ADP in the automobile accident medical claims market. In the financial services market, the Company has experienced competition from Fair, Isaac & Co., Inc., Cogensys (a subsidiary of Policy Management Systems Corporation), Fannie Mae, Freddie Mac, IBM, Nestor, Inc., NeuralTech Inc., Neuralware Inc., PMI Mortgage Services Co., VISA International and others. In the retail market, the Company has experienced competition from JDA Software Group, Inc., SAP AG, PeopleSoft, Inc., IBM, Manugistics Group, Inc. and others. The Company expects to experience additional competition from other established and emerging companies, as well as other technologies. For example, the Company's Falcon product competes against other methods of preventing credit card fraud, such as card activation 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, reduced gross margins and loss of market share, any of which could materially adversely affect the Company's business, financial condition and results of operations. The Company believes that most of its products are currently priced at a premium when compared to its competitors' products. The market for the Company's products is highly competitive, and the Company expects that it will face increasing pricing pressures from its current competitors and new market entrants. In particular, increased competition could reduce or eliminate such premiums and cause further price reductions. In addition, such competition could adversely affect the Company's ability to obtain new long-term contracts and renewals of existing long-term contracts on terms favorable to the Company. Any reduction in the price of the Company's products could materially adversely affect the Company's business, financial condition and results of operations. The Company believes that the principal competitive factors affecting its market include technical performance (for example, accuracy in detecting credit card fraud or evaluating workers' compensation claims), access to unique proprietary databases and product attributes such as adaptability, scalability, ability to integrate with products produced by other vendors, functionality, ease-of-use, product reputation, quality, performance, price, customer service and support, the effectiveness of sales and marketing efforts and Company reputation. Although the Company believes that its products currently compete favorably with respect to such factors, there can be no assurance that the Company can maintain its competitive position against current and potential 44 47 competitors, especially those with significantly greater financial, marketing, service, support, technical and other resources. Some of the Company's current, and many of the Company's potential, competitors have significantly greater financial, technical, marketing and other resources than the Company. 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 the Company. 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 the Company's prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly gain significant market share. Also, the Company relies upon its customers to provide data, expertise and other support for the ongoing updating of the Company's models. The Company's customers, most of which have significantly greater financial and marketing resources than the Company, may compete with the Company in the future or otherwise discontinue their relationships with or support of the Company. There can be no assurance that the Company will be able to compete successfully against current and future competitors or that competitive pressures faced by the Company will not materially adversely affect its business, financial condition and results of operations. EMPLOYEES As of December 31, 1997, the Company had 706 employees, including 316 in product development and support, 87 in customer service, 125 in sales and marketing and 178 in finance, administration and MIS. Most of these employees are located in the United States. None of the Company's employees are represented by a labor union. The Company has experienced no work stoppages and believes that its employee relationships are generally good. The Company's success depends to a significant degree upon the continued service of members of the Company's senior management and other key research, development, sales and marketing personnel. Accordingly, the loss of any of the Company's senior management or key research, development, sales or marketing personnel could have a material adverse effect on the Company's business, financial condition and results of operations. Only a small number of employees have employment agreements with the Company, and there can be no assurance that such agreements will result in the retention of these employees for any significant period of time. In addition, the untimely loss of a member of the management team or a key employee of a business acquired by the Company could have a material adverse effect on the Company's business, financial condition and results of operations, particularly if such loss occurred before the Company has had adequate time to familiarize itself with the operating details of that business. In the past, the Company has experienced difficulty in recruiting a sufficient number of qualified sales and technical employees. In addition, competitors may attempt to recruit the Company's key employees. There can be no assurance that the Company will be successful in attracting, assimilating and retaining such personnel. The failure to attract, assimilate and retain key personnel could have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Risks Associated with Managing Growth." 45 48 FACILITIES The Company's principal administrative, sales, marketing, support, research and development facilities are located in approximately 85,000 square feet of space in San Diego, California. The Company and its subsidiaries also lease an aggregate of approximately 95,000 square feet of additional office space elsewhere in San Diego and in Atlanta, Georgia; Minneapolis, Minnesota; Costa Mesa, California; and Irvine, California. The Company and its subsidiaries also maintain numerous field offices in the United States and in foreign countries. The Company believes that its current facilities are adequate to meet its needs for the foreseeable future. The Company believes that suitable additional or alternative space will be available in the future on commercially reasonable terms as needed. 46 49 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The names, ages and positions of the Company's directors and executive officers as of February 17, 1998 are as follows:
NAME AGE POSITION ------------------------------------------ --- ----------------------------------------------- Robert L. North........................... 62 President, Chief Executive Officer and Director Raymond V. Thomas......................... 55 Vice President, Finance and Administration, Chief Financial Officer and Secretary John Mutch................................ 41 Vice President, Marketing Todd W. Gutschow.......................... 37 Vice President, Technology Development Michael A. Thiemann....................... 41 President, Aptex Software Inc. Edward K. Chandler(1)..................... 39 Director Oliver D. Curme(2)........................ 44 Director Thomas F. Farb(1)......................... 41 Director Charles H. Gaylord, Jr.(2)................ 52 Director
- --------------- (1) Member of the Audit Committee (2) Member of the Compensation Committee Mr. North has been President and Chief Executive Officer and a director of the Company since June 1987. Mr. North is also a director of Peerless Systems Corporation. Mr. North holds Bachelor of Science and Master of Science degrees in Electrical Engineering from Stanford University. Mr. Thomas has been Vice President, Finance and Administration and Chief Financial Officer of the Company since February 1995 and Secretary of the Company since May 1995. From May 1993 to February 1995, he served as Executive Vice President and Chief Financial Officer of Golden Systems, Inc., a power supply manufacturer, and from September 1994 to February 1995 he also served as Chief Operating Officer. From April 1991 to May 1993, Mr. Thomas served as Senior Vice President of Finance and Administration and Chief Financial Officer of Vitesse Semiconductor Corporation, a semiconductor manufacturer. Mr. Thomas holds a Bachelor of Science degree in Industrial Management from Purdue University and attended the Wharton School of Business at the University of Pennsylvania. Mr. Mutch joined the Company in July 1997 as Vice President, Marketing. He was a founder of MVenture Holdings, Inc., a private equity fund that invests in start-up technology companies, and served as a General Partner from June 1994 to July 1997. From December 1986 to June 1994, Mr. Mutch held a variety of positions with Microsoft Corporation, including Director of Organization Marketing. He holds a Bachelor of Science degree in Applied Economics from Cornell University and a Masters degree in Business Administration from the University of Chicago. Mr. Gutschow is a co-founder of the Company and has been Vice President, Technology Development of the Company since October 1990. He was also Secretary of the Company from January 1993 to May 1995. Mr. Gutschow holds a Bachelor of Arts degree in Physics from Harvard University and attended the University of California at San Diego. Mr. Thiemann joined the Company in June 1989. He ran the Company's Aptex text analysis division from January 1996 to September 1996 and in September 1996 was named President and Chief Executive Officer of Aptex Software Inc. From May 1993 to January 1996, he served as Executive Vice President, Sales and Marketing of the Company. He has also served as Executive Vice President and General Manager, Decision Systems of the Company from January 1993 to May 1993, Vice President and General Manager, Decision Systems of the Company from February 1990 to January 1993 and Vice President, New Business Development of the Company from June 1989 to February 1990. Mr. Thiemann holds a Bachelor of Arts degree in Art, a Bachelor of Science degree in Electrical Engineering and a Masters degree in Electrical 47 50 Engineering from Stanford University and a Masters degree in Business Administration from Harvard University. Mr. Chandler has been a director of the Company since August 1991. Since July 1991, he has been President of Prairie-EKC, Inc., a partner of the general partner of PCE 1991 Limited Partnership, a venture capital firm. Since November 1996, Mr. Chandler has also been a Managing Director of Graystone Venture Partners, LLC, a venture capital firm. Mr. Chandler holds a Bachelor of Arts degree in Economics from Yale University and a Masters degree in Business Administration from Harvard University. Mr. Curme has been a director of the Company since June 1987. Since January 1988, he has been a general partner of the general partner of Battery Ventures, L.P., a national venture capital firm. Mr. Curme also serves as a director of several privately held technology companies. Mr. Curme is also a director of InfoSeek Corporation, an Internet search and navigation service company. He holds a Bachelor of Science degree in Biochemistry from Brown University and a Masters degree in Business Administration from Harvard University. Mr. Farb has been a director of the Company since November 1987. Since April 1994, he has been Senior Vice President, Chief Financial Officer and Treasurer of Interneuron Pharmaceuticals, Inc., a publicly-held diversified pharmaceutical company, and an officer of several of its subsidiaries. From October 1992 to March 1994, Mr. Farb served as Vice President of Corporate Development, Chief Financial Officer and Controller of Cytyc Corporation, a medical device and diagnostics company. Mr. Farb also serves as a director of Redwood Trust, Inc., a California-based publicly-held Real Estate Investment Trust. He holds a Bachelor of Arts degree in Sociology from Harvard College. Mr. Gaylord has been a director of the Company since May 1995. He is currently a private technology investor and a director of Stac Inc., a publicly-held software company. From December 1993 to September 1994, Mr. Gaylord served as Executive Vice President of Intuit Inc., a publicly-held personal and small business finance software company, following Intuit's acquisition of ChipSoft, Inc., a tax preparation software company. Prior to that acquisition, from June 1990 to December 1993, he served first as President and Chief Executive Officer and a director of ChipSoft and then as Chairman of the Board of Directors and Chief Executive Officer. He holds Bachelor of Science and Master of Science degrees in Aerospace Engineering from Georgia Institute of Technology and a Masters degree in Business Administration from Harvard University. 48 51 DESCRIPTION OF NOTES The Notes will be issued under an indenture to be dated as of March 1, 1998 (the "Indenture"), between the Company and State Street Bank and Trust Company of California, N.A., as trustee (the "Trustee"), a copy of which has been filed as an exhibit to the Registration Statement of which this Prospectus forms a part. The terms of the Notes will include those stated in the Indenture and those made a part of the Indenture by reference to the Trust Indenture Act of 1939, as amended (the "TIA"), as in effect on the date of the Indenture. The Notes will be subject to all such terms, and Holders of the Notes are referred to the Indenture and the TIA for a statement of such terms. The following is a summary of important terms of the Notes and does not purport to be complete and is qualified in its entirety by reference to the Indenture and the TIA. Reference should be made to all provisions of the Indenture, including the definitions therein of certain terms and all terms made a part of the Indenture by reference to the TIA. Wherever particular provisions or defined terms of the Indenture (or the form of Note which is a part thereof) are referred to, such provisions or defined terms are incorporated herein by reference. References in this section to the "Company" are solely to HNC Software Inc., a Delaware corporation, and not its subsidiaries. GENERAL The Notes will be general unsecured obligations of the Company, subordinate in right of payment to certain other obligations of the Company as described under "-- Subordination," and convertible into Common Stock as described under "-- Conversion." The Notes will be limited to $90,000,000 aggregate principal amount ($100,000,000 if the over-allotment option is exercised in full), will be issued in fully registered form only in denominations of $1,000 or any integral multiple thereof and will mature on March 1, 2003, unless earlier redeemed or repurchased. The Notes will bear interest from March , 1998 at the annual rate set forth on the cover page hereof, payable semiannually on March 1 and September 1, commencing on September 1, 1998, to Holders of record at the close of business on the preceding February 15 and August 15, respectively (subject to certain exceptions in the case of conversion, redemption or repurchase of such Notes prior to the applicable interest payment date). Interest will be computed on the basis of a 360-day year comprised of twelve 30-day months. Principal of and premium, if any, and interest on the Notes will be payable, and the transfer of Notes will be registrable, and the Notes may be presented for conversion, at the office or agency of the Company maintained for such purposes in The City of New York, the State of New York, which shall initially be an office or agency of the Trustee. In addition, payment of interest may, at the option of the Company, be made by check mailed to the address of the person entitled thereto as it appears on the Note register, provided that any Holder of a Note or Notes with an aggregate principal amount in excess of $1,000,000 shall, at the election of such Holder, be paid by wire transfer in immediately available funds. No service charge will be made for any registration or transfer or exchange of Notes, but the Company may require payment of a sum sufficient to cover any tax or other governmental charge payable in connection therewith. The Company is not required to exchange or register the transfer of (i) any Note for a period of 15 days next preceding any selection of Notes to be redeemed, (ii) any Note or portion thereof selected for redemption, (iii) any Note or portion thereof surrendered for conversion or (iv) any Note or portion thereof surrendered for repurchase (and not withdrawn) in connection with a Fundamental Change. The Indenture does not contain any financial covenants or restrictions on the payment of dividends by the Company, the incurrence of indebtedness, including Senior Indebtedness (as defined), or the issuance or repurchase of securities by the Company. The Indenture contains no covenants or other provisions to afford protection to Holders of the Notes in the event of a highly 49 52 leveraged transaction or a change in control of the Company except to the extent described below under "-- Repurchase at Option of Holders Upon a Fundamental Change." CONVERSION The Holder of any Note will be entitled at any time through the close of business on the final maturity date of the Notes, subject to prior redemption or repurchase, to convert any Notes or portions thereof (in denominations of $1,000 or multiples thereof) into Common Stock of the Company, at the conversion price set forth on the cover page of this Prospectus, subject to adjustment as described below. Except as described below, no adjustment will be made on conversion of any Notes for interest accrued thereon or for dividends on any Common Stock issued. If Notes are converted after a record date for the payment of interest and on or prior to the close of business on the business day prior to the next succeeding interest payment date, such Notes, other than Notes called for redemption, when submitted for conversion by the Holder, must be accompanied by funds equal to the interest payable on such succeeding interest payment date on the principal amount so converted. No such payment will be required with respect to interest payable on March 1, 2001. The Company is not required to issue fractional shares of Common Stock upon conversion of Notes and, in lieu thereof, will pay a cash adjustment based upon the market price of the Common Stock on the last business day prior to the date of conversion. In the case of Notes called for redemption, conversion rights will expire at the close of business on the business day preceding the date fixed for redemption, unless the Company defaults in payment of the redemption price, in which case the conversion right shall terminate on the date such default is cured and such Note is redeemed. A Note for which a Holder has delivered a Fundamental Change purchase notice exercising the option of such Holder to require the Company to repurchase such Note may be converted only if such notice is withdrawn by a written notice of withdrawal delivered by the Holder to the Company prior to the close of business on the business day preceding the date fixed for repurchase. The right of conversion attaching to any Note may be exercised by the Holder by delivering the Note at the specified office of a conversion agent, accompanied by a duly signed and completed notice of conversion, together with any funds that may be required as described in the preceding paragraph. The conversion date shall be the date on which the Note, the duly signed and completed notice of conversion and any funds that may be required as described in the preceding paragraph shall have been so delivered. A Holder delivering a Note for conversion will not be required to pay any taxes or duties payable in respect of the issue or delivery of Common Stock on conversion, but will be required to pay any tax or duty which may be payable in respect of any transfer involved in the issue or delivery of the Common Stock in a name other than that of the Holder of the Note. Certificates representing shares of Common Stock will not be issued or delivered unless all taxes and duties, if any, payable by the Holder have been paid. The initial conversion price of $ share of Common Stock (equivalent to a conversion rate of approximately shares per $1,000 principal amount of the Notes) is subject to adjustment (under formulae set forth in the Indenture) in certain events, including: (i) the issuance of Common Stock as a dividend or distribution on Common Stock; (ii) certain subdivisions and combinations of the Common Stock; (iii) the issuance to all Holders of Common Stock of certain rights or warrants to purchase Common Stock (provided that the conversion price will be readjusted to the extent that such rights or warrants are not exercised prior to the expiration thereof); (iv) the distribution to all Holders of Common Stock of shares of capital stock of the Company (other than Common Stock) or evidences of indebtedness of the Company or assets (including securities, but excluding those rights, warrants, dividends and distributions referred to above or paid in cash); (v) distributions consisting of cash, excluding any quarterly cash dividend on the Common Stock to the extent that the aggregate cash dividend per share of Common Stock in any quarterly period does not exceed the greater of (x) the amount per share of Common Stock of the next preceding quarterly cash dividend on the Common Stock to the extent that such 50 53 preceding quarterly dividend did not require an adjustment of the conversion price pursuant to this clause (v), and (y) 3.75% of the average of the daily Closing Prices (as defined) of the Common Stock for the ten consecutive Trading Days (as defined) immediately prior to the date of declaration of such dividend, and excluding any dividend or distribution in connection with the liquidation, dissolution or winding up of the Company; (vi) payment in respect of a tender or exchange offer by the Company for the Common Stock to the extent that the cash and value of any other consideration included in such payment per share of Common Stock exceeds the Current Market Price (as defined) per share of Common Stock on the Trading Day next succeeding the last date on which tenders or exchanges may be made pursuant to such tender or exchange offer; and (vii) payment in respect of a tender offer or exchange offer by a person other than the Company in which, as of the closing date of the offer, the Board of Directors is not recommending rejection of the offer. In the event of a distribution to substantially all Holders of Common Stock of rights to subscribe for additional shares of the Company's capital stock as provided in clause (iii) above, the Company may, instead of making any adjustment in the conversion price, make proper provision so that each Holder of a Note who converts such Note after the record date for such distribution and prior to the expiration or redemption of such rights shall be entitled to receive upon such conversion, in addition to shares of Common Stock, an appropriate number of such rights. If an adjustment is required to be made as set forth in clause (v) above as a result of a distribution that is not a quarterly dividend, such adjustment would be based upon the full amount of the distribution. The adjustment referred to in clause (vii) above will only be made if the tender offer or exchange offer is for an amount which increases that person's ownership of Common Stock to more than 25% of the total shares of Common Stock outstanding and if the cash and value of any other consideration included in such payment per share of Common Stock exceeds the Current Market Price per share of Common Stock on the business day next succeeding the last date on which tenders or exchanges may be made pursuant to such tender or exchange offer. The adjustment referred to in clause (vii) above will not be made, however, if, as of the closing of the offer, the offering documents with respect to such offer disclose a plan or an intention to cause the Company to engage in a consolidation or merger of the Company or a sale of all or substantially all of the Company's assets. The Indenture will provide that if the Company implements a stockholders' rights plan, such rights plan must provide that, subject to customary exceptions, upon conversion of the Notes the Holders will receive, in addition to the Common Stock issuable upon such conversion, such rights whether or not such rights have separated from the Common Stock at the time of such conversion. In the case of (i) any reclassification of the Common Stock or (ii) a consolidation, merger or combination involving the Company or a sale or conveyance to another person of the property and assets of the Company as an entirety or substantially as an entirety, in each case, as a result of which holders of Common Stock shall be entitled to receive stock, other securities, other property or assets (including cash) with respect to or in exchange for such Common Stock, the Holders of the Notes then outstanding will generally be entitled thereafter to convert such Notes for the kind and amount of shares of stock, other securities, other property or assets (including cash) which they would have owned or been entitled to receive upon such reclassification, consolidation, merger, combination, sale or conveyance had such Notes been converted into Common Stock immediately prior to such reclassification, consolidation, merger, combination, sale or conveyance, assuming that such Holder would not have exercised any rights of election as to the stock, other securities, other property or assets (including cash) receivable in connection therewith. In the event of a taxable distribution to holders of Common Stock (or other transaction) which results in any adjustment of the conversion price, the Holders may, in certain circumstances, be deemed to have received a distribution subject to the United States income tax as a dividend; in certain other circumstances, the absence of such an adjustment may result in a taxable dividend to the Holders of Common Stock. See "Certain United States Federal Income Tax Considerations." 51 54 The Company from time to time may, to the extent permitted by law, reduce the conversion price by any amount for any period of at least 20 days, in which case the Company shall give at least 15 days' notice of such reduction, if the Board of Directors of the Company has made a determination that such reduction would be in the best interests of the Company, which determination shall be conclusive. The Company may, at its option, make such reductions in the conversion price, in addition to those set forth above, as the Board of Directors of the Company deems advisable to avoid or diminish any income tax to holders of Common Stock resulting from any dividend or distribution of stock (or rights to acquire stock) or from any event treated as such for income tax purposes. No adjustment in the conversion price will be required unless such adjustment would require a change of at least 1% in the conversion price then in effect; provided that any adjustment that would otherwise be required to be made shall be carried forward and taken into account in any subsequent adjustment. Except as stated above, the conversion price will not be adjusted for the issuance of Common Stock or any securities convertible into or exchangeable for Common Stock or carrying the right to purchase any of the foregoing. SUBORDINATION The indebtedness evidenced by the Notes is subordinated in right of payment to the extent provided in the Indenture to the prior payment in full of all Senior Indebtedness (as defined). Upon any distribution of assets of the Company upon any dissolution, winding up, liquidation or reorganization (including any of the foregoing as a result of bankruptcy or moratorium of payment), the payment on account of the principal of, redemption of, or premium, if any, and interest on the Notes (including on account of a Fundamental Change) is to be subordinated to the extent provided in the Indenture in right of payment to the prior payment in full of all Senior Indebtedness in cash or other payment satisfactory to the holders of such Senior Indebtedness. In the event of any acceleration of the Notes because of an Event of Default (as defined), the holders of any Senior Indebtedness then outstanding would be entitled to payment in full in cash or other payment satisfactory to the holders of such Senior Indebtedness of all obligations in respect of such Senior Indebtedness before the Holders of the Notes are entitled to receive any payment or other distribution in respect thereof. The Indenture will require that the Company promptly notify Holders of Senior Indebtedness if payment of the Notes is accelerated because of an Event of Default. The Company also may not make any payment upon, redemption of, or purchase or otherwise acquire the Notes if (i) a default in the payment of the principal of, premium, if any, interest, rent or other obligations in respect of Senior Indebtedness occurs and is continuing beyond any applicable period of grace or (ii) any other default occurs and is continuing with respect to Designated Senior Indebtedness (as defined) that permits the Holders of the Designated Senior Indebtedness as to which such default relates to accelerate its maturity and the Trustee receives a notice of such default (a "Payment Blockage Notice") from any person permitted to give such notice under the Indenture. Payments on the Notes may and shall be resumed (a) in case of a payment default, upon the date on which such default is cured or waived or ceases to exist and (b) in case of a nonpayment default, the earlier of the date on which such nonpayment default is cured or waived or ceases to exist or 179 days after the date on which the applicable Payment Blockage Notice is received if the maturity of the Designated Senior Indebtedness has not been accelerated. No new period of payment blockage may be commenced pursuant to a Payment Blockage Notice unless and until 365 days have elapsed since the effectiveness of the immediately prior Payment Blockage Notice. No nonpayment default that existed or was continuing on the date of delivery of any Payment Blockage Notice to the Trustee shall be, or be made, the basis for a subsequent Payment Blockage Notice. 52 55 By reason of the subordination provisions described above, in the event of the Company's bankruptcy, dissolution or reorganization, holders of Senior Indebtedness may receive more, ratably, and Holders of the Notes may receive less, ratably, than the other creditors of the Company. Such subordination will not prevent the occurrence of any Event of Default under the Indenture. In the event that, notwithstanding the foregoing, the Trustee or any Holder of Notes receives any payment or distribution of assets of the Company of any kind in contravention of any of the subordination provisions of the Indenture, whether in cash, property or securities, including, without limitation, by way of set-off or otherwise, in respect of the Notes before all Senior Indebtedness is paid in full, then such payment or distribution will be held by the recipient in trust for the benefit of holders of Senior Indebtedness or their representative or representatives to the extent necessary to make payment in full of all Senior Indebtedness of the Company remaining unpaid, after giving effect to any concurrent payment or distribution, or provision therefor, to or for the holders of Senior Indebtedness. The Notes are obligations exclusively of the Company. As a significant portion of the Company's consolidated operations is conducted through subsidiaries, the cash flow and the consequent ability to service debt of the Company, including the Notes, is partially dependent upon the earnings of such subsidiaries and the distribution of those earnings, or upon loans or other payments of funds by those subsidiaries, to the Company. Such subsidiaries are separate and distinct legal entities, and have no obligation, contingent or otherwise, to pay any amounts due pursuant to the Notes or to make any funds available therefor, whether by dividends, distributions, loans or other payments. In addition, the payment of dividends or distributions and the making of loans and advances to the Company by any such subsidiaries may be subject to statutory or contractual restrictions, and may be contingent upon the earnings of those subsidiaries and subject to various business considerations. Any right of the Company to receive assets of subsidiaries upon their liquidation or reorganization (and the consequent right of the Holders of the Notes to participate in these assets) would be effectively subordinated to the claims of that subsidiary's creditors (including trade creditors), except to the extent that the Company is itself recognized as a creditor of such subsidiary, in which case the claims of the Company would still be subordinate to any security interests in the assets of such subsidiary and any indebtedness of such subsidiary senior to that held by the Company. As of December 31, 1997, the Company had no indebtedness outstanding that would have constituted Senior Indebtedness and the Company's subsidiaries had indebtedness and other liabilities outstanding aggregating approximately $254,000 (excluding intercompany liabilities and liabilities of a type not required to be reflected as liabilities on the balance sheets of such subsidiaries in accordance with generally accepted accounting principles) to which the Notes would have been effectively subordinated. The Indenture will not limit the amount of additional indebtedness, including Senior Indebtedness, which the Company can create, incur, assume or guarantee, nor will the Indenture limit the amount of indebtedness which any subsidiary of the Company can create, incur, assume or guarantee. The Company is obligated to pay reasonable compensation to the Trustee and to indemnify the Trustee against any losses, liabilities or expenses incurred by it in connection with its duties relating to the Notes. The Trustee's claims for such payments will be senior to those of Holders of the Notes in respect of all funds collected or held by the Trustee. The term "Senior Indebtedness" means the principal of, premium, if any, interest (including all interest accruing subsequent to the commencement of any bankruptcy or similar proceeding, whether or not a claim for post-petition interest is allowable as a claim in any such proceeding) and rent payable on or in connection with, and all fees, costs, expenses and other amounts accrued or due on or in connection with, Indebtedness (as defined) of the Company, whether outstanding on the date of the Indenture or thereafter created, incurred, assumed, guaranteed or in 53 56 effect guaranteed by the Company (including all deferrals, renewals, extensions or refundings of, or amendments, modifications or supplements to, the foregoing), unless in the case of any particular Indebtedness the instrument creating or evidencing the same or the assumption or guarantee thereof expressly provides that such Indebtedness shall not be senior in right of payment to the Notes or expressly provides that such Indebtedness is pari passu or "junior" to the Notes. Notwithstanding the foregoing, Senior Indebtedness shall not include (i) Indebtedness of the Company to any Subsidiary of the Company or (ii) the Notes. The term "Indebtedness" means, with respect to any Person (as defined), and without duplication, (a) all indebtedness, obligations and other liabilities (contingent or otherwise) of such Person for borrowed money (including obligations of the Person in respect of overdrafts, foreign exchange contracts, currency exchange agreements, interest rate protection agreements, and any loans or advances from banks, whether or not evidenced by notes or similar instruments) or evidenced by bonds, debentures, notes or similar instruments (whether or not the recourse of the lender is to the whole of the assets of such Person or to only a portion thereof), (b) all reimbursement obligations and other liabilities (contingent or otherwise) of such Person with respect to letters of credit, bank guarantees or bankers' acceptances, (c) all obligations and liabilities (contingent or otherwise) in respect of leases of such Person required, in conformity with generally accepted accounting principles, to be accounted for as capitalized lease obligations on the balance sheet of such Person and all obligations and other liabilities (contingent or otherwise) under any lease or related document (including a purchase agreement) in connection with the lease of real property or improvements thereon which provides that such Person is contractually obligated to purchase or cause a third party to purchase the leased property and thereby guarantee a minimum residual value of the leased property to the lessor and the obligations of such Person under such lease or related document to purchase or to cause a third party to purchase such leased property, (d) all obligations of such Person (contingent or otherwise) with respect to an interest rate or other swap, cap or collar agreement or other similar instrument or agreement or foreign currency hedge, exchange, purchase or similar instrument or agreement, (e) all direct or indirect guaranties or similar agreements by such Person in respect of, and obligations or liabilities (contingent or otherwise) of such Person to purchase or otherwise acquire or otherwise assure a creditor against loss in respect of, indebtedness, obligations or liabilities of another Person of the kind described in clauses (a) through (d), (f) any indebtedness or other obligations described in clauses (a) through (d) secured by any mortgage, pledge, lien or other encumbrance existing on property which is owned or held by such Person, regardless of whether the indebtedness or other obligation secured thereby shall have been assumed by such Person, and (g) any and all deferrals, renewals, extensions and refundings of, or amendments, modifications or supplements to, any indebtedness, obligation or liability of the kind described in clauses (a) through (f). Notwithstanding the foregoing, "Indebtedness" shall not include any account payable or other accrued current liability or obligation incurred in the ordinary course of business in connection with the obtaining of materials or services. The term "Designated Senior Indebtedness" means the Company's obligations under the Credit Agreement and the Company's obligations under any other particular Senior Indebtedness in which the instrument creating or evidencing the same or the assumption or guarantee thereof (or related agreements or documents to which the Company is a party) expressly provides that such Senior Indebtedness shall be "Designated Senior Indebtedness" for purposes of the Indenture (provided that such instrument, agreement or other document may place limitations and conditions on the right of such Senior Indebtedness to exercise the rights of Designated Senior Indebtedness). The term "Credit Agreement" means that certain Loan and Security Agreement dated as of July 11, 1997, between the Company and Wells Fargo Bank, National Association, as amended through the date of the Indenture, and as further amended, restated, supplemented or otherwise modified from time to time. 54 57 OPTIONAL REDEMPTION At any time on or after March 6, 2001, the Notes may be redeemed at the Company's option on at least 20 and not more than 60 days' notice, in whole or from time to time in part, at the following prices (expressed as percentages of the principal amount), together with accrued interest to, but excluding, the Redemption Date. If redeemed during the 12-month period beginning March 1 (beginning March 6, 2001 and ending February 28, 2002, in the case of the first such period):
REDEMPTION YEAR PRICE -------------------------------------------------------- ---------- 2001.................................................... % 2002....................................................
and 100% at March 1, 2003; provided that any semi-annual payment of interest becoming due on the Redemption Date shall be payable to the Holders of record on the Regular Record Date of the Notes being redeemed. If fewer than all the Notes are to be redeemed, the Trustee will select the Notes to be redeemed in principal amounts of $1,000 or multiples thereof by lot or, in its sole discretion, on a pro rata basis. If any Note is to be redeemed in part only, a new Note or Notes in principal amount equal to the unredeemed principal portion thereof will be issued. If a portion of a Holder's Notes is selected for partial redemption and such Holder converts a portion of such Notes, such converted portion shall be deemed to be taken from the portion selected for redemption. There is no sinking fund provided for the Notes. REPURCHASE AT OPTION OF HOLDERS UPON A FUNDAMENTAL CHANGE If a Fundamental Change (as defined) occurs, each Holder of Notes shall have the right, at the Holder's option, to require the Company to repurchase all of such Holder's Notes, or any portion of a Note that is $1,000 or an integral multiple of $1,000 in excess thereof, on the date (the "Repurchase Date") that is 45 days after the date of the Company Notice (as defined), at a price (the "Repurchase Price") (expressed as a percentage of the principal amount) equal to (i) % if the Repurchase Date is during the 12-month period beginning March 1, 1998, (ii) % if the Repurchase Date is during the 12-month period beginning March 1, 1999, (iii) % if the Repurchase Date is during the 12-month period beginning March 1, 2000 and (iv) thereafter at the redemption price set forth under "-- Optional Redemption" which would be applicable to a redemption at the option of the Company on the Repurchase Date; provided that, if the Applicable Price (as defined) is less than the Reference Market Price (as defined), the Company shall repurchase such Notes at a price equal to the foregoing Repurchase Price multiplied by the fraction obtained by dividing the Applicable Price by the Reference Market Price. In each case, the Company shall also pay accrued interest on the redeemed Notes to, but excluding, the Repurchase Date. Any Notes repurchased by the Company shall be canceled. Within 30 days after the occurrence of a Fundamental Change, the Company is obligated to give to all Holders of the Notes notice, as provided in the Indenture (the "Company Notice"), of the occurrence of such Fundamental Change and of the repurchase right arising as a result thereof. The Company must also deliver a copy of the Company Notice to the Trustee. To exercise the repurchase right, a Holder of Notes must deliver on or before the 30th day after the date of the Company Notice written notice to the Trustee or any Paying Agent of the Holder's exercise of such right, together with the Notes with respect to which the right is being exercised. The term "Fundamental Change" means the occurrence of any transaction or event in connection with which all or substantially all of the Common Stock shall be exchanged for, converted into, acquired for or constitute solely the right to receive, consideration (whether by 55 58 means of an exchange offer, liquidation, tender offer, consolidation, merger, combination, reclassification, recapitalization or otherwise) which is not all or substantially all common stock or shares which are (or, upon consummation of or immediately following such transaction or event, will be) listed on a United States national securities exchange or approved for quotation on the Nasdaq National Market or any similar United States system of automated dissemination of quotations of securities prices. The term "Applicable Price" means (i) in the event of a Fundamental Change in which the holders of Common Stock receive only cash, the amount of cash received by the holders of one share of Common Stock and (ii) in the event of any other Fundamental Change, the average of the last reported sale price for the Common Stock during the ten Trading Days prior to the record date for the determination of the holders of Common Stock entitled to receive cash, securities, property or other assets in connection with such Fundamental Change or, if no such record date exists, the date upon which the holders of the Common Stock shall have the right to receive such cash, securities, property or other assets in connection with the Fundamental Change. The term "Reference Market Price" shall initially mean $ (which is equal to 66 2/3% of the last bid price of the Common Stock on , 1998, as reflected on the cover page of this Prospectus) and in the event of any adjustment to the conversion price described above pursuant to the provisions of the Indenture, the Reference Market Price shall also be adjusted so that the ratio of the Reference Market Price to the conversion price after giving effect to any such adjustment shall always be the same as the ratio of $ to the conversion price specified on the cover page of this Prospectus (without regard to any adjustment thereto). Rule 13e-4 under the Exchange Act requires the dissemination of certain information to security holders in the event of an issuer tender offer and may apply in the event that the repurchase option becomes available to Holders of the Notes. The Company will comply with this rule and any other securities laws to the extent applicable at that time. The repurchase option upon a Fundamental Change feature of the Notes may in certain circumstances make more difficult or discourage a takeover of the Company and, thus, the removal of incumbent management. The Fundamental Change repurchase feature, however, is not the result of management's knowledge of any specific effort to accumulate the Company's stock or to obtain control of the Company by means of a merger, tender offer, solicitation or otherwise, or part of a plan by management to adopt a series of anti-takeover provisions. Instead, the Fundamental Change repurchase feature is a result of negotiations between the Company and the Underwriters. Management has no present intention to engage in a transaction involving a Fundamental Change, although it is possible that the Company could decide to do so in the future. Subject to the limitations on mergers, consolidations and sale of assets described herein, the Company could, in the future, enter into certain transactions, including acquisitions, refinancings or other recapitalizations, that would not constitute a Fundamental Change under the Indenture, but that could increase the amount of indebtedness (including Senior Indebtedness) outstanding at such time or otherwise affect the Company's capital structure or credit ratings. The payment of the repurchase price in the event of a Fundamental Change is subordinated to the prior payment of Senior Indebtedness as described under "-- Subordination" above. The term "Fundamental Change" is limited to certain specified transactions and may not include other events that might adversely affect the financial condition of the Company nor would the requirement that the Company offer to repurchase the Notes upon a Fundamental Change necessarily afford Holders of the Notes protection in the event of a highly leveraged transaction, reorganization, merger or similar transaction involving the Company. If a Fundamental Change were to occur, there can be no assurance that the Company would have or be able to obtain sufficient funds to pay the repurchase price for all Notes tendered by the Holders thereof. The Company's existing credit agreement contains, and any future credit agreements or other agreements relating to other indebtedness (including other Senior Indebtedness) to which the Company becomes a party may contain, restrictions and provisions that prohibit the Company from repurchasing or redeeming any Notes or provide that a Fundamental Change would 56 59 constitute an event of default thereunder. In the event a Fundamental Change occurs at a time when the Company is prohibited from repurchasing or redeeming Notes, the Company could seek the consent of its lenders to the repurchase of Notes or could attempt to refinance the borrowings that contain such prohibition. If the Company does not obtain such a consent or repay such borrowings, the Company would remain prohibited from repurchasing Notes. In such case, the Company's failure to repurchase tendered Notes would constitute an Event of Default under the Indenture, which may, in turn, constitute a further default under the terms of other Indebtedness that the Company may enter into from time to time, including Senior Indebtedness. In such circumstances, the subordination provisions in the Indenture would likely prohibit the repurchase of the Notes. MERGERS AND SALES OF ASSETS BY THE COMPANY The Company may not consolidate with or merge into any other Person (in a transaction in which the Company is not the surviving entity) or transfer or lease its properties and assets substantially as an entirety to any Person unless (i) the Person formed by such merger or into which the Company is merged or the Person to which the properties and assets of the Company are so transferred or leased shall be a corporation, limited liability company, partnership or trust organized under the laws of the United States of America and any political subdivision thereof and expressly assume the payment of the principal of, premium, if any, and interest on the Notes and the performance of every covenant of the Indenture and the Notes on the part of the Company to be performed or observed, (ii) no default and no Event of Default shall have occurred and be continuing as a result of such consolidation, merger, transfer or lease and (iii) certain other conditions are met. EVENTS OF DEFAULT The following will be Events of Default under the Indenture: (i) failure to pay principal of or premium, if any, on any Note (including the payment of any redemption or repurchase price) when due; (ii) failure to pay any interest on any Note when due continuing for 30 days; (iii) failure to perform any other covenant of the Company in the Indenture, continuing for 60 days after written notice as provided in the Indenture; and (iv) certain events of bankruptcy, insolvency or reorganization. The Indenture provides that the Trustee shall, within 90 days after the occurrence of a default, give to the registered Holders of the Notes notice of all uncured defaults known to it, but the Trustee shall be protected in withholding such notice if it in good faith determines that the withholding of such notice is in the best interest of such registered Holders, except in the case of a default in the payment of the principal of, or premium, if any, or interest on, any of the Notes when due or in the payment of any redemption or repurchase obligation. The Indenture provides that if any Event of Default shall have occurred and be continuing, the Trustee or the Holders of not less than 25% in principal amount of the Notes then outstanding by notice to the Company and the Trustee may declare the principal of and premium, if any, on the Notes to be due and payable immediately, but if the Company shall cure all defaults (except the nonpayment of interest on, premium, if any, and principal of any Notes which shall have become due by acceleration) and certain other conditions are met, such declaration may be canceled and past defaults may be waived by the Holders of a majority in principal amount of Notes then outstanding. If any Event of Default resulting from certain events of bankruptcy, insolvency or reorganization were to occur, all unpaid principal of and accrued interest on the outstanding Notes will become due and payable immediately without any declaration or other act on the part of the Trustee or any Holders of Notes, subject to certain limitations. The Indenture provides that the Holders of a majority in principal amount of the outstanding Notes may direct the time, method and place of conducting any proceeding for any remedy 57 60 available to the Trustee or exercising any trust or power conferred on the Trustee, subject to certain limitations specified in the Indenture. Before proceeding to exercise any right or power under the Indenture at the direction of such Holders, the Trustee shall be entitled to receive from such Holders reasonable security or indemnity against the costs, expenses and liabilities which might be incurred by it in complying with any such direction. The right of a Holder to institute a proceeding with respect to the Indenture is subject to certain conditions precedent, including the written notice by such Holders of an Event of Default and an offer of indemnity to the Trustee, along with the written request by the Holders of not less than 25% in principal amount of the outstanding Notes that such a proceeding be instituted, but the Holder has an absolute right to institute suit for the enforcement of payment of the principal of, and premium, if any, and interest on, such Holder's Notes when due and to enforce such Holder's right to convert such Notes. The Holders of not less than a majority in principal amount of the outstanding Notes may on behalf of the Holders of all Notes waive any past defaults, except (i) a default in payment of the principal of, or premium, if any, or interest on, any Note (including the payment of any redemption or repurchase price) when due, (ii) a failure by the Company to convert any Notes into Common Stock or (iii) in respect of certain provisions of the Indenture which cannot be modified or amended without the consent of the Holder of each outstanding Note affected thereby. The Company is required to furnish to the Trustee annually within 120 days of the end of the fiscal year a statement of certain officers of the Company stating whether or not to the best of their knowledge the Company is in default in the performance and observation of the terms of the Indenture and, if they have knowledge that the Company is in default, specifying such default and its status. The Company is also required, upon becoming aware of any default or Event of Default, to deliver to the Trustee a statement specifying such default or Event of Default and the action the Company has taken, is taking or proposes to take with respect thereto. MODIFICATIONS OF THE INDENTURE The Indenture contains provisions permitting the Company and the Trustee, with the consent of the Holders of not less than a majority in principal amount of the Notes at the time outstanding, to modify the Indenture or any supplemental indenture or the rights of the Holders of the Notes, except that no such modification shall (i) extend the fixed maturity of any Note, reduce the rate or extend the time for payment of interest thereon, reduce the principal amount thereof or premium, if any, thereon, reduce any amount payable upon redemption or repurchase thereof, impair or change in any respect adverse to the Holders of Notes the obligation of the Company to make an offer to repurchase Notes, and to repurchase Notes in accordance with such offer, upon the happening of a Fundamental Change, impair or adversely affect the right of a Holder to institute suit for the payment thereof, change the currency in which the Notes are payable, or impair or change in any respect adverse to the Holders of the Notes the right to convert the Notes into Common Stock subject to the terms set forth in the Indenture or modify the provisions of the Indenture with respect to the subordination of the Notes in a manner adverse to the Holders of the Notes, without the consent of the Holders of each Note so affected, or (ii) reduce the aforesaid percentage of Notes, without the consent of the Holders of all of the Notes then outstanding. TAXATION OF NOTES See "Certain United States Federal Income Tax Considerations" for a discussion of certain federal tax aspects which will apply to Holders of Notes. SATISFACTION AND DISCHARGE The Company may discharge its obligations under the Indenture while Notes remain outstanding if (i) all outstanding Notes will become due and payable at their scheduled maturity within one year or (ii) all outstanding Notes are to be called for redemption within one year and, in either 58 61 case, the Company has deposited with the Trustee an amount sufficient to pay and discharge all outstanding Notes on the date of their scheduled maturity or the scheduled date of redemption. GOVERNING LAW The Indenture and the Notes will be governed by and construed in accordance with the laws of the State of New York. INFORMATION CONCERNING THE TRUSTEE State Street Bank and Trust Company of California, N.A., is the Trustee under the Indenture. The Company may maintain deposit accounts and conduct other banking transactions with the Trustee and its affiliates in the normal course of business. During the existence of an Event of Default, the Trustee will exercise such rights and powers vested in it under the Indenture and use the same degree of care and skill in its exercise as a prudent person would exercise under the circumstances in the conduct of such person's own affairs. The Indenture and the TIA will contain certain limitations on the rights of the Trustee, should it become a creditor of the Company, to obtain payment of claims in certain cases or to realize on certain property received in respect of any such claim as security or otherwise. Subject to the TIA, the Trustee will be permitted to engage in other transactions; provided, however, that if it acquires any conflicting interest (as described in the TIA), it must eliminate such conflict or resign. 59 62 DESCRIPTION OF CAPITAL STOCK The authorized capital stock of the Company consists of 50,000,000 shares of Common Stock and 4,000,000 shares of Preferred Stock. As of December 31, 1997, there were 24,537,550 outstanding shares of Common Stock held of record by approximately 186 stockholders and options to purchase 4,591,133 shares of Common Stock. COMMON STOCK Subject to preferences that may apply to any Preferred Stock outstanding at the time, the holders of outstanding shares of Common Stock are entitled to receive dividends out of assets legally available therefor at such times and in such amounts as the Board of Directors may from time to time determine. Each stockholder is entitled to one vote for each share of Common Stock held on all matters submitted to a vote of stockholders. Cumulative voting for the election of directors is not provided for in the Company's Certificate of Incorporation, which means that the holders of a majority of the shares voted can elect all of the directors then standing for election. The Common Stock is not entitled to preemptive rights and is not subject to conversion or redemption. Upon liquidation, dissolution or winding-up of the Company, the assets legally available for distribution to stockholders are distributable ratably among the holders of the Common Stock and any participating Preferred Stock outstanding at that time after payment of liquidation preferences, if any, on any outstanding Preferred Stock and payment of other claims of creditors. Each outstanding share of Common Stock is fully paid and nonassessable. The Company's Common Stock is traded on the Nasdaq National Market under the symbol "HNCS." PREFERRED STOCK The Board of Directors is authorized, subject to any limitations prescribed by Delaware law, to provide for the issuance of additional shares of Preferred Stock in one or more series, to establish from time to time the number of shares to be included in each such series, to fix the powers, designations, preferences and rights of the shares of each wholly unissued series and any qualifications, limitations or restrictions thereon, and to increase or decrease the number of shares of any such series (but not below the number of shares of such series then outstanding), without any further vote or action by the stockholders. The Board of Directors may authorize the issuance of Preferred Stock with voting or conversion rights that could adversely affect the voting power of other rights of the holders of Common Stock. Thus, the issuance of Preferred Stock could have the effect of delaying, deferring or preventing a change in control of the Company. The Company has no current plan to issue any shares of Preferred Stock. DELAWARE GENERAL CORPORATION LAW SECTION 203 As a corporation organized under the laws of the State of Delaware, the Company is subject to Section 203 of the Delaware General Corporation Law (the "DGCL"), which restricts certain business combinations between the Company and an "interested stockholder" (in general, a stockholder owning 15% or more of the Company's outstanding voting stock) or its affiliates or associates for a period of three years following the date on which the stockholder becomes an "interested stockholder." The restrictions do not apply if (i) prior to an interested stockholder becoming such, the Board of Directors approves either the business combination or the transaction in which the stockholder becomes an interested stockholder, (ii) upon consummation of the transaction in which the stockholder becomes an interested stockholder, such interested stockholder owns at least 85% of the voting stock of the Company outstanding at the time the transaction commences (excluding shares owned by certain employee stock ownership plans and persons who are both directors and officers of the Company) or (iii) on or subsequent to the date an interested stockholder becomes such, the business combination is both approved by the Board of Directors and authorized at an annual or special meeting of the Company's stockholders, not by 60 63 written consent, but by the affirmative vote of at least 66 2/3% of the outstanding voting stock not owned by the interested stockholder. REGISTRATION RIGHTS; EXISTING SHELF REGISTRATION 1994 Registration Rights Agreement. Certain holders of outstanding shares of Common Stock who are parties to the Company's Third Amended Registration Rights Agreement dated April 26, 1994 (the "1994 Registration Rights Agreement") have contractual rights to have certain shares of the Company's Common Stock registered under the Securities Act. To the Company's best knowledge, based solely on its review of its current stockholders of record, parties to the 1994 Registration Rights Agreement together own approximately 412,666 shares of Common Stock that may be registered pursuant to the 1994 Registration Rights Agreement (the "Registrable Shares"). If requested by holders of at least 50% of the outstanding Registrable Shares, the Company must file a registration statement under the Securities Act covering all Registrable Shares requested to be included by all holders thereof. For purposes of exercising such demand registration rights, the Registrable Shares do not include any shares of Common Stock that were issued upon the conversion of formerly outstanding shares of the Company's Series A Preferred Stock. The Company may be required to effect up to four such demand registrations of Registrable Shares, plus one additional such registration for each registration that does not include at least 80% of the Registrable Shares requested to be included. All expenses incurred in connection with such registrations (other than underwriters' discounts and commissions) will be borne by the Company until there have been two such registrations that include at least 80% of the Registrable Shares requested to be included. In addition, if the Company proposes to register any of its securities under the Securities Act (other than in connection with a Company employee benefit plan or a business combination), the holders of Registrable Shares may require the Company to include all or a portion of such shares in such registration, although the managing underwriter of any such offering has certain rights to limit the number of shares in such registration. All expenses incurred in connection with such registrations (other than underwriters' discounts and commissions) will be borne by the Company. If the Company is eligible to use Form S-3 to register its shares, any holder or holders of Registrable Shares who hold at least 10% of the Registrable Shares originally issued may request the Company to register such shares on a Form S-3 registration statement, provided the reasonably anticipated aggregate offering price of such shares exceeds $500,000. The Company is not obligated to effect more than two such Form S-3 registrations in any calendar year. All expenses of such Form S-3 registrations must be borne by the selling stockholders. The registration rights under the 1994 Registration Rights Agreement expire in July 2000. Risk Data Registration Rights. Pursuant to a Registration Rights Agreement dated August 30, 1996, former stockholders of Risk Data who hold at least 30% of the shares of the Company's Common Stock that were issued in the Risk Data acquisition and have not been publicly resold ("Risk Data Shares") may request the Company to register such shares under the Securities Act on a Form S-3 registration statement, provided the aggregate public offering price of such shares is at least $2,000,000. The Company is not obligated to register any holder's Risk Data Shares if all such shares may be resold within a three-month period under Rule 144 or Rule 145(d) under the Securities Act. The Company may be required to effect up to two such Form S-3 registrations and will bear all expenses incurred in connection with such registrations. These registration rights expire on August 31, 1998. CompReview Registration Rights. Pursuant to a Registration Rights Agreement dated November 28, 1997, the former stockholders of CompReview are entitled to have the shares of the Company's Common Stock that were issued to them in the CompReview acquisition ("CompReview Shares") registered, at the Company's expense, on a shelf registration statement on Form S-3 pursuant to Rule 415 under the Securities Act (the "CompReview Shelf Registration"). The Company expects to file the CompReview Shelf Registration in the near future. Under 61 64 the CompReview Registration Rights Agreement, once the former CompReview stockholders have together sold an aggregate combined total of 1,250,000 CompReview Shares, sales of CompReview Shares may be made pursuant to the CompReview Shelf Registration only during certain time periods after advance notice to the Company. The Company is not obligated to maintain the effectiveness of the CompReview Shelf Registration after November 28, 1998 unless, pursuant to the CompReview registration rights agreement, the Company exercises its rights to defer a requested sale of CompReview Shares, in which case the time period during which the CompReview Shelf Registration must be kept effective must be extended by a period of time equal to the period of deferral. Retek Shelf Registration. Pursuant to a Registration Rights Agreement dated October 25, 1996, as amended, the Company has filed a Form S-3 registration statement pursuant to Rule 415 under the Securities Act (the "Retek Shelf Registration"), covering the sale of the shares of the Company's Common Stock issued in the Retek acquisition (the "Retek Shares"). Sales of Retek Shares may be made pursuant to the Retek Shelf Registration only during certain time periods after advance notice to the Company. The Company is not obligated to maintain the effectiveness of the Retek Shelf Registration after November 29, 1998 unless, pursuant to the Retek registration rights agreement, the Company exercises its rights to defer a requested sale of Retek Shares, in which case the time period during which the Retek Shelf Registration must be kept effective must be extended by a period of time equal to the period of deferral. TRANSFER AGENT AND REGISTRAR The Transfer Agent and Registrar for the Company's Common Stock is BancBoston, N.A. 62 65 CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS The following is a general discussion of certain U.S. federal income and related tax considerations relevant to holders of the Notes and Common Stock into which the Notes may be converted. This discussion is based upon the Internal Revenue Code of 1986, as amended (the "Code"), Treasury Regulations, Internal Revenue Service ("IRS") rulings and judicial decisions now in effect, all of which are subject to change (possibly with retroactive effect) or different interpretations. There can be no assurance that the IRS will not challenge one or more of the tax consequences described herein, and the Company has not obtained, nor does it intend to obtain, a ruling from the IRS with respect to the U.S. federal income tax, state tax, local tax, foreign tax or other tax consequences of acquiring or holding Notes or Common Stock. This discussion does not purport to deal with all aspects of U.S. federal income taxation that may be relevant to a particular holder in light of the holder's particular circumstances (for example, persons subject to the alternative minimum tax provisions of the Code). Also, it is not intended to be wholly applicable to all categories of investors, some of which (such as dealers in securities, banks, insurance companies, tax-exempt (employment, charitable or other) organizations, and persons holding Notes or Common Stock as part of a hedging or conversion transaction or straddle or persons deemed to sell Notes or Common Stock under the constructive sale provisions of the Code) may be subject to special rules. The discussion also does not discuss any aspect of state, local or foreign law, or U.S. federal estate and gift tax law as applicable to U.S. Holders (as defined below). In addition, this discussion is limited to original purchasers of Notes who acquire the Notes at their original issue price within the meaning of Section 1273 of the Code, and who will hold the Notes and Common Stock as "capital assets" within the meaning of Section 1221 of the Code. ALL PROSPECTIVE PURCHASERS OF THE NOTES ARE ADVISED TO CONSULT THEIR OWN TAX ADVISORS REGARDING THE FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF THE NOTES AND THE COMMON STOCK. U.S. HOLDERS As used herein, the term "U.S. Holder" means the beneficial holder of a Note or Common Stock that for United States federal income tax purposes is (i) a citizen or resident (as defined in Section 7701(b) of the Code) of the United States, (ii) a corporation, partnership or other entity formed under the laws of the United States or any political subdivision thereof, (iii) an estate the income of which is subject to U.S. federal income taxation regardless of its source and (iv) in general, a trust subject to the primary supervision of a court within the United States and the control of a United States person as described in Section 7701(a)(30) of the Code. A "Non-U.S. Holder" is any holder other than a U.S. Holder. Interest Stated interest on the Notes will generally be includable in a U.S. Holder's gross income and taxable as ordinary income for U.S. federal income tax purposes at the time it is paid or accrued in accordance with the U.S. Holder's regular method of accounting. There are several circumstances under which the Company could make a payment on a Note which would affect the yield to maturity of a Note, including (as described under "Description of Notes") the redemption of a Note by the Company, or the repurchase of a Note at the option of a Holder in the event of a Fundamental Change. According to Treasury Regulations, the possibility of a change in the timing or amount of a payment on the debt obligation will not affect the amount of interest income recognized by a holder (or the timing of such recognition) if the likelihood of the change, as of the date the debt obligations are issued, is remote. The Company believes that the likelihood of a change in the timing or amount of a payment on the Notes is remote and does not intend to treat the possibility of a change in the interest rate as affecting the yield to maturity of any Note. 63 66 Conversion of Notes Into Common Stock A U.S. Holder generally will not recognize any income, gain or loss upon conversion of a Note into Common Stock except to the extent the Common Stock is considered attributable to accrued interest not previously included in income (which is taxable as ordinary income). Cash received in lieu of a fractional share of Common Stock should generally be treated as a payment in exchange for such fractional share rather than as ordinary dividend income. Gain or loss recognized on the receipt of cash paid in lieu of such fractional share generally will equal the difference between the amount of cash received and the amount of tax basis allocable to the fractional share. The adjusted basis of shares of Common Stock received on conversion will equal the adjusted basis of the Note converted (reduced by the portion of adjusted basis allocated to any fractional share of Common Stock exchanged for cash). The holding period of the Common Stock received on conversion will generally include the period during which the converted Notes were held prior to conversion. However, a U.S. Holder's tax basis in shares of Common Stock considered attributable to accrued interest as described above, generally will equal the amount of such accrued interest included in income, and the holding period for such shares shall begin as of the date of the conversion. The conversion price of the Notes is subject to adjustment under certain circumstances. Section 305 of the Code and the Treasury Regulations issued thereunder may treat the holders of the Notes as having received a constructive distribution, resulting in ordinary income (subject to a possible dividends received deduction in the case of corporate holders) to the extent of the Company's current and/or accumulated earnings and profits, if, and to the extent that certain adjustments in the conversion price, which may occur in limited circumstances (particularly an adjustment to reflect a taxable dividend to holders of Common Stock), increase the proportionate interest of a holder of Notes in the fully diluted Common Stock, whether or not such holder ever exercises its conversion privilege. Moreover, if there is not a full adjustment to the conversion ratio of the Notes to reflect a stock dividend or other event increasing the proportionate interest of the holders of outstanding Common Stock in the assets or earnings and profits of the Company, then such increase in the proportionate interest of the holders of the Common Stock generally will be treated as a distribution to such holders, taxable as ordinary income (subject to a possible dividends received deduction in the case of corporate holders) to the extent of the Company's current and/or accumulated earnings and profits. Therefore, U.S. Holders may recognize income in the event of a deemed distribution in such circumstances under Section 305 of the Code even though they may not receive any cash or property if these type of conversion adjustments occur. Sale, Exchange or Retirement of the Notes Each U.S. Holder generally will recognize gain or loss upon the sale, exchange, redemption, retirement or other disposition of Notes measured by the difference (if any) between (i) the amount of cash and the fair market value of any property received (except to the extent that such cash or other property is attributable to the payment of accrued interest not previously included in income, which amount will be taxable as ordinary income) and (ii) such holder's adjusted tax basis in the Notes. Any such gain or loss recognized on the sale, exchange, redemption, retirement or other disposition of a Note should be capital gain or loss and will generally be long-term capital gain or loss if the Note has been held or deemed held for more than one year at the time of the sale or exchange. Gain on most capital assets held by an individual more than 18 months is subject to a maximum tax rate of 20%, and gain on most capital assets held by an individual more than one year and up to 18 months is subject to tax at a maximum rate of 28%. Deductions for capital losses in excess of capital gains for individuals may be limited and are not allowed for noncorporate taxpayers. Carryback and carryover of such excess capital losses may be allowed. A holder's initial basis in a Note will be the amount paid therefor. 64 67 The Common Stock Distributions, if any, paid on the Common Stock after a conversion, to the extent made from current and/or accumulated earnings and profits of the Company, as determined for U.S. federal income tax purposes, will be included in a U.S. Holder's income as ordinary income (subject to a possible dividends received deduction in the case of corporate holders) as they are properly accrued as dividend income. Gain or loss realized on the sale or exchange of Common Stock will equal the difference between the amount realized on such sale or exchange and the U.S. Holder's adjusted tax basis in such Common Stock. Such gain or loss will generally be long-term capital gain or loss if the holder has held or is deemed to have held the Common Stock for more than one year. Long-term capital gain realized on a sale or exchange of Common Stock by an individual will be subject to certain maximum tax rates, and losses realized on a sale or exchange of Common Stock held by any type of taxpayer may be limited. See the discussion in "-- Sale, Exchange or Retirement of the Notes" above. The adjusted tax basis and holding period for Common Stock received in a conversion is described above. Information Reporting and Backup Withholding A U.S. Holder of Notes or Common Stock may be subject to "backup withholding" at a rate of 31% with respect to certain "reportable payments," including interest payments, dividend payments and, under certain circumstances, principal payments on the Notes. These backup withholding rules apply if the holder, among other things, (i) fails to furnish a social security number or other taxpayer identification number ("TIN") certified under penalties of perjury within a reasonable time after the request therefor, (ii) furnishes a TIN as to which the IRS provides notification that it is an incorrect TIN, (iii) fails to report properly interest or dividends, or (iv) under certain circumstances, fails to provide a certified statement, signed under penalties of perjury, that the TIN furnished is the correct number and that such holder is not subject to backup withholding. A holder who does not provide the Company with its correct TIN also may be subject to penalties imposed by the IRS. Any amount withheld from a payment to a holder under the backup withholding rules is creditable against the holder's federal income tax liability, provided that the required information is furnished to the IRS. Backup withholding will not apply, however, with respect to payments made to certain holders, including corporations, tax-exempt organizations and certain foreign persons, provided their exemptions from backup withholding are properly established. The Company will report to the U.S. Holders of Notes and Common Stock and to the IRS the amount of any "reportable payments" for each calendar year and the amount of tax withheld, if any, with respect to such payments. NON-U.S. HOLDERS The following discussion is limited to the U.S. federal income tax consequences relevant to a Non-U.S. Holder. Non-U.S. Holders should consult their own tax advisors concerning the state, local, foreign and other tax consequences of the purchase, ownership and disposition of the Notes and the Common Stock. For purposes of U.S. federal withholding tax on interest and dividends discussed below, a Non-U.S. Holder (as defined above) includes a non-resident fiduciary of an estate or trust. For purposes of the following discussion, interest, dividends and gain on the sale, exchange or other disposition of a Note or Common Stock will be considered to be "U.S. trade or business income" if such income or gain is (i) effectively connected with the conduct of a trade or business within the U.S. of such Non-U.S. Holder or (ii) in the case of a certain residents of certain countries which have an income tax treaty in force with the U.S., attributable to a permanent establishment (or, in the case of an individual, a fixed base) in the United States as such terms are defined in the applicable treaty. 65 68 Stated Interest Generally, any interest paid to a Non-U.S. Holder of a Note that is not U.S. trade or business income will not be subject to U.S. federal income tax if the interest qualifies as "portfolio interest." Generally, interest on the Notes will qualify as portfolio interest if (i) the Non-U.S. Holder does not actually or constructively own 10% or more of the total voting power of all voting stock of the Company and is not a "controlled foreign corporation" with respect to which the Company is a "related person" within the meaning of the Code, (ii) the beneficial owner, under penalty of perjury, certifies that the beneficial owner is not a U.S. person and such certificate provides the beneficial owner's name and address, (iii) the Non-U.S. Holder is not a bank receiving interest on an extension of credit made pursuant to a loan agreement made in the ordinary course of its trade or business, and (iv) the Notes are in registered form. The gross amount of payments of interest to a Non-U.S. Holder that do not qualify for the portfolio interest exemption and that are not U.S. trade or business income will be subject to U.S. federal income tax at the rate of 30%, unless a U.S. income tax treaty applies to reduce or eliminate such tax. U.S. trade or business income will be taxed at regular U.S. income tax rates rather than the 30% gross rate. In the case of a Non-U.S. Holder that is a corporation, such U.S. trade or business income may also be subject to the branch profits tax (which is generally imposed on a foreign corporation on the actual or deemed repatriation from the United States of earnings and profits attributable to U.S. trade or business income) at a 30% rate. The branch profits tax may not apply (or may apply at a reduced rate) if a recipient is a qualified resident of certain countries with which the United States has an income tax treaty in force. To claim the benefit of an income tax treaty or to claim exemption from withholding because the income is U.S. trade or business income, the Non-U.S. Holder must provide a properly executed IRS Form 1001 or IRS Form 4224 (or such successor forms as the IRS designates), as applicable, prior to the payment of interest. Under recently issued Treasury Regulations generally under Sections 1441 and 1442 of the Code that will generally be effective on and after January 1, 1999 (the "Withholding Regulations"), the required Forms 1001 and 4224 will be replaced by a new Form W-8. Under the Withholding Regulations, a Non-U.S. Holder may under certain circumstances be required to obtain a U.S. taxpayer identification number and make certain certificates to the Company. Special procedures are provided in the Withholding Regulations for payments through qualified intermediaries. Prospective investors should consult their tax advisors regarding the effect, if any, of the Withholding Regulations. Dividends In general, distributions on Common Stock treated as dividend income paid to a Non-U.S. Holder of Common Stock will be subject to withholding of U.S. federal income tax at a 30% rate unless such is reduced by an applicable income tax treaty. Dividends that are connected with such holder's conduct of a trade or business in the United States (U.S. trade or business income) could be subject to U.S. federal income tax at regular ordinary income tax rates, but are not generally subject to the 30% U.S. federal withholding tax if the Non-U.S. Holder makes the appropriate notification to the payor. To claim the benefit of an income tax treaty or to claim exemption from withholding because the income is U.S. trade or business income, the Non-U.S. Holder must provide a properly executed IRS Form 1001 or IRS Form 4224 (or such successor forms as the IRS designates), as applicable, prior to the payment of dividend income. Any U.S. trade or business income received by a Non-U.S. Holder that is a corporation may also, under certain circumstances, be subject to an additional "branch profits tax" at a 30% rate or such lower rate as may be applicable under an income tax treaty. Dividends paid to an address in a foreign country generally are presumed (absent actual knowledge to the contrary) to be paid to a resident of such country for purposes of the withholding tax discussed above and for purposes of determining the applicability of a tax treaty rate. Under the Withholding Regulations, a Non-U.S. Holder claiming the benefits of a treaty generally will be required to provide a Form W-8 (or suitable substitute form) 66 69 to the Company certifying such Non-U.S. Holder's entitlements to treaty benefits. Other recently adopted Treasury Regulations generally under Section 894 of the Code that are effective with respect to payments made on and after January 1, 1998, provide special rules to determine whether, for purposes of determining the applicability of a tax treaty, dividends paid to a Non-U.S. Holder that is an entity should be treated as paid to the entity or those holding an interest in that entity. Prospective investors should consult their tax advisors regarding the effect, if any, of the recently adopted regulations. A Non-U.S. Holder of Common Stock that is eligible for a reduced rate of U.S. withholding tax pursuant to an income tax treaty may obtain a refund of any amounts withheld at the 30% statutory rate by filing an appropriate claim for a refund with the IRS. Conversion A Non-U.S. Holder generally will not be subject to U.S. federal income tax on the conversion of Notes into Common Stock, except with respect to cash (if any) received in lieu of a fractional share, cash received for interest not previously included in income, or Common Stock received for interest not previously included in income. Cash received in lieu of a fractional share may give rise to gain that would be subject to the rules described below for the sale of Notes. Cash or Common Stock issued for accrued interest would be treated as interest under the rules described above. Sale, Exchange or Redemption of Notes or Common Stock Except as described below and subject to the discussion concerning backup withholding, any gain realized by a Non-U.S. Holder on the sale, exchange or redemption of a Note or Common Stock generally will not be subject to U.S. federal income tax, unless (i) such gain is U.S. trade or business income, (ii) subject to certain exceptions, the Non-U.S. Holder is an individual who holds the Note or Common Stock as a capital asset and is present in the United States for 183 days or more in the taxable year of the disposition, (iii) the Non-U.S. Holder is subject to tax pursuant to the provisions of U.S. tax law applicable to certain U.S. expatriates (including certain former citizens or residents of the United States) or (iv) in the case of the disposition of Common Stock, the Company is a U.S. real property holding corporation. The Company does not believe that it is currently a "United States real property holding corporation," or that it will become one in the future. Federal Estate Tax Notes held (or treated as held) by an individual who is not a citizen or resident of the United States (for federal estate tax purposes) at the time of his or her death will not be subject to U.S. federal estate tax provided that the interest thereon qualifies as portfolio interest and was not U.S. trade or business income. Common Stock owned or treated as owned by an individual who is not a citizen or resident of the United States (for federal estate tax purposes) will be included in such individual's estate for U.S. federal income tax purposes unless an applicable estate tax treaty otherwise provides. Information Reporting and Backup Withholding The Company must report annually to the IRS and to each Non-U.S. Holder any interest or dividend that is subject to withholding, or that is exempt from U.S. withholding tax pursuant to a tax treaty, or interest that is exempt from U.S. tax under the portfolio interest exception or because it is U.S. trade or business income. Copies of these information returns may also be made available under the provisions of a specific treaty or agreement to the tax authorities of the country in which the Non-U.S. Holder resides. Under certain circumstances the Company will have to report to the IRS payments of principal. 67 70 Generally, information reporting and backup withholding of United States federal income tax at a rate of 31% may apply to payments of principal, interest and premium (if any) to Non-U.S. Holders if the payee fails to certify that the holder is a non-U.S. person or if the Company or its paying agent has actual knowledge that the payee is a United States person. The 31% backup withholding tax generally will not apply to dividends paid to foreign holders outside the United States that are subject to 30% withholding as discussed above or that are subject to a tax treaty that reduces such withholding. The payment of the proceeds on the disposition of the Notes or shares of Common Stock to or through a United States office of a United States or foreign broker will be subject to information reporting and backup withholding unless the owner provides certification as to its Non-U.S. Holder status under penalty of perjury or otherwise establishes an exemption, provided that the broker does not have actual knowledge that the holder is a U.S. person or that the conditions of any other exception are not, in fact, satisfied. The proceeds of the disposition by a Non-U.S. Holder of the Notes or shares of Common Stock to or through a foreign office of a broker will generally not be subject to backup withholding. However, if such broker is a U.S. person, a controlled foreign corporation for United States tax purposes, or a foreign person 50% or more of whose gross income from all sources for certain periods is effectively connected with a United States trade or business, information reporting will apply unless such broker has documentary evidence in its files of the Non-U.S. Holder's foreign status and has no actual knowledge to the contrary or unless the Non-U.S. Holder otherwise establishes an exemption. Both backup withholding and information reporting will apply to the proceeds of such dispositions if the broker has actual knowledge that the payee is a U.S. Holder. The Withholding Regulations alter the foregoing rules in certain respects. The Withholding Regulations provide presumptions under which a Non-U.S. Holder is subject to information reporting and backup withholding at the rate of 31% unless the Company receives certification of the holder's non-U.S. status. Depending on the circumstances, this certification will need to be provided (i) directly by the Non-U.S. Holder, (ii) in the case of a Non-U.S. Holder that is treated as a partnership or other fiscally transparent entity, by the partners, shareholders or other beneficiaries of such entity, or (iii) by certain qualified financial institutions or other qualified entities on behalf of the Non-U.S. Holder. Any amounts withheld under the backup withholding rules from a payment to a Non-U.S. Holder will be allowed as a refund or a credit against such Non-U.S. Holder's U.S. federal income tax liability, provided that the requisite procedures for claiming such refund or credit are followed. THE PRECEDING DISCUSSION OF CERTAIN U.S. FEDERAL INCOME AND ESTATE TAX CONSEQUENCES IS FOR GENERAL INFORMATION ONLY AND IS NOT TAX ADVICE. ACCORDINGLY, EACH INVESTOR SHOULD CONSULT ITS OWN TAX ADVISER AS TO PARTICULAR U.S. FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES TO IT OF PURCHASING, HOLDING AND DISPOSING OF THE NOTES AND THE COMMON STOCK OF THE COMPANY, INCLUDING THE APPLICABILITY AND EFFECT OF ANY STATE, LOCAL OR FOREIGN TAX LAWS, AND OF ANY PROPOSED CHANGES IN APPLICABLE LAWS. 68 71 UNDERWRITING The Underwriters named below have severally agreed, subject to the terms and conditions contained in the Underwriting Agreement (the form of which is filed as an exhibit to the Company's Registration Statement, of which this Prospectus is a part), to purchase from the Company the respective principal amount of Notes indicated below opposite their respective names. The Underwriters are committed to purchase all of the Notes (other than those covered by the Underwriters' over-allotment option described below), if they purchase any.
PRINCIPAL NAME AMOUNT ----------------------------------------------------- ----------- Deutsche Morgan Grenfell Inc......................... BancAmerica Robertson Stephens....................... Smith Barney Inc..................................... ---------- Total...................................... $90,000,000 ==========
The Underwriting Agreement provides that the obligations of the several Underwriters thereunder are subject to approval of certain legal matters by counsel and to various other conditions. The Underwriters have advised the Company that the Underwriters propose initially to offer the Notes to the public on the terms set forth on the cover page of this Prospectus. The Underwriters may allow to selected dealers (who may include the Underwriters) a concession of not more than $ per Note. The selected dealers may reallow a concession of not more than $ per Note to certain other dealers. After the initial public offering of the Notes, the price and concessions and re-allowances to dealers and other selling terms may be changed by the Underwriters. The Notes are offered subject to receipt and acceptance by the Underwriters, and to certain other conditions, including the right to reject orders in whole or in part. The Underwriters do not intend to sell any of the Notes offered hereby to accounts for which they exercise discretionary authority. The Company has granted an option to the Underwriters to purchase up to a maximum of $10,000,000 additional aggregate principal amount of Notes to cover over-allotments, if any, at the public offering price, less the underwriting discount set forth on the cover page of this Prospectus. Such option may be exercised at any time until 30 days after the date of the Underwriting Agreement. To the extent the Underwriters exercise this option, each of the Underwriters will be committed, subject to certain conditions, to purchase such additional shares in approximately the same proportion as set forth in the above table. The Underwriters may purchase such Notes only to cover over-allotments made in connection with this offering. The Company, certain of its stockholders and each of its directors and executive officers have agreed that, without the prior written consent of Deutsche Morgan Grenfell Inc. on behalf of the Underwriters, it will not, during the period ending 90 days after the date of this Prospectus (i) offer, pledge, sell, offer to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, or otherwise transfer, lend or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock or (ii) enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the Common Stock, whether any such transaction described in clause (i) or (ii) above is to be settled by delivery of Common Stock or such other securities, in cash or otherwise, except under certain limited circumstances. The Underwriting Agreement provides that the Company will indemnify the several Underwriters against certain liabilities, including civil liabilities under the Securities Act, as amended, or will contribute to payments the Underwriters may be required to make in respect thereof. 69 72 The Underwriters are also currently offering 2,100,000 shares of the Company's Common Stock (of which 2,080,000 shares will be sold by Selling Stockholders) and intend to enter into an Underwriting Agreement (the form of which is filed as an exhibit to the Company's Registration Statement, of which this Prospectus is a part) for that purpose. Pursuant to that agreement, the Underwriters will be entitled to exercise an over-allotment option for 315,000 additional shares of Common Stock, will receive customary underwriters' compensation for an offering of that size and type and will be indemnified by the Company and the Selling Stockholders. The completion of this Note offering is contingent upon completion of such Common Stock offering. Prior to this offering, there has been no public market for the Notes. Each of the Underwriters has informed the Company that it currently intends to make a market in the Notes subsequent to the effectiveness of this offering; however, they are not obligated to do so and any market-making activities with respect to the Notes may be discontinued at any time without notice. There can be no assurance that an active trading market for the Notes will develop or be maintained. See "Risk Factors -- Absence of Public Market for the Notes." Certain persons participating in this offering may over-allot or effect transactions which stabilize, maintain or otherwise affect the market price of the Notes or the Common Stock at levels above those which might otherwise prevail in the open market, including by entering stabilizing bids, imposing penalty bids or otherwise. A stabilizing bid means the placing of any bid or effecting of any purchase for the purpose of pegging, fixing or maintaining the price of the Notes or the Common Stock. A syndicate covering transaction means the placing of any bid on behalf of the underwriting syndicate or the effecting of any purchase to reduce a short position created in connection with this offering. A penalty bid means an arrangement that permits the Underwriters to reclaim a selling concession from an Underwriter when Notes sold by the Underwriter are purchased in stabilization transactions. Such transactions may be effected on the Nasdaq Stock Market, in the over-the-counter market, or otherwise. Such stabilizing, if commenced, may be discontinued at any time. The Underwriters and dealers may engage in passive market making transactions in the Common Stock in accordance with Rule 103 of Regulation M promulgated by the Commission. In general, a passive market maker may not bid for, or purchase, the Common Stock at a price that exceeds the highest independent bid. In addition, the net daily purchases made by any passive market maker generally may not exceed 30% of its average daily trading volume in the Common Stock during a specified two month prior period, or 200 shares, whichever is greater. A passive market maker must identify passive market making bids as such on the Nasdaq electronic inter-dealer reporting system. Passive market making may stabilize or maintain the market price of the Common Stock above independent market levels. Underwriters and dealers are not required to engage in passive market making and may end passive market making activities at any time. LEGAL MATTERS The validity of the issuance of the Notes and the Common Stock issuable upon conversion thereof will be passed upon for the Company by Fenwick & West LLP, Palo Alto, California. Certain legal matters will be passed upon for the Underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. EXPERTS The consolidated financial statements as of December 31, 1996 and 1997 and for each of the three years in the period ended December 31, 1997 included in this Prospectus have been so included in reliance on the report of Price Waterhouse LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. 70 73 HNC SOFTWARE INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Report of Independent Accountants..................................................... F-2 Consolidated Balance Sheet............................................................ F-3 Consolidated Statement of Income...................................................... F-4 Consolidated Statement of Cash Flows.................................................. F-5 Consolidated Statement of Changes in Stockholders' Equity............................. F-6 Notes to Consolidated Financial Statements............................................ F-7
F-1 74 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of HNC Software Inc. In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, of cash flows and of changes in stockholders' equity present fairly, in all material respects, the financial position of HNC Software Inc. and its subsidiaries at December 31, 1996 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. 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 generally accepted auditing standards 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 the opinion expressed above. PRICE WATERHOUSE LLP San Diego, California January 29, 1998, except as to Note 11 which is as of February 13, 1998 F-2 75 HNC SOFTWARE INC. CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT PER SHARE DATA) ASSETS
DECEMBER 31, -------------------- 1996 1997 ------- -------- Current assets: Cash and cash equivalents......................................... $ 8,121 $ 18,068 Investments available for sale.................................... 26,728 24,878 Accounts receivable, net.......................................... 21,856 32,980 Current portion of deferred income taxes.......................... 6,383 11,310 Other current assets.............................................. 2,553 2,802 ------- -------- Total current assets...................................... 65,641 90,038 Deferred income taxes, less current portion......................... 22,966 15,322 Property and equipment, net......................................... 6,339 12,102 Other assets........................................................ 3,330 2,415 ------- -------- $98,276 $119,877 ======= ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.................................................. $ 4,368 $ 5,728 Accrued liabilities............................................... 4,433 5,933 Deferred revenue.................................................. 3,377 3,883 Other current liabilities......................................... 445 191 ------- -------- Total current liabilities................................. 12,623 15,735 Non-current liabilities............................................. 683 239 Minority interest in consolidated subsidiary........................ -- 43 Commitments and contingencies (Notes 5 and 10) Stockholders' equity: Preferred stock, $0.001 par value -- 4,000 shares authorized: no shares issued or outstanding................................ -- -- Common stock, $0.001 par value -- 50,000 shares authorized: 24,012 and 24,538 shares issued and outstanding, respectively.................................................. 24 25 Paid-in capital................................................... 83,991 95,919 Unrealized loss on investments available for sale................. (59) (2) Foreign currency translation adjustment........................... 54 (111) Retained earnings................................................. 960 8,029 ------- -------- Total stockholders' equity................................ 84,970 103,860 ------- -------- $98,276 $119,877 ======= ========
See accompanying notes to consolidated financial statements F-3 76 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, -------------------------------- 1995 1996 1997 -------- ------- ------- Revenues: License and maintenance.............................. $ 24,561 $48,890 $89,643 Installation and implementation...................... 4,648 6,691 10,702 Contracts and other.................................. 9,146 11,128 7,772 Service bureau....................................... 5,349 4,730 5,618 -------- ------- ------- Total revenues............................... 43,704 71,439 113,735 -------- ------- ------- Operating expenses: License and maintenance.............................. 7,903 13,725 19,937 Installation and implementation...................... 1,425 2,714 5,174 Contracts and other.................................. 6,894 7,694 5,438 Service bureau....................................... 3,025 3,365 4,320 Research and development............................. 6,998 13,808 21,151 Sales and marketing.................................. 7,276 11,923 22,049 General and administrative........................... 5,101 8,551 12,626 -------- ------- ------- Total operating expenses..................... 38,622 61,780 90,695 -------- ------- ------- Operating income....................................... 5,082 9,659 23,040 Interest and other income.............................. 912 2,178 2,003 Interest expense....................................... (428) (478) (81) Minority interest in income of consolidated subsidiary........................................... -- -- (43) -------- ------- ------- Income before income tax (benefit) provision.................................. 5,566 11,359 24,919 Income tax (benefit) provision......................... (511) (534) 7,354 -------- ------- ------- Net income................................... $ 6,077 $11,893 $17,565 ======== ======= ======= Earnings per share: Basic net income per common share.................... $ 0.38 $ 0.50 $ 0.72 ======== ======= ======= Diluted net income per common share.................. $ 0.28 $ 0.47 $ 0.68 ======== ======= ======= Unaudited pro forma data (Note 1): Income before income tax provision................... $ 5,566 $11,359 $24,919 Income tax provision................................. 1,032 1,628 9,502 -------- ------- ------- Net income................................... $ 4,534 $ 9,731 $15,417 ======== ======= ======= Basic pro forma net income per common share.......... $ 0.64 ======= Diluted pro forma net income per common share........ $ 0.60 ======= Shares used in computing basic net income per common share and unaudited basic pro forma net income per common share (Notes 1 and 8)......................... 15,195 23,552 24,275 ======== ======= ======= Shares used in computing diluted net income per common share and unaudited diluted pro forma net income per common share (Notes 1 and 8)......................... 21,510 25,363 25,681 ======== ======= =======
See accompanying notes to consolidated financial statements. F-4 77 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------ 1995 1996 1997 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income....................................................... $ 6,077 $ 11,893 $ 17,565 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization.................................. 1,874 3,605 4,833 Tax benefit from stock option transactions..................... 800 896 3,848 Changes in assets and liabilities: Accounts receivable, net..................................... (1,658) (10,978) (11,124) Other assets................................................. (674) (1,207) (295) Deferred income taxes........................................ (1,551) (1,324) 6,909 Accounts payable............................................. 1,172 2,167 1,360 Accrued liabilities.......................................... 1,756 625 (2,348) Deferred revenue............................................. 1,337 1,472 375 Other liabilities............................................ 22 (441) (116) -------- -------- -------- Net cash provided by operating activities................. 9,155 6,708 21,007 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of investments available for sale....................... (28,666) (26,113) (26,517) Maturities of investments available for sale..................... 4,182 18,125 24,666 Proceeds from sales of investments available for sale............ 2,467 3,707 3,716 Acquisitions of property and equipment........................... (2,246) (3,978) (9,593) -------- -------- -------- Net cash used in investing activities..................... (24,263) (8,259) (7,728) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from issuances of common stock...................... 33,726 1,935 4,039 Proceeds from issuances of notes payable to stockholders......... 1,000 -- -- Repayments of notes payable to stockholders...................... -- (1,000) -- Proceeds from bank line of credit................................ 1,085 309 -- Repayments of bank line of credit................................ (265) (2,504) -- Repayments of debt from asset purchases.......................... -- (4,710) -- Capital lease payments........................................... (502) (553) (408) Proceeds from issuances of bank notes payable.................... -- 1,999 -- Repayments of bank notes payable................................. (687) (1,999) -- Distributions to CompReview stockholders......................... (3,845) (5,908) (6,798) -------- -------- -------- Net cash provided by (used in) financing activities....... 30,512 (12,431) (3,167) -------- -------- -------- Effect of exchange rate changes on cash............................ -- 54 (165) -------- -------- -------- Net increase (decrease) in cash and cash equivalents............... 15,404 (13,928) 9,947 Cash and cash equivalents at beginning of period................... 6,645 22,049 8,121 -------- -------- -------- Cash and cash equivalents at end of period......................... $ 22,049 $ 8,121 $ 18,068 ======== ======== ======== SIGNIFICANT NON-CASH INVESTING AND FINANCING ACTIVITIES: Assets purchased through issuance of debt........................ $ -- $ 4,710 $ -- ======== ======== ======== Acquisitions of property and equipment under capital leases...... $ 411 $ 344 $ -- ======== ======== ======== Conversion of preferred stock.................................... $ 13,518 $ -- $ -- ======== ======== ======== Accretion of dividends on mandatorily redeemable convertible preferred stock................................................ $ 348 $ -- $ -- ======== ======== ======== SUPPLEMENTAL CASH FLOW DISCLOSURE: Interest paid.................................................... $ 390 $ 448 $ 101 ======== ======== ======== Income taxes paid................................................ $ 190 $ 165 $ 547 ======== ======== ========
See accompanying notes to consolidated financial statements F-5 78 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (IN THOUSANDS)
CONVERTIBLE PREFERRED STOCK --------------------------------- SERIES A SERIES E COMMON STOCK --------------- --------------- --------------- SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT ------ ------ ------ ------ ------ ------ BALANCE AT DECEMBER 31, 1994......... 380 $ -- 1,282 $ 1 8,656 $ 9 Common stock options exercised....... 207 Accretion of dividends............... Issuance of common stock in initial public offering, net of issuance costs............................... 2,376 2 Conversion of convertible preferred stock into common stock............. (380) -- (1,282) (1) 8,956 9 Issuance of common stock in follow-on public offering, net of issuance costs............................... 1,116 2 Issuance of common stock at inception of Retek (Note 1)................... 1,367 1 Tax benefit from stock option transactions........................ Unrealized gain on investments....... Stock warrant exercised.............. 100 Distributions to CompReview stockholders........................ Net income........................... ---- ----- ------ --- ------ --- BALANCE AT DECEMBER 31, 1995......... -- -- -- -- 22,778 23 Common stock options exercised....... 1,140 1 Common stock issued under Employee Stock Purchase Plan................. 94 Tax benefit from stock option transactions........................ Tax benefit from Retek taxable pooling (Note 7).................... Unrealized loss on investments....... Foreign currency translation adjustment.......................... Distributions to CompReview stockholders........................ Net income........................... ---- ----- ------ --- ------ --- BALANCE AT DECEMBER 31, 1996......... -- -- -- -- 24,012 24 Common stock options exercised....... 475 1 Common stock issued under Employee Stock Purchase Plan................. 51 Tax benefit from stock option transactions........................ Unrealized gain on investments....... Foreign currency translation adjustment.......................... Distributions to CompReview stockholders........................ CompReview contribution to capital... Net income........................... ---- ----- ------ --- ------ --- BALANCE AT DECEMBER 31, 1997......... -- $ -- -- $ -- 24,538 $ 25 ==== ===== ====== === ====== === UNREALIZED GAIN (LOSS) ON FOREIGN (ACCUMULATED INVESTMENTS CURRENCY DEFICIT) TOTAL PAID-IN AVAILABLE TRANSLATION RETAINED STOCKHOLDERS' CAPITAL FOR SALE ADJUSTMENT EARNINGS EQUITY --------- -------------- ----------- ------------ ------------- < BALANCE AT DECEMBER 31, 1994.........$ 10,980 $ -- $ -- $(10,149) $ 841 Common stock options exercised....... 85 85 Accretion of dividends............... (348) (348) Issuance of common stock in initial public offering, net of issuance costs............................... 14,329 14,331 Conversion of convertible preferred stock into common stock............. 10,618 2,892 13,518 Issuance of common stock in follow-on public offering, net of issuance costs............................... 19,184 19,186 Issuance of common stock at inception of Retek (Note 1)................... (1) -- Tax benefit from stock option transactions........................ 800 800 Unrealized gain on investments....... 92 92 Stock warrant exercised.............. 124 124 Distributions to CompReview stockholders........................ (3,845) (3,845) Net income........................... 6,077 6,077 ------- ----- ----- -------- -------- BALANCE AT DECEMBER 31, 1995......... 55,771 92 -- (5,025) 50,861 Common stock options exercised....... 1,095 1,096 Common stock issued under Employee Stock Purchase Plan................. 839 839 Tax benefit from stock option transactions........................ 7,889 7,889 Tax benefit from Retek taxable pooling (Note 7).................... 18,397 18,397 Unrealized loss on investments....... (151) (151) Foreign currency translation adjustment.......................... 54 54 Distributions to CompReview stockholders........................ (5,908) (5,908) Net income........................... 11,893 11,893 ------- ----- ----- -------- -------- BALANCE AT DECEMBER 31, 1996......... 83,991 (59) 54 960 84,970 Common stock options exercised....... 2,845 2,846 Common stock issued under Employee Stock Purchase Plan................. 1,193 1,193 Tax benefit from stock option transactions........................ 4,192 4,192 Unrealized gain on investments....... 57 57 Foreign currency translation adjustment.......................... (165) (165) Distributions to CompReview stockholders........................ (6,798) (6,798) CompReview contribution to capital... 3,698 (3,698) -- Net income........................... 17,565 17,565 ------- ----- ----- -------- -------- BALANCE AT DECEMBER 31, 1997.........$ 95,919 $ (2) $(111) $ 8,029 $ 103,860 ======= ===== ===== ======== ========
See accompanying notes to consolidated financial statements F-6 79 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 1 -- THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES The Company Headquartered in San Diego, California, HNC Software Inc. (the "Company" or "HNC") develops, markets and supports predictive software solutions in client/server environments. HNC provides innovative predictive software systems in the healthcare/insurance, financial services and retail markets. Acquisitions On August 30, 1996, the Company completed an acquisition of all of the outstanding shares of Risk Data Corporation ("Risk Data"). Risk Data is an insurance information technology services firm that develops, markets and supports analytical benchmarking and risk management software products primarily for insurance carriers, state insurance funds and third party administrators primarily in the workers' compensation insurance field. Under the terms of the acquisition, accounted for as a pooling of interests, the Company exchanged 1,891 shares of common stock for all of the then outstanding shares of Risk Data preferred and common stock. On November 29, 1996, the Company completed an acquisition of all of the outstanding shares of Retek Distribution Corporation ("Retek"). Retek develops, markets and supports inventory management system software primarily for customers in the retail industry. Under the terms of the acquisition, accounted for as a pooling of interests, the Company exchanged 1,367 shares of common stock for all of the then outstanding shares of Retek common stock. On November 28, 1997, the Company completed an acquisition of all of the outstanding shares of CompReview, Inc. ("CompReview"). CompReview develops, markets and supports cost containment software for workers' compensation insurance carriers and for insurers that handle automobile accident personal injury claims. Under the terms of the acquisition, accounted for as a pooling of interests, the Company exchanged 4,886 shares of common stock for all of the then outstanding shares of CompReview common stock. The consolidated financial statements and related notes give retroactive effect to all three acquisitions for all of the periods presented. The consolidated balance sheet as of December 31, 1996 and 1997 includes the accounts of Risk Data, Retek and CompReview as of December 31, 1996 and 1997. The consolidated statements of income, of cash flows and of changes in stockholders' equity for each of the three years in the period ended December 31, 1997 include the results of Risk Data, Retek and CompReview for each of the years then ended. The term "Company" as used in these consolidated financial statements refers to HNC and its subsidiaries, including Risk Data, Retek and CompReview. F-7 80 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) No adjustments to conform the accounting methods of the acquired companies to the accounting methods of HNC were required. Certain amounts have been reclassified with regard to presentation of the financial information of the acquired companies. Revenues and net income (loss) for each of the previously separate companies for the periods prior to their respective acquisition dates are as follows:
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SIX MONTHS SEPTEMBER 30, ---------------------------- ENDED ----------------- 1995 1996 1997 JUNE 30, 1996 1997 ------- ------- -------- 1996 ------- ------- ---------- (UNAUDITED) (UNAUDITED) Revenues: HNC............... $25,174 $53,833 $113,735 $ 16,478 $31,423 $62,683 Risk Data......... 4,577 -- -- 2,600 -- -- Retek............. 921 -- -- 3,377 5,635 -- CompReview........ 13,032 17,606 -- 8,119 12,631 18,971 ------- ------- -------- -------- ------- ------- $43,704 $71,439 $113,735 $ 30,574 $49,689 $81,654 ======= ======= ======== ======== ======= ======= Net income (loss): HNC............... $ 4,457 $ 6,376 $ 17,565 $ 1,780 $ 975 $ 7,597 Risk Data......... (1,952) -- -- (2,184) -- -- Retek............. (382) -- -- 43 93 -- CompReview........ 3,954 5,517 -- 2,123 3,679 6,702 ------- ------- -------- -------- ------- ------- $ 6,077 $11,893 $ 17,565 $ 1,762 $ 4,747 $14,299 ======= ======= ======== ======== ======= =======
Transaction costs of $563, $515 and $1,440 were incurred to complete the acquisitions of Risk Data, Retek and CompReview, respectively. Transaction costs were deferred and charged to income when the related transactions were consummated. Transaction costs consisted primarily of investment banker, legal and accounting fees, and printing, mailing and registration expenses. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. During 1996, the Company established Aptex Software Inc. ("Aptex"), a majority owned subsidiary, in order to develop, market and support certain text analysis technology that is being used to develop products for the Internet market. The minority stockholders' interest in Aptex's financial position and results of operations is presented as a minority interest in the Company's consolidated financial statements. Financial Statement Preparation 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. F-8 81 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Cash Equivalents Cash equivalents are highly liquid investments and consist of investments in money market accounts and commercial paper purchased with maturities of three months or less. Investments Management determines the appropriate classification of its investments in marketable debt and equity securities at the time of purchase and re-evaluates such designation as of each balance sheet date. The Company classifies all securities as "available for sale" and carries them at fair value with unrealized gains or losses related to these securities included in stockholders' equity in the Company's consolidated balance sheet. Property and Equipment Property and equipment are recorded at cost. The Company computes depreciation and amortization using either the straight-line method over the estimated useful lives of the assets of three to seven years or an accelerated method over the estimated useful lives of the assets of five to seven years. The Company amortizes leasehold improvements over the shorter of their estimated useful lives or the remaining term of the related lease. Repair and maintenance costs are charged to expense as incurred. Software Costs Software costs are recorded at cost and amortized over their estimated useful lives of 36 to 42 months. Software costs are comprised of purchased software and other rights that are stated at the lower of cost or net realizable value. At December 31, 1996 and 1997, software costs of $2,561 and $2,581, respectively, were included in other assets in the consolidated balance sheet net of accumulated amortization of $642 and $1,451, respectively. Development costs for 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, 1997, no significant amounts were expended subsequent to reaching technological feasibility. Long-Lived Assets The Company investigates potential impairments of long-lived assets, certain identifiable intangibles and associated goodwill when events or changes in circumstances have made recovery of an asset's carrying value unlikely. An impairment loss would be recognized if the sum of the expected future net cash flows were less than the carrying amount of the asset. No such impairments of long-lived assets existed through December 31, 1997. Stock-Based Compensation The Company measures compensation expense for its stock-based employee compensation plans using the intrinsic value method and provides pro forma disclosures of net income and earnings per share as if the fair value-based method had been applied in measuring compensation expense. F-9 82 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Revenue Recognition The Company's revenue from periodic software license and maintenance agreements is generally recognized ratably over the respective license periods. Revenue from certain short-term periodic software license and maintenance agreements with guaranteed minimum license fees is recognized as related services are performed. Transactional fees are recognized as revenue based on system usage or when fees based on system usage exceed the monthly minimum license fees. Revenue from perpetual licenses of the Company's software for which there are no significant continuing obligations and collection of the related receivables is probable is recognized on delivery of the software and acceptance by the customer. Revenue from hardware product sales, which is included in contracts and other revenue, is recognized upon shipment to the customer. The Company's revenue from software installation and implementation and from contract services is generally recognized as the services are performed using the percentage of completion method based on costs incurred to date compared to total estimated costs at completion. Amounts received under contracts in advance of performance are recorded as deferred revenue and are generally recognized within one year from receipt. Contract losses are recorded as a charge to income in the period such losses are first identified. Unbilled accounts receivable are stated at estimated realizable value. Service bureau fees are from review and repricing of customers' medical bills and are assessed to customers on the basis of volume of bills processed and are recognized as revenue when the processing services are performed. Income Taxes The Company's current income tax expense is the amount of income taxes expected to be payable for the current year. 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 carryforwards. 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 are reflected in income during the period such changes are enacted. Net Income Per Common Share The Company adopted Statement of Financial Accounting Standard No. 128 ("FAS 128"), "Earnings per Share," for fiscal 1997 and retroactively restated all prior periods to conform with FAS 128 as required. Basic net income per common share is computed as net income less accretion of dividends on mandatorily redeemable convertible preferred stock divided by the weighted average number of common shares outstanding during the period. Diluted net income per common share is computed as net income divided by the weighted average number of common shares and potential common shares, using the treasury stock method, outstanding during the period and assumes conversion into common stock at the beginning of each period of all outstanding shares of convertible preferred stock (Note 8). Unaudited Pro Forma Data Prior to the acquisition of CompReview by HNC on November 28, 1997, CompReview had elected subchapter S corporation status for income tax purposes; therefore, its income was included in the tax returns of its stockholders, and no income tax provision was recorded for F-10 83 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) CompReview other than certain minimum state taxes on subchapter S corporations. As a result of the acquisition, beginning November 29, 1997, CompReview became subject to corporate income taxes on its taxable income. For comparative purposes, the consolidated statement of income includes unaudited pro forma adjusted data with respect to the merged companies' income tax provision as if CompReview had been subject to corporate income taxes on its taxable income for all periods presented. Foreign Currency Translation The financial statements of the Company's international operations are 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 stockholders' equity. Gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the entity's local currency) are included in the consolidated statement of income and are not material. Diversification of Credit Risk The Company's financial instruments that are subject to concentrations of credit risk consist primarily of cash equivalents, investments available for sale and accounts receivable, which are generally not collateralized. The Company's policy is to place its cash, cash equivalents and investments available for sale with high credit quality financial institutions and commercial companies and government agencies in order to limit the amount of its credit exposure. The Company's software license and installation agreements and commercial development contracts are primarily with large customers in the healthcare/insurance, financial services and retail industries. The Company maintains reserves for potential credit losses. The Company has one major product or product line in each of its three target markets. In the healthcare/insurance market, revenues from one product accounted for 29.8%, 24.6% and 23.0% of the Company's total revenues for 1995, 1996 and 1997, respectively. During those same periods, one product in the retail market accounted for 2.2%, 13.6% and 18.9%, respectively, of the Company's total revenues, and one product line in the financial services market accounted for 28.0%, 20.9% and 16.0%, respectively, of the Company's total revenues. Revenues from international operations and export sales, primarily to Western Europe and Canada, represented approximately 12.6%, 17.7% and 16.8% of total revenues in 1995, 1996 and 1997, respectively. Export sales were $4,595, $7,310 and $7,896 in 1995, 1996 and 1997, respectively. Disclosures About Fair Value of Financial Instruments The carrying amounts of cash and cash equivalents and accrued liabilities approximate fair value because of the short-term maturities of these financial instruments. The carrying amounts of capital lease obligations approximate their fair values based on interest rates currently available to the Company for borrowings with similar terms and maturities. Reincorporation and Stock Split In May 1995, the Company's stockholders approved an Agreement and Plan of Merger whereby the Company merged with and into a newly incorporated Delaware corporation ("HNC Delaware"), which is the surviving corporation. In conjunction with the merger, each share of the F-11 84 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Company's common stock, preferred stock and options and warrants to purchase the Company's common stock was exchanged for one-half share of HNC Delaware's common stock, preferred stock and options and warrants to purchase HNC Delaware's common stock, at twice the exercise price for options and warrants. In April 1996, the Company consummated a two-for-one stock split effected in the form of a common stock dividend. All references to share and per share amounts of common and preferred stock and other data in these financial statements have been retroactively restated to reflect the reincorporation and stock split. New Accounting Pronouncements In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130 ("FAS 130"), "Reporting Comprehensive Income," which the Company is required to adopt for 1998. This statement will require the Company to report in the financial statements, in addition to net income, comprehensive income and its components including foreign currency items and unrealized gains and losses on certain investments in debt and equity securities. Upon adoption of FAS 130, the Company is also required to reclassify financial statements for earlier periods provided for comparative purposes. The adoption of FAS 130 will not have a significant impact on the Company's consolidated financial statement disclosures. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and Related Information," which the Company is required to adopt for its 1998 annual financial statements. This statement establishes standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. Under FAS 131, operating segments are to be determined consistent with the way that management organizes and evaluates financial information internally for making operating decisions and assessing performance. The Company has not determined the impact of the adoption of this new accounting standard on its consolidated financial statement disclosures. In October 1997, the American Institute of Certified Public Accountants issued Statement of Position No. 97-2 ("SOP 97-2"), "Software Revenue Recognition," which the Company is required to adopt for agreements entered into with customers beginning in 1998. This statement provides guidance for software revenue recognition matters primarily from a conceptual level and does not include specific implementation guidance. Based on its reading and interpretation of SOP 97-2, the Company believes that the adoption of SOP 97-2 will not have a significant impact on its financial statements; however, detailed implementation guidelines for this standard have not yet been issued. Once issued, such detailed implementation guidelines could lead to unanticipated changes in the Company's current revenue recognition practices, and such changes could be material to the Company's financial statements. F-12 85 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Reclassifications Certain prior year balances have been reclassified to conform to the current year presentation. NOTE 2 -- COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
DECEMBER 31, ------------------- 1996 1997 ------- ------- Accounts receivable, net: Billed............................................. $13,266 $27,812 Unbilled........................................... 9,299 8,368 ------- ------- 22,565 36,180 Less allowance for doubtful accounts................. (709) (3,200) ------- ------- $21,856 $32,980 ======= =======
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.
DECEMBER 31, ------------------- 1996 1997 ------- ------- Property and equipment, net: Computer equipment................................. $ 9,302 $15,611 Furniture and fixtures............................. 2,210 4,632 Leasehold improvements............................. 273 1,012 ------- ------- 11,785 21,255 Less accumulated depreciation and amortization....... (5,446) (9,153) ------- ------- $ 6,339 $12,102 ======= =======
DECEMBER 31, ------------------- 1996 1997 ------- ------- Accrued liabilities: Payroll and related benefits....................... $ 1,645 $ 3,456 Vacation........................................... 860 927 Other.............................................. 1,928 1,550 ------- ------- $ 4,433 $ 5,933 ======= =======
F-13 86 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 3 -- INVESTMENTS At December 31, 1996 and 1997, the amortized cost and estimated fair value of investments available for sale were as follows:
DECEMBER 31, 1996 --------------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- ------- U.S. government and federal agencies........................ $ 18,212 $ -- $ (38) $18,174 Foreign government debt........... 1,006 -- (2) 1,004 U.S. corporate debt............... 4,851 -- (14) 4,837 Foreign corporate debt............ 2,718 -- (5) 2,713 ------- ------- ------- ------- $ 26,787 $ -- $ (59) $26,728 ======= ======= ======= =======
DECEMBER 31, 1997 --------------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- ------- U.S. government and federal agencies........................ $ 20,682 $ -- $ (1) $20,681 U.S. corporate debt............... 1,894 -- (1) 1,893 Foreign corporate debt............ 2,304 -- -- 2,304 ------- ------- ------- ------- $ 24,880 $ -- $ (2) $24,878 ======= ======= ======= =======
No significant gains or losses were realized during the years ended December 31, 1996 and 1997. The cost of securities sold is determined by the specific identification method. NOTE 4 -- NOTES PAYABLE The Company has a Credit Agreement with a bank which provides for a $15,000 revolving line of credit through July 11, 1999. The agreement requires that the Company maintain certain financial ratios and levels of working capital, tangible net worth and profitability, and also restricts the Company's ability to pay cash dividends and make loans, advances or investments without the bank's consent. At December 31, 1997, the Company had no amounts outstanding under the revolving line of credit. Interest is payable monthly at the bank's prime rate or LIBOR rate plus 1.5%. The applicable interest rate was 7.22% at December 31, 1997. The Risk Data credit facilities were comprised of a revolving line of credit secured by eligible accounts receivable, as well as a bridge loan that was secured by the guarantees of certain stockholders. The revolving line of credit matured on January 5, 1997. The bridge loan matured on September 5, 1996. All outstanding amounts were repaid during 1996, and neither credit facility was renewed. During 1995, the preferred stockholders of Risk Data loaned the Company $1,000 under subordinated note agreements (secured by the assets of Risk Data but subordinated to borrowings under the Risk Data line of credit) bearing interest at 9%. All outstanding amounts were repaid during 1996. F-14 87 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 5 -- LEASES At December 31, 1997, the Company was obligated through 2004 under noncancelable operating leases for its facilities and certain equipment as follows:
NET FUTURE FUTURE MINIMUM LESS SUBLEASE MINIMUM LEASE LEASE PAYMENTS INCOME PAYMENTS -------------- ------------- ------------- 1998............................. $2,984 $ 127 $ 2,857 1999............................. 3,047 -- 3,047 2000............................. 3,043 -- 3,043 2001............................. 2,994 -- 2,994 2002............................. 2,884 -- 2,884 thereafter....................... 1,535 -- 1,535
The lease for the Company's corporate headquarters provides for scheduled rent increases and an option to extend the lease for five years with certain changes to the terms of the lease agreement and a refurbishment allowance. Rent expense under operating leases for the years ended December 31, 1995, 1996 and 1997 was approximately $1,503, $1,623 and $2,687, respectively, net of sublease income of $83, $125 and $477, respectively. Risk Data maintains a lease line of credit with a leasing company for the acquisition of equipment under capital lease arrangements. Future minimum payments are $222 for 1998 and $66 for 1999 with a total of $34 of such amounts representing interest. The gross value of assets under capital leases at December 31, 1996 and 1997 was $1,481 and $714, and accumulated amortization was $599 and $556, respectively. Amortization expense for assets acquired under capital leases is included in depreciation expense. NOTE 6 -- CAPITAL STOCK During June 1995, the Company completed its initial public offering of 5,176 shares of common stock (of which 2,376 shares were sold by the Company and 2,800 shares were sold by certain selling stockholders) at a price to the public of $7.00 per share, which resulted in net proceeds to the Company of $15,461 after the payment of underwriters' commissions but before the deduction of offering expenses. Upon the closing of the Company's initial public offering, all outstanding shares of Series A, B, C, D and E convertible preferred stock were automatically converted into shares of common stock at their then effective conversion prices. Upon conversion, the preferred stockholders were no longer entitled to any undeclared cumulative dividends and all class voting rights terminated. During December 1995, the Company completed a follow-on public offering of 3,000 shares of common stock (of which 1,116 shares were sold by the Company and 1,884 shares were sold by certain selling stockholders) at a price to the public of $18.50 per share, which resulted in net proceeds to the Company of $19,606 after the payment of underwriters' commissions but before the deduction of offering expenses. The Company's Board of Directors is authorized to issue up to 4,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to the rights of the holders of any preferred stock that may be issued in the future. F-15 88 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 7 -- INCOME TAXES Income (loss) before income tax (benefit) provision was taxed under the following jurisdictions:
YEAR ENDED DECEMBER 31, ------------------------------ 1995 1996 1997 ------ ------- ------- Domestic.................................. $5,764 $ 8,599 $23,907 Foreign................................... (198) 2,760 1,012 ------ ------- ------- $5,566 $11,359 $24,919 ====== ======= =======
The income tax (benefit) provision is summarized as follows:
YEAR ENDED DECEMBER 31, ------------------------------ 1995 1996 1997 ------ ------- ------- CURRENT: Federal................................. $ 97 $ 1,132 $ 2,257 State................................... 143 204 537 Foreign................................. -- 51 233 DEFERRED: Federal................................. (521) (1,569) 3,197 State................................... (186) (56) 985 Foreign................................. (44) (296) 145 ------ ------- ----- $ (511) $ (534) $ 7,354 ====== ======= =====
Deferred tax assets are summarized as follows:
YEAR ENDED DECEMBER 31, ------------------- 1996 1997 ------- ------- Taxable pooling basis difference..................... $18,397 $16,955 Net operating loss carryforwards..................... 8,587 7,404 Tax credit carryforwards............................. 1,878 2,059 Other................................................ 487 214 ------- ------- Gross deferred tax assets............................ 29,349 26,632 Deferred tax asset valuation allowance............... -- -- ------- ------- Net deferred tax asset..................... $29,349 $26,632 ======= =======
During 1995, the Company released the valuation allowance related to its deferred tax assets based on management's assessment that it was more likely than not that the Company would realize a portion of those assets in future periods due to improvements in the Company's operating results. During 1996, the Company released the valuation allowances related to Risk Data's and Retek's deferred tax assets based on management's assessment that it was more likely than not that the Company would realize those assets in future periods due to improvements in the operating results of those subsidiaries. During 1995, 1996 and 1997, the Company realized certain tax benefits related to stock option transactions in the amount of $800, $7,889 and $4,192, respectively. The benefit from the stock option tax deduction is credited directly to paid-in capital. F-16 89 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) During 1996, in connection with the acquisition of Retek, the Company made an Internal Revenue Code Section 338 election for federal and state tax purposes, resulting in the treatment of the acquisition as a taxable transaction, whereby the tax bases of the acquired assets and liabilities were adjusted to their fair values as of the date of the acquisition. As the purchase price exceeded the carrying value of the net assets acquired by approximately $46,000, the Company recorded a deferred tax asset in the amount of $18,397. A reconciliation of the income tax (benefit) provision to the amount computed by applying the statutory federal income tax rate to income before income tax provision is summarized as follows:
YEAR ENDED DECEMBER 31, ------------------------------- 1995 1996 1997 ------- ------- ------- Amounts computed at statutory federal rate................................... $ 1,892 $ 3,862 $ 8,472 State income taxes.................. 465 554 1,407 Subchapter S corporation earnings... (1,366) (1,901) (2,888) Change in tax status of S corporation....................... -- -- 869 Tax credit carryforwards generated......................... (68) (334) (284) Release of valuation allowance...... (2,223) (2,717) -- Foreign income taxes................ (44) (296) 27 Losses without tax benefit.......... 794 -- -- Other............................... 39 298 (249) ------- ------- ------- Income tax (benefit) provision........... $ (511) $ (534) $ 7,354 ======= ======= =======
Prior to the acquisition of CompReview by the Company on November 28, 1997, CompReview had elected subchapter S corporation status and the cash basis of accounting for income tax purposes; therefore, its cash basis income was included in the tax returns of its stockholders, and no income tax provision was recorded for CompReview other than certain minimum state taxes on subchapter S corporations. As of the date of CompReview's acquisition, its tax status was changed to C corporation status with the accrual basis of accounting. As a result of this change in tax status, the Company recorded a deferred tax liability in the amount of $869 based on the cumulative income recognition differences as of the date of acquisition between CompReview's former and prospective tax accounting methods. At December 31, 1997, the Company had federal, state and foreign net operating loss carryforwards of approximately $19,992, $7,785 and $352, respectively. The net operating loss carryforwards expire as follows: 2001...................................... $ 6,982 2003...................................... 84 2005...................................... 123 2006...................................... 1,670 2007...................................... 17 2008...................................... 1,692 2009...................................... 1,370 2010...................................... 1,840 2011...................................... 14,086
The Company also has approximately $1,295 of federal research and development credit carryforwards, which expire from 2000 to 2012, $711 of state research and development credit F-17 90 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) carryforwards, which have no expiration date, and $53 of foreign tax credit carryforwards, which expire from 1999 to 2002. Certain of these net operating loss and research and development credit carryforwards generated by Risk Data, Retek and CompReview prior to their acquisitions by HNC are subject to annual limitations on their utilization and also are limited to utilization solely by the company that generated them. Should a substantial change in HNC's ownership occur, as defined by the Tax Reform Act of 1986, there will be an annual limitation on its utilization of net operating loss and research and development credit carryforwards. NOTE 8 -- RECONCILIATION OF NET INCOME AND SHARES USED IN PER SHARE COMPUTATIONS
YEAR ENDED DECEMBER 31, ------------------------------- 1995 1996 1997 ------- ------- ------- NET INCOME USED: Net income used in computing basic net income per common share..... $ 5,729 $11,893 $17,565 Add back accretion of dividends on mandatorily redeemable convertible preferred stock...................................... 348 -- -- ------- ------- ------- Net income used in computing diluted net income per common share... $ 6,077 $11,893 $17,565 ======= ======= ======= SHARES USED: Weighted average common shares outstanding used in computing basic net income per common share...................................... 15,195 23,552 24,275 Weighted average options and warrants to purchase common stock as determined by application of the treasury stock method......... 1,995 1,796 1,383 Incremental shares for assumed conversion of convertible preferred stock................................................ 4,265 -- -- Purchase Plan common stock equivalents........................... 55 15 23 ------- ------- ------- Shares used in computing diluted net income per common share....... 21,510 25,363 25,681 ======= ======= =======
All outstanding shares of the Company's preferred stock automatically converted into shares of common stock upon the closing of the Company's initial public offering on June 26, 1995. Shares used in computing diluted net income per common share for 1995 assume conversion of all outstanding shares of convertible preferred stock were converted at the beginning of that year. NOTE 9 -- EMPLOYEE BENEFIT PLANS During 1987, the Company adopted the 1987 Stock Option Plan and reserved 2,500 shares of the Company's common stock for issuance pursuant to nonqualified and incentive stock options to its officers, directors, key employees and consultants. The plan, as amended, is administered by the Board of Directors or its designees and provides generally that, for incentive stock options and nonqualified stock options, the exercise price must not be less than the fair market value of the shares as determined by the Board of Directors at the date of grant. The options expire no later than ten years from the date of grant and may be exercised in installments based upon stipulated timetables (not in excess of seven years). At December 31, 1997, options to purchase 490 shares were exercisable. During 1995, the Company adopted the 1995 Directors Stock Option Plan (the "Directors Plan"), the 1995 Equity Incentive Plan (the "Incentive Plan") and the 1995 Employee Stock Purchase Plan (the "Purchase Plan"). For purposes of the discussion contained in the three paragraphs below, "fair market value" means the closing price of the Company's common stock on the Nasdaq National Market on the grant date. F-18 91 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The Directors Plan provides for the issuance of up to 300 nonqualified stock options to the Company's outside directors. Under the provisions of the Directors Plan, options to purchase 25 shares of the Company's common stock are granted to outside directors upon their respective dates of becoming members of the Board of Directors and options to purchase ten shares of such stock will be granted on each anniversary of such dates. Options under the Directors Plan are granted at the fair market value of the stock at the grant date and vest at specific times over a four-year period. At December 31, 1997, options to purchase 72 shares were exercisable. The Incentive Plan provides for the issuance of up to 3,550 shares of the Company's common stock in the form of nonqualified or incentive stock options, restricted stock or stock bonuses. In addition, all shares that remained unissued under the 1987 Stock Option Plan on the effective date of the Incentive Plan, and all shares issuable upon exercise of options granted pursuant to the 1987 Stock Option Plan that expire or become unexercisable for any reason without having been exercised in full are available for issuance under the Incentive Plan. 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 term of up to ten years. The Company has the discretion to provide for restrictions and the lapse thereof 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, the Company may, at its discretion, implement a different vesting schedule with respect to any new stock option grant. At December 31, 1997, 316 shares were exercisable. The Purchase Plan provides for the issuance of a maximum of 400 shares of common stock. Each purchase period, eligible employees may designate between 2% and 10% of their cash compensation, subject to certain limitations, to be deducted from their compensation for the purchase of common stock under the Purchase Plan. The purchase price of the shares under the 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. Approximately 60% of eligible employees have participated in the Purchase Plan in the last two years. Risk Data's stock option plan is administered by HNC's Board of Directors. All outstanding Risk Data options were converted into options to purchase HNC common stock and adjusted to give effect to the acquisition exchange ratio in the Risk Data acquisition. No changes were made to the terms of the Risk Data options in connection with the exchange. Options granted under the Risk Data stock option plan generally vest at the rate of 25% of the total grant per year and expire ten years after the date of grant. At December 31, 1997, 30 shares were exercisable under the Risk Data plan. Retek's stock options are administered by HNC's Board of Directors. All outstanding Retek options were converted into options to purchase the Company's common stock and adjusted to give effect to the acquisition exchange ratio in the Retek acquisition. No changes were made to the terms of the Retek options in connection with the exchange. Options granted vest ratably over periods from one to four years and have a term of up to ten years. At December 31, 1997, options to purchase 32 shares were exercisable. The CompReview 1995 Stock Option Plan is administered by HNC's Board of Directors. All outstanding CompReview stock options were converted into options to purchase HNC common stock in the CompReview acquisition and adjusted to give effect to the acquisition exchange ratio. No changes were made to the terms of the CompReview options in connection with the exchange. Options granted under the CompReview Stock Option Plan generally vest ratably over periods from F-19 92 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) two to four years and expire ten years after the date of grant. At December 31, 1997, options to purchase 156 shares were exercisable. Transactions under the Company's stock option and purchase plans during the years ended December 31, 1995, 1996 and 1997, including options under the Risk Data stock option plan, options under the Retek stock option plan and options under the CompReview Stock Option Plan, but excluding options to purchase stock of Aptex, a subsidiary of the Company, are summarized as follows.
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------ 1995 1996 1997 ------------------------ ------------------------ ------------------------ WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE ------ ---------------- ------ ---------------- ------ ---------------- Outstanding at beginning of year.... 2,080 $ 0.49 2,868 $ 2.84 3,215 $15.65 Options granted...... 1,272 6.08 1,645 27.98 2,177 32.61 Options exercised.... (207) 0.52 (1,140) 0.96 (475) 6.16 Options canceled..... (277) 1.80 (158) 17.62 (326) 26.33 ------ ------ Outstanding at end of year................. 2,868 2.84 3,215 15.65 4,591 23.92 ====== ====== Options exercisable at end of year.......... 1,437 841 1,096 Weighted average fair value of options granted during the year................. $ 3.10 $14.50 $19.79
The following table summarizes information about employee stock options outstanding at December 31, 1997:
OPTIONS OUTSTANDING ------------------------------------------- OPTIONS EXERCISABLE WEIGHTED ------------------------- NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED OUTSTANDING AT REMAINING AVERAGE OUTSTANDING AT AVERAGE RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE EXERCISE PRICES 1997 LIFE (IN YEARS) PRICE 1997 PRICE ---------------------- -------------- --------------- -------- -------------- -------- $ 0.02 to $ 3.00...... 1,002 5.90 $ 1.90 702 $ 1.60 4.50 25.38...... 793 8.21 19.22 188 15.69 25.60 30.75...... 791 8.86 29.39 147 30.33 30.81 31.50...... 944 9.57 31.40 1 30.94 31.88 39.00...... 774 9.42 36.03 32 34.24 39.09 49.50...... 287 9.27 41.42 26 42.64 ----- ----- 0.02 49.50...... 4,591 8.37 23.92 1,096 9.82 ===== =====
During 1996, Aptex adopted the 1996 Equity Incentive Plan (the "Aptex Plan") whereby 2,000 shares of Aptex common stock were reserved for issuance pursuant to nonqualified and incentive stock options and restricted stock awards. The plan is administered by the Board of Directors of Aptex or its designees and provides generally that nonqualified stock options and restricted stock may be awarded at a price not less than 85% of the fair market value, as determined by the Board of Directors, 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, or 110% of fair market value for awards to more than 10% stockholders. Options granted under the Incentive Plan may have a term of up to ten years. The Company has the F-20 93 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) discretion to provide for restrictions and the lapse thereof in respect of restricted stock awards, and options typically vest at the rate of 25% of the total grant per year. However, the Company may, at its discretion, implement a different vesting schedule with respect to any new stock option grant. During 1996, Aptex issued 1,000 shares of common stock at fair market value under the Aptex Plan for cash consideration of $0.03 per share. At December 31, 1997, options to purchase 79 shares were exercisable under the Aptex Plan. The Company applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for its stock-based compensation. No compensation expense has been recognized for its employee stock option grants, which are fixed in nature, as the options have been granted at fair market value. No compensation expense has been recognized for the Purchase Plan. Had compensation cost for the Company's stock-based compensation awards issued during 1997 and 1996 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 ("FAS 123"), the Company's net income and basic and diluted pro forma net income per common share would have been reduced to the pro forma amounts indicated below:
YEAR ENDED DECEMBER 31, -------------------------- 1995 1996 1997 ------ ------- ------- Net income: As reported................................. $6,077 $11,893 $17,565 Pro forma................................... 5,126 6,122 2,232 Basic net income per common share: As reported................................. 0.38 0.50 0.72 Pro forma................................... 0.31 0.26 0.09 Diluted net income per common share: As reported................................. 0.28 0.47 0.68 Pro forma................................... 0.24 0.24 0.09
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants during the years ended December 31, 1995, 1996 and 1997, respectively: dividend yield of 0.0% for all three years, risk-free interest rates of 6.29%, 6.03% and 6.10%, expected volatilities of 75%, 70% and 65% (0% for 1995 and 1996 options granted by Risk Data, Retek and CompReview prior to their acquisition by HNC), and expected lives of 3.5, 3.5 and 3.0 years. The fair value of the employees' purchase rights pursuant to the Purchase Plan is estimated using the Black-Scholes model with the following assumptions: dividend yield of 0.0% for all three years, risk-free interest rates of 5.66%, 5.36% and 5.32%, expected volatilities of 75%, 70% and 65%, and an expected life of 6 months for all three years. The weighted average fair value of those purchase rights granted in 1995, 1996 and 1997 was $2.75, $9.61 and $14.10, respectively. The fair value of each option granted under the Aptex Plan is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants during the years ended December 31, 1996 and 1997: dividend yield of 0.0% for both years, risk-free interest rates of 6.42% and 6.33%, expected volatility of 90% for both years, and expected lives of 9.25 and 8.0 years. Options to purchase 704 shares and 214 shares were granted during 1996 and 1997, with weighted average exercise prices per share of $0.03 and $0.08, respectively. During 1997, options to purchase 173 shares with a weighted average exercise price of $0.03 per share were exercised. During 1997, options to purchase 58 shares F-21 94 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) with a weighted average exercise price of $0.03 per share were cancelled. The weighted average fair value per share of options granted during 1996 and 1997 was $0.03 and $0.07, respectively. The following table summarizes information about Aptex employee stock options outstanding at December 31, 1997:
OPTIONS OUTSTANDING ------------------------------------------- OPTIONS EXERCISABLE WEIGHTED ------------------------- NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED OUTSTANDING AT REMAINING AVERAGE OUTSTANDING AT AVERAGE RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE EXERCISE PRICES 1997 LIFE (IN YEARS) PRICE 1997 PRICE ------------------- -------------- --------------- -------- -------------- -------- $0.03 to $0.03 497 8.75 $ 0.03 79 $ 0.03 0.05 0.05 39 9.40 0.05 -- -- 0.10 0.10 151 9.82 0.10 -- -- ----- --- 0.03 0.10 687 9.03 0.05 79 0.03 ========== ==========
NOTE 10 -- CONTINGENCIES Various claims arising in the course of business, seeking monetary damages and other relief, are pending. The amount of the liability, if any, from such claims cannot be determined with certainty; however, in the opinion of management, the ultimate liability for such claims will not have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows. NOTE 11 -- SUBSEQUENT EVENTS On January 30, 1998, the Company signed a definitive agreement to acquire Practical Control Systems Technologies, Inc. ("PCS"), a distribution center management software vendor based in Cincinnati, Ohio, subject to the satisfaction of certain closing conditions and the approval of PCS' shareholders. If consummated, the acquisition of PCS will be accounted for under the purchase method and will not be considered a "significant" acquisition pursuant to regulations set forth by the Securities and Exchange Commission. On February 13, 1998, the Company adopted the 1998 Stock Option Plan (the "1998 Plan"), under which 1,000,000 shares of HNC Common Stock were reserved for issuance pursuant to nonqualified stock options. The 1998 Plan is administered by the Board of Directors of HNC or a committee appointed by the Board and provides that nonqualified stock options granted under the plan must be awarded at an exercise price of not less than 100% of the fair market value of the stock at the date of grant. Options granted under the 1998 Plan may have a term of up to ten years. No options have been granted under the 1998 Plan to date. F-22 95 NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS. IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR BY ANY OF THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, SUCH SECURITIES BY ANYONE IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATES AS OF WHICH INFORMATION IS GIVEN IN THIS PROSPECTUS. TABLE OF CONTENTS
PAGE ---- Available Information.................. 2 Incorporation of Certain Documents by Reference............................ 2 Prospectus Summary..................... 3 Risk Factors........................... 5 Use of Proceeds........................ 17 Price Range of Common Stock............ 17 Dividend Policy........................ 17 Capitalization......................... 18 Selected Consolidated Financial Data... 19 Management's Discussion and Analysis of Financial Condition and Results of Operations........................... 21 Business............................... 31 Management............................. 47 Description of Notes................... 49 Description of Capital Stock........... 60 Certain United States Federal Income Tax Considerations................... 63 Underwriting........................... 69 Legal Matters.......................... 70 Experts................................ 70 Index to Consolidated Financial Statements........................... F-1
- ------------------------------------------------------------ LOGO U.S. $90,000,000 % CONVERTIBLE SUBORDINATED NOTES DUE 2003 DEUTSCHE MORGAN GRENFELL BANCAMERICA ROBERTSON STEPHENS SALOMON SMITH BARNEY PROSPECTUS , 1998 96 Information contained herein is subject to completion or amendment. A registration statement relating to these securities has been filed with the Securities and Exchange Commission. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This prospectus shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such jurisdiction. SUBJECT TO COMPLETION, DATED FEBRUARY 26, 1998 LOGO - -------------------------------------------------------------------------------- 2,100,000 SHARES COMMON STOCK - -------------------------------------------------------------------------------- Of the 2,100,000 shares of Common Stock, par value $0.001 per share ("Common Stock") offered hereby, 2,080,000 are being sold by certain stockholders (the "Selling Stockholders") of HNC Software Inc. ("HNC" or the "Company") and 20,000 are being issued and sold by the Company. The Company will not receive any of the proceeds from the sale of shares by the Selling Stockholders. See "Selling Stockholders." The Common Stock is listed on the Nasdaq National Market under the symbol "HNCS." The last reported sale price of the Common Stock on the Nasdaq National Market on February 25, 1998 was $32 11/16 per share. See "Price Range of Common Stock." FOR INFORMATION CONCERNING CERTAIN RISK FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS, SEE "RISK FACTORS" COMMENCING ON PAGE 4. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
PROCEEDS PROCEEDS TO PRICE TO UNDERWRITING TO SELLING PUBLIC DISCOUNT(1) COMPANY(2) STOCKHOLDERS Per Share $ $ $ $ Total(3) $ $ $ $
(1) The Company and the Selling Stockholders have agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended. See "Underwriting." (2) Before deducting expenses estimated at $700,000, payable by the Company. (3) Certain of the Selling Stockholders have granted to the Underwriters an option for 30 days to purchase up to an additional 315,000 shares of Common Stock solely to cover over-allotments, if any. If such option is exercised in full, the total Price to Public, Underwriting Discount and Proceeds to Selling Stockholders will be $ , $ and $ , respectively. See "Underwriting." The shares of Common Stock offered hereby are offered by the Underwriters subject to prior sale, when, as and if delivered to and accepted by them, and subject to approval of certain legal matters by counsel and certain other conditions. The Underwriters reserve the right to withdraw, cancel or modify such offer and to reject orders in whole or in part. Delivery of the shares of Common Stock offered hereby to the Underwriters is expected to be made in New York, New York on or about , 1998. DEUTSCHE MORGAN GRENFELL BANCAMERICA ROBERTSON STEPHENS SALOMON SMITH BARNEY The date of this Prospectus is , 1998. 97 AVAILABLE INFORMATION HNC is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance therewith, files reports, proxy statements and other information with the Securities and Exchange Commission (the "Commission"). Such reports, proxy statements and other information can be inspected and copied at the public reference facilities maintained by the Commission at Room 1024, 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549, and at the Commission's following Regional Offices: 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and Seven World Trade Center, 13th Floor, New York, New York 10048. Copies of such material can be obtained at prescribed rates from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549. The Commission maintains a World Wide Web site that contains reports, proxy statements and other information regarding registrants that file electronically with the Commission. The address of the site is http://www.sec.gov. The Company's Common Stock is quoted on the Nasdaq National Market and reports, proxy statements and other information concerning the Company also may be inspected at the offices of Nasdaq Operations, 1735 K Street, N.W., Washington, D.C. 20006. The Company has filed with the Commission a Registration Statement on Form S-3 (the "Registration Statement") under the Securities Act of 1933, as amended (the "Securities Act"), with respect to the securities offered by this Prospectus. This Prospectus, which forms a part of the Registration Statement, does not contain all of the information set forth in the Registration Statement, certain parts of which have been omitted in accordance with the rules and regulations of the Commission. For further information with respect to the Company and the securities offered hereby, reference is made to the Registration Statement, including the exhibits filed or incorporated by reference in the Registration Statement. Statements made in this Prospectus about any contract or other document are not necessarily complete and in each instance in which a copy of such contract is filed with, or incorporated by reference in, the Registration Statement as an exhibit, reference is made to such copy, and each such statement shall be deemed qualified in all respects by such reference. Copies of the Registration Statement may be inspected, without charge, at the offices of the Commission, or obtained at prescribed rates from the Public Reference Section of the Commission at the address set forth above. INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE The following documents that HNC has previously filed with the Commission are hereby incorporated herein by reference: (a) The Company's Annual Report on Form 10-K for the year ended December 31, 1997, as amended and (b) The description of the Company's Common Stock contained in the Company's registration statement on Form 8-A filed with the Commission on May 26, 1995. All documents filed by the Company pursuant to Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act after the date of this Prospectus and prior to the termination of the offering covered by this Prospectus shall be deemed to be incorporated by reference in this Prospectus and to be a part hereof from the date of filing of such documents. Any statement contained in any document incorporated by reference herein shall be deemed to be modified or superseded for purposes of this Prospectus to the extent that a statement contained herein or in any other subsequently filed document that also is or is deemed to be incorporated by reference herein, modifies or supersedes such statement. Any statement so modified or superseded shall not be deemed, except as so modified or superseded, to constitute a part of this Prospectus. The Company will provide without charge, upon written or oral request of any person to whom this Prospectus is delivered, a copy of any or all of the documents that have been or may be incorporated by reference in this Prospectus (other than exhibits to such documents that are not specifically incorporated by reference into such documents). Requests for such copies should be directed to HNC at 5930 Cornerstone Court West, San Diego, California 92121-3728, Attention: Raymond V. Thomas (telephone number (619) 546-8877). ------------------------ CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK, INCLUDING BY ENTERING STABILIZING BIDS, IMPOSING PENALTY BIDS, OR OTHERWISE. SUCH ACTIVITIES, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. FOR A DISCUSSION OF THESE ACTIVITIES, SEE "UNDERWRITING." IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS (AND SELLING GROUP MEMBERS, IF ANY) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE "UNDERWRITING." 2 98 PROSPECTUS SUMMARY The following summary should be read in conjunction with and is qualified in its entirety by the more detailed information, including "Risk Factors" and the consolidated financial statements and notes thereto, appearing elsewhere in this Prospectus or incorporated by reference in this Prospectus. THE COMPANY HNC develops, markets and supports predictive software solutions for leading service industries. These predictive software solutions employ proprietary neural-network predictive decision engines, profiles, traditional statistical modeling, business models, expert rules and context vectors to convert existing data and business experiences into meaningful recommendations and actions. Just as manufacturing organizations have implemented manufacturing resource planning software to automate routine transactions, leading service industries such as the healthcare/insurance, financial services and retail industries are using predictive software solutions to improve profitability, competitiveness and customer satisfaction. The Company's objective is to be the leading supplier of predictive software solutions by leveraging its core computational intelligence technology across a series of product lines targeted at specific service industries. In the healthcare/insurance industry, the Company's products are used to automate workers' compensation bill review and loss reserving, detect and prevent workers' compensation fraud and increase workers' compensation payor and provider effectiveness. In the financial services industry, the Company's products are used to detect and prevent credit card fraud, manage the profitability of credit card portfolios and automate lending decisions and residential property valuations. In the retail industry, the Company's products address inventory control, merchandise management, demand forecasting and private label credit card fraud. The Company markets most of its predictive software solutions as an ongoing service that includes software licenses, decision model updates, application consulting and on-line or on-site support and maintenance. The Company's customers include many of the leading companies in each of its target markets, including Concentra Managed Care Inc., CIGNA Corp. and CNA Financial Corporation in the healthcare/insurance industry, First Data Resources, Inc., Household International Inc. and MBNA Corp. in the financial services industry, and the Computer City division of Tandy Corp., Caldor Corp. and Hills Department Stores Inc. in the retail industry. The Company was founded in 1986 under the laws of California and was reincorporated in June 1995 under the laws of Delaware. The Company's principal executive offices are located at 5930 Cornerstone Court West, San Diego, California 92121-3728, and its telephone number is (619) 546-8877. In this Prospectus, the terms "HNC" and the "Company" each refer to HNC Software Inc., a Delaware corporation, and its consolidated subsidiaries unless the context otherwise requires. THE OFFERING Common Stock offered................................... 2,100,000 shares (including 20,000 shares by the Company and 2,080,000 shares by Selling Stockholders) Common Stock outstanding after this offering........... 24,557,550 shares NASDAQ National Market Symbol.......................... HNCS
SUMMARY CONSOLIDATED FINANCIAL INFORMATION (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, ------------------------------------------------ 1993 1994 1995 1996 1997 ------- ------- ------- ------- -------- STATEMENT OF INCOME DATA:(1) Total revenues................................................ $16,167 $29,838 $43,704 $71,439 $113,735 Operating income.............................................. 1,034 2,881 5,082 9,659 23,040 Net income.................................................... 875 3,142 6,077 11,893 17,565 Basic net income per common share(2).......................... 0.02 0.28 0.38 0.50 0.72 Diluted net income per common share(2)........................ 0.02 0.17 0.28 0.47 0.68 Pro forma net income(3)....................................... 641 2,137 4,534 9,731 15,417 Basic pro forma net income per common share(3)................ 0.64 Diluted pro forma net income per common share(3).............. 0.60 Shares used in computing basic net income per common share and basic pro forma net income per common share................. 8,591 8,642 15,195 23,552 24,275 Shares used in computing diluted net income per common share and diluted pro forma net income per common share........... 9,289 18,142 21,510 25,363 25,681
DECEMBER 31, 1997(4) ------------------------- BALANCE SHEET DATA: Cash, cash equivalents and investments available for sale........................... $ 42,946 Working capital..................................................................... 74,303 Total assets........................................................................ 119,877 Total stockholders' equity.......................................................... 103,860
- --------------- (1) The summary consolidated financial information gives retroactive effect to the acquisitions of Risk Data Corporation ("Risk Data"), Retek Distribution Corporation, now known as Retek Information Systems("Retek") and CompReview, Inc. ("CompReview") for all periods presented, accounted for as poolings of interests. (2) The computations of basic net income per common share for 1993, 1994 and 1995 include reductions of consolidated net income in the amounts of $717,000, $717,000 and $348,000, respectively, related to the accretion of dividends on mandatorily redeemable convertible Preferred Stock, which converted into Common Stock upon the closing of the Company's initial public offering on June 26, 1995. The computation of diluted net income per common share for 1993 does not include the assumed conversion of all outstanding shares of mandatorily redeemable convertible Preferred Stock into 7,675,000 shares of Common Stock or an increase to net income per common share related to the elimination of dividend accretion on such Preferred Stock as the impact would be antidilutive. (3) Pro forma net income and net income per common share reflect a provision for taxes on the income of CompReview, which was a subchapter S corporation prior to its acquisition by HNC, as if CompReview had been subject to corporate income taxes as a C corporation for all periods presented. (4) The net proceeds to the Company from this offering will not result in a material change in the December 31, 1997 balance sheet data. The Underwriters are concurrently offering $90.0 million of the Company's % Convertible Subordinated Notes due 2003 ("Notes"), which if sold will result in an increase of $87.2 million in each of the balance sheet data items, except for total stockholders' equity. 3 99 RISK FACTORS This Prospectus (including without limitation the following Risk Factors) contains forward-looking statements (within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act) regarding the Company and its business, financial condition, results of operations and prospects. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this Prospectus. Additionally, statements concerning future matters such as the development of new products, enhancements or technologies, possible changes in legislation and other statements regarding matters that are not historical are forward-looking statements. Although forward-looking statements in this Prospectus reflect the good faith judgment of the Company's management, such statements can only be based on facts and factors currently known by the Company. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and actual results and outcomes may differ materially from the results and outcomes discussed in the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include without limitation those discussed below as well as those discussed elsewhere in this Prospectus and in any documents that are incorporated into this Prospectus by reference. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Prospectus. The Company undertakes no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Prospectus. Readers are urged to carefully review and consider the various disclosures made by the Company in this Prospectus and in the Company's Annual Report on Form 10-K for the year ended December 31, 1997, as amended, filed with the Commission, which attempts to advise interested parties of the risks and factors that may affect the Company's business, financial condition and results of operations and prospects. POTENTIAL FLUCTUATIONS IN OPERATING RESULTS. The Company's revenues and operating results have varied significantly in the past and may do so in the future. Because the Company's expense levels are based in part on its expectations regarding future revenues and in the short term are fixed to a large extent, the Company may be unable to adjust its spending in time to compensate for any unexpected revenue shortfall. Factors affecting operating results include market acceptance of the Company's products; the relatively large size and small number of customer orders that may be received during a given period; customer cancellation of long-term contracts yielding recurring revenues or customers' ceasing their use of Company products for which the Company's fees are usage based; the length of the Company's sales cycle; the Company's ability to develop, introduce and market new products and product enhancements; the timing of new product announcements and introductions by the Company and its competitors; changes in the mix of distribution channels; changes in the level of operating expenses; the Company's ability to achieve progress on percentage-of-completion contracts; the Company's success in completing certain pilot installations for contracted fees; competitive conditions in the industry; domestic and international economic conditions; and market conditions in the Company's targeted markets. In addition, as a result of recently issued guidance on software revenue recognition, license agreements entered into during a quarter may not meet the Company's revenue recognition criteria. Therefore, even if the Company meets or exceeds its forecast of aggregate licensing and other contracting activity, it is possible that the Company's revenues would not meet expectations. Furthermore, the Company's operating results may be affected by factors unique to certain of its product lines. For example, the Company derives a substantial and increasing portion of its revenues from its retail products, which are generally priced as "perpetual" license transactions in which the Company receives a one-time license fee. The Company recognizes these fees as revenue upon delivery of the software and acceptance by the customer. Thus, failure to complete a perpetual license transaction during a fiscal quarter would have a disproportionate adverse impact on the Company's operating results for that quarter. 4 100 The Company expects fluctuations in its operating results to continue for the foreseeable future. Accordingly, the Company believes that period-to-period comparisons of its financial results should not be relied upon as an indication of future performance. The Company may not be able to maintain profitability on a quarterly or annual basis in the future. Due to all of the foregoing factors, it is possible that in some future quarter the Company's operating results will be below the expectations of public market analysts and investors. In that event, the price of the Company's Common Stock would likely be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." LENGTHY AND UNPREDICTABLE SALES CYCLE. Due in part to the mission-critical nature of certain of the Company's applications, potential customers perceive high risk in connection with adoption of the Company's products. As a result, customers have been cautious in making decisions to acquire the Company's products. In addition, because the purchase of the Company's 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 affect key operations. For these and other reasons, the sales cycle associated with the purchase of the Company's products is typically lengthy, unpredictable and subject to a number of significant risks over which the Company has little or no control, including customers' budgetary constraints and internal acceptance reviews. The sales cycle associated with the licensing of the Company's 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, the Company's ability to forecast the timing and amount of specific sales is limited. A lost or delayed sale could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Sales and Marketing." ACQUISITIONS. Between August 1996 and November 1997, the Company acquired three businesses. In August 1996, the Company acquired Risk Data, a company that develops, markets and supports proprietary software decision products for use in the insurance industry. In November 1996, the Company acquired Retek, a company that develops, markets and supports management decision software products for retailers and their vendors. In November 1997, the Company acquired CompReview, a company that develops, markets and supports a software product and related services designed to assist in the management and containment of the medical costs of workers' compensation and automobile accident medical claims. The Company believes that its future growth depends, in part, upon the success of these and possible future acquisitions. There can be no assurance that the Company will successfully identify, acquire on favorable terms or integrate such businesses, products, services or technologies. The Company may in the future face increased competition for acquisition opportunities, which may inhibit the Company's ability to consummate suitable acquisitions and increase the costs of completing such acquisitions. The acquisitions of Risk Data, Retek and CompReview, as well as other potential future acquisitions, will require the Company to successfully manage and integrate such acquired businesses, which may be located in diverse geographic locations. Acquiring other businesses also requires the Company to successfully develop and market products to new industries and markets with which the Company may not be familiar. It also requires the Company to coordinate (and possibly change) the diverse operating structures, policies and practices of the acquired companies and to integrate the employees of the acquired companies into the Company's organization and culture. Failure of the Company to successfully integrate and manage acquired businesses, to retain their employees, and to successfully address new industries and markets associated with such acquired businesses, would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, although the acquisitions of Risk Data, Retek and CompReview have been accounted for as poolings of interests, future acquisitions may be accounted for as purchases, resulting in potential charges that may adversely affect the Company's earnings. Additional acquisitions may also involve the issuance of shares of the Company's stock 5 101 to owners of acquired businesses, resulting in dilution in the percentage of the Company's stock owned by other stockholders. See "Business -- HNC's Strategy." RISKS ASSOCIATED WITH MANAGING GROWTH. In recent years, the Company has experienced changes in its operations that have placed significant demands on the Company's administrative, operational and financial resources. The growth in the Company's customer base and expansion of its product functionality, together with its acquisition of other businesses and their employees, have challenged and are expected to continue to challenge the Company's management and operations, including its sales, marketing, customer support, research and development and finance and administrative operations. The Company's future performance will depend in part on its ability to successfully manage change, both in its domestic and international operations, and to adapt its operational and financial control systems, if necessary, to respond to changes in its business and to facilitate the integration of acquired businesses with the Company's operations. The failure of the Company's management to effectively respond to and manage growth could have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE ON EMERGING TECHNOLOGIES AND MARKETS. The market for predictive software solutions is still emerging. The rate at which businesses have adopted the Company's products has varied significantly by market and by product within each market, and the Company expects to continue to experience such variations with respect to its target markets and products in the future. The Company has introduced products for the healthcare/insurance, financial services and retail markets. The Company has recently announced several new products, including PMAdvisor, VeriComp, SelectCast, SelectResponse and SelectResource. To date, none of these products has achieved any significant degree of market acceptance, and there can be no assurance that such products will ever be widely accepted. Although businesses in the Company's target markets have recognized the advantages of using predictive software solutions to automate the decision-making process, many have developed decision automation systems internally rather than licensing them from outside vendors. There can be no assurance that the markets for the Company's products will continue to develop or that the Company's products will be widely accepted, if at all. If the markets for the Company's new or existing products fail to develop, or develop more slowly than anticipated, the Company's sales would be negatively impacted, which would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Emerging Market Opportunities." RISKS ASSOCIATED WITH TECHNOLOGICAL CHANGE AND DELAYS IN DEVELOPING NEW PRODUCTS. The market for the Company's predictive software solutions for service industries is characterized by rapidly changing technology and improvements in computer hardware, network operating systems, programming tools, programming languages, operating systems and database technology. The Company's success will depend upon its ability to continue to develop and maintain competitive technologies, enhance its 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. For example, the rapid growth of the Internet environment creates new opportunities, risks and uncertainties for businesses, such as the Company, which develop software solutions that now may have to be designed to operate in Internet, intranet and other on-line environments. The Company may not be able to develop and market, on a timely basis, or at all, product enhancements or new products that respond to changing technologies. The Company has 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. Any significant delay in the completion of new products, or the failure of such products, if and when installed, to achieve any significant degree of 6 102 market acceptance, would have a material adverse effect on the Company's business, financial condition and results of operations. Any failure by the Company to anticipate or to respond adequately to changing technologies, or any significant delays in product development or introduction, could cause customers to delay or decide against purchases of the Company's products and would have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Technology" and "-- Research and Development." PRODUCT CONCENTRATION. The Company currently has one product or product line in each of its three target markets that accounts for a majority of the Company's total revenues from that market. These products in the aggregate accounted for 60.0%, 59.1% and 57.9% of the Company's total revenues in 1995, 1996 and 1997, respectively. In the healthcare/insurance market, the Company's revenues from its CRLink product accounted for 29.8%, 24.6% and 23.0% of the Company's total revenues in 1995, 1996 and 1997, respectively, and are expected to account for a substantial portion of the Company's total revenues for the foreseeable future. Continued market acceptance of CRLink will be affected by future product enhancements and competition. Decline in demand for, or use of, CRLink, whether as a result of competition, simplification of state workers' compensation fee schedules, changes in the overall payment system or regulatory structure for workers' compensation claims, technological change, an inability to obtain or use state fee schedule or claims data, saturation of market demand, industry consolidation or otherwise, could result in decreased revenues from CRLink, which could have a material adverse effect on the Company's business, financial condition and results of operations. Further, revenues from the Retek Merchandising System ("RMS"), a retail management product, accounted for 2.2%, 13.6% and 18.9% of the Company's total revenues in 1995, 1996 and 1997, respectively, and are expected to continue to account for a substantial portion of the Company's revenues in the foreseeable future. Continued market acceptance of RMS will be affected by the quality and timely introduction of future product enhancements and competition. Decline in demand for, or use of, RMS as a result of continued entry into the retail inventory management market by vendors that may have significantly greater resources and a broader customer base than the Company could result in decreased revenues from RMS, which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, decline in demand for RMS, as a result of technological change, saturation of market demand, industry consolidation or otherwise would have a material adverse effect on the Company's business, financial condition and results of operations. Revenues from the Company's Falcon product line for credit card fraud detection for financial institutions accounted for 28.0%, 20.9% and 16.0% of the Company's total revenues in 1995, 1996 and 1997, respectively, and are expected to continue to account for a substantial portion of the Company's total revenues in the foreseeable future. Continued market acceptance of the Falcon product line will be affected by the quality and timely introduction of future product enhancements and competition. In addition, it is possible that patterns of credit card fraud may change in a manner that the Falcon product line would not detect and that other methods of credit card fraud prevention may reduce customers' needs for the Falcon product line. As a result of increasing saturation of market demand for the Falcon product line, the Company may also need to rely increasingly on international sales to maintain or increase Falcon revenue levels. Furthermore, Falcon customers are banks and related financial institutions. Accordingly, the Company's future success depends upon the capital expenditure budgets of such customers and the continued demand by such customers for Falcon products. The financial services industry tends to be cyclical in nature, which may result in variations in demand for the Company's products. In addition, there has been and continues to be consolidation in the financial services industry, which in some cases has lengthened the sales cycle and may lead to reduced demand for the Company's products. Decline in demand for, or use of, Falcon, whether as a result of competition, technological change, change in fraud patterns, the cyclical nature of the financial services industry, saturation of market demand, fluctuations in interest rates, industry consolidation, reduction in capital spending or otherwise, could have a 7 103 material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Markets and Products." DEPENDENCE ON DATA. The development, installation and support of the Company's credit card fraud control and profitability management, loan underwriting, home valuation and certain healthcare/insurance products require periodic model updates. The Company must develop or obtain a reliable source of sufficient amounts of current and statistically relevant data to analyze transactions and update its models. For example, in the electronic payments market, the data required by the Company are collected privately and maintained in proprietary databases. As a result, the Company and its Falcon and ProfitMax customers enter into agreements pursuant to which customers agree to provide the data the Company requires to analyze transactions, report results and build new fraud detection and profitability models. For its AREAS home valuation product, the Company obtains data from commercial databases on available terms and conditions. Many of the Company's healthcare/insurance products use historical workers' compensation claims data obtained from customers. CRLink also uses data from state workers' compensation fee schedules adopted by state regulatory agencies, and certain third parties have asserted copyright interests in such data. In most cases, such data must be periodically updated and refreshed to enable the Company's predictive software products to continue to work effectively. In addition, the development of new and enhanced products also depends to a significant extent on the availability of sufficient amounts of statistically relevant data to enable the Company to develop models. For example, to expand the geographic coverage of its AREAS product, the Company would be required to develop or obtain data on home sales in each county for which AREAS is marketed. There can be no assurance that the Company will be able to continue to obtain adequate amounts of statistically relevant data on a timely basis, in the required formats or on reasonable terms and conditions, whether from customers or commercial suppliers. Any such failure by the Company to obtain required data when it is needed, for a reasonable price and on reasonable terms, could have a significant negative impact on existing product performance, new product development and product pricing which could in turn have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Customer Service and Support." COMPETITION. The market for predictive software solutions for service industries is intensely competitive and subject to rapid change. Competitors, many of which have substantially greater financial resources than the Company, vary in size and in the scope of the products and services they offer. The Company encounters competition from a number of sources, including (i) other application software companies, (ii) management information systems departments of customers and potential customers, including banks, insurance companies and retailers, (iii) third-party professional services organizations, including without limitation, consulting divisions of public accounting firms, (iv) hardware suppliers that bundle or develop complementary software, (v) network and service providers that seek to enhance their value-added services, (vi) neural-network tool suppliers and (vii) managed care organizations. In the healthcare/insurance market, the Company has experienced competition primarily from National Council on Compensation Insurance ("NCCI"), Corporate Systems and CSC Incorporated. In the workers' compensation and medical cost administration market, the Company has experienced competition from MediCode, Inc. ("MediCode"), Medata, Inc. and Embassy Software with regard to software licensing, and Intracorp and Corvel Corporation in the service bureau operations market. Additionally, the Company has faced competition from Automatic Data Processing, Inc. ("ADP") in the automobile accident medical claims market. In the financial services market, the Company has experienced competition from Fair, Isaac & Co., Inc., Cogensys (a subsidiary of Policy Management Systems Corporation), Federal National Mortgage Association ("Fannie Mae"), Federal Home Loan Mortgage Corporation ("Freddie Mac"), International Business Machines Corporation ("IBM"), Nestor, Inc., NeuralTech Inc., Neuralware Inc., PMI Mortgage Services Co., VISA International and others. In the retail market, the Company has experienced competition from JDA Software Group, Inc., SAP AG, PeopleSoft, Inc., IBM, Manugistics Group, Inc. and others. The 8 104 Company expects to experience additional competition from other established and emerging companies, as well as other technologies. For example, the Company's Falcon product competes against other methods of preventing credit card fraud, such as card activation 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, reduced gross margins and loss of market share, any of which could materially adversely affect the Company's business, financial condition and results of operations. The Company believes that most of its products are currently priced at a premium when compared to its competitors' products. The market for the Company's products is highly competitive, and the Company expects that it will face increasing pricing pressures from its current competitors and new market entrants. In particular, increased competition could reduce or eliminate such premiums and cause further price reductions. In addition, such competition could adversely affect the Company's ability to obtain new long-term contracts and renewals of existing long-term contracts on terms favorable to the Company. Any reduction in the price of the Company's products could materially adversely affect the Company's business, financial condition and results of operations. Some of the Company's current, and many of the Company's potential, competitors have significantly greater financial, technical, marketing and other resources than the Company. 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 the Company. 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 the Company's prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly gain significant market share. Also, the Company relies upon its customers to provide data, expertise and other support for the ongoing updating of the Company's models. The Company's customers, most of which have significantly greater financial and marketing resources than the Company, may compete with the Company in the future or otherwise discontinue their relationships with or support of the Company. There can be no assurance that the Company will be able to compete successfully against current and future competitors or that competitive pressures faced by the Company will not materially adversely affect its business, financial condition and results of operations. See "Business -- Competition." RISKS ASSOCIATED WITH RECRUITING AND RETAINING QUALIFIED PERSONNEL. The Company's success depends to a significant degree upon the continued service of members of the Company's senior management and other key research, development, sales and marketing personnel. Accordingly, the loss of any of the Company's senior management or key research, development, sales or marketing personnel could have a material adverse effect on the Company's business, financial condition and results of operations. Only a small number of employees have employment agreements with the Company, and there can be no assurance that such agreements will result in the retention of these employees for any significant period of time. In addition, the untimely loss of a member of the management team or a key employee of a business acquired by the Company could have a material adverse effect on the Company's business, financial condition and results of operations, particularly if such loss occurred before the Company has had adequate time to familiarize itself with the operating details of that business. In the past, the Company has experienced difficulty in recruiting a sufficient number of qualified sales and technical employees. In addition, competitors may attempt to recruit the Company's key employees. There can be no assurance that the Company will be successful in attracting, assimilating and retaining such personnel. The failure to attract, assimilate and retain key personnel could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Employees" and "Management." 9 105 CUSTOMER CONCENTRATION. Product licenses to First Data Resources, Inc. ("First Data"), the largest provider of credit card charge receipt processing services to banks, accounted for 8.7%, 8.6% and 7.6% of the Company's total revenues in 1995, 1996 and 1997, respectively. The Company has licensed First Data to provide its customers with access to the Company's ProfitMax product pursuant to a license agreement entered into in January 1996 (the "ProfitMax Contract"). The Company's revenues under the ProfitMax Contract represented approximately one-quarter of the Company's revenues from First Data in 1997. In late January 1998, First Data asserted that certain restrictive covenants under the ProfitMax Contract violated certain intellectual property laws. First Data also asserted that the existence of such restrictions made the ProfitMax Contract at least temporarily unenforceable and that First Data is therefore not obligated to pay the Company license fees due under the ProfitMax Contract. The Company disputed First Data's claim, released and waived the above-mentioned restrictive covenants in the ProfitMax Contract and gave First Data written notice that the Company intended to terminate the ProfitMax Contract pursuant to its terms unless First Data cured its failure to pay the delinquent license fees in a timely manner. Currently, First Data and the Company are working to resolve their dispute regarding the ProfitMax Contract by negotiating a new agreement; however, there can be no assurance that such an agreement will be reached or that the terms of such an agreement would be as favorable to HNC as its existing contractual arrangements with First Data. If no such agreement can be reached and First Data maintains its current position, it is possible that litigation or arbitration could ensue, which would likely result in a loss of anticipated revenue to the Company under the ProfitMax Contract and possibly other agreements between the Company and First Data, which could have a material adverse effect on the Company's business, financial condition and results of operation. See "Business -- Sales and Marketing." RISKS ASSOCIATED WITH INTERNATIONAL SALES. In 1995, 1996 and 1997, international operations and export sales (including sales in Canada) represented 12.6%, 17.7% and 16.8% of the Company's total revenues, respectively. The Company intends to continue to expand its operations outside the United States and to enter additional international markets, including by adding sales and support offices in Europe and Japan, which will require significant management attention and financial resources. For certain more mature products, such as Falcon, the Company may need to increase international sales in order to continue to expand the product's customer base. The Company has committed and continues to commit significant time and development resources to customizing certain of its products for selected international markets and to developing international sales and support channels. There can be no assurance that the Company's efforts to develop products, databases and models for targeted international markets or to develop additional international sales and support channels will be successful. The failure of such efforts, which can entail considerable expense, could have a material adverse effect on the Company's business, financial condition and results of operations. International sales are subject to 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. The Company's international sales are currently denominated predominantly in United States dollars and a small portion are denominated in British pounds sterling. An increase in the value of the United States dollar relative to foreign currencies could make the Company's products more expensive, and therefore potentially less competitive, in foreign markets. In the future, to the extent the Company's international sales are denominated in local currencies, foreign currency translations may contribute to significant fluctuations in the Company's business, financial condition and results of operations. If for any reason exchange or price controls or other restrictions on foreign currencies are imposed, the Company's business, financial condition and results of operations could be materially adversely affected. See "Business -- Sales and Marketing." 10 106 RISKS ASSOCIATED WITH CHANGING REGULATORY ENVIRONMENT. The Company's customers are subject to a number of government regulations and certain other industry standards with which the Company's products must comply. For example, the Company's financial services products are affected by Regulation B promulgated under the Equal Credit Opportunity Act, by regulations governing the extension of credit to consumers and by Regulation E promulgated under the Electronic Fund Transfers Act governing the transfer of funds from and to consumer deposit accounts, as well as VISA and MasterCard electronic payment standards. In the mortgage services market, the Company's products are affected by regulations such as Fannie Mae and Freddie Mac regulations for conforming loans, Uniform Standards of Professional Appraisal Practice and appraisal standards for federally insured institutions under the Financial Institutions Reform, Recovery and Enforcement Act. In addition, recent regulatory initiatives have restricted the availability of bank and credit bureau data, reflecting a consumer privacy trend that could limit the Company's ability to obtain or use certain credit-related information. It is also possible that insurance-related regulations may in the future apply to the Company's healthcare/insurance products. 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, and such changes, if adopted, might adversely affect the Company's healthcare/insurance business. In addition, if state-mandated workers' compensation laws or regulations or state workers' compensation fee schedules are simplified, such changes would diminish the need for, and the benefit provided by, the CRLink product. Changes in workers' compensation laws or regulations could also adversely affect the Company's healthcare/insurance products by making them obsolete, or by requiring extensive changes in these products to reflect new workers' compensation rules. To the extent that the Company sells new products targeted to markets that include regulated industries and businesses, the Company's products will need to comply with these additional regulations. Any failure of the Company's products to comply with existing or new regulations and standards could result in legal action against the Company or its customers by regulatory authorities or by third parties, including actions seeking civil or criminal penalties, injunctions against the Company's use of data or civil damages, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company may also be liable to its customers for failure of its products to comply with such regulatory requirements. Furthermore, changes to these regulations and standards or the adoption of new regulations or standards that affect the Company's products could affect the performance of such products and have a material adverse effect on the Company's business, financial condition and results of operations. PROTECTION OF INTELLECTUAL PROPERTY. The Company relies on a combination of patent, copyright, trademark and trade secret laws and confidentiality procedures to protect its proprietary rights. The Company currently owns seven issued United States patents and has four United States patent applications pending. The Company has applied for additional patents for its Falcon technology in Canada, Europe and Japan and for its MIRA product in Australia, Canada and Europe. There can be no assurance that patents will be issued with respect to pending or future patent applications or that the Company's patents will be upheld as valid or will prevent the development of competitive products. The Company seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. As part of its confidentiality procedures, the Company generally enters into invention assignment and proprietary information agreements with its employees and independent contractors and nondisclosure agreements with its distributors, corporate partners and licensees, and limits access to and distribution of its 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 the Company's products or technology without authorization, or to develop similar technology independently. In addition, to ensure that customers will not be adversely affected by an interruption in the Company's business, the Company places source code for certain of its products into escrow, which may increase the likelihood of misappropriation or other misuse of the 11 107 Company's intellectual property. Moreover, effective protection of intellectual property rights may be unavailable or limited in certain foreign countries in which the Company has done and may do business. Also, the Company has developed technologies under research projects conducted under agreements with various United States Government agencies or subcontractors to such agencies. Although the Company has acquired certain commercial rights to such technologies, the United States Government typically retains ownership of certain intellectual property rights and licenses in the technologies developed by the Company under such contracts, and in some cases can terminate the Company's rights in such technologies if the Company fails to commercialize them on a timely basis. In addition, under certain United States Government contracts, the results of the Company's research may be made public by the government, which could limit the Company's competitive advantage with respect to future products based on such research. See "Business -- Intellectual Property and Other Proprietary Rights." INFRINGEMENT OF PROPRIETARY RIGHTS. In the past, the Company has received communications from third parties asserting that Company trademarks infringed such other parties' trademarks, none of which has resulted in litigation or losses to the Company. Given the Company's ongoing efforts to develop and market new technologies and products, the Company may receive communications from third parties asserting that the Company's products infringe, or may infringe, their intellectual property rights. If as a result of any such claims the Company were precluded from using certain technologies or intellectual property rights, licenses to such disputed third-party technology or intellectual property rights might not be available on reasonable commercial terms, if at all. Furthermore, the Company may initiate claims or litigation against third parties for infringement of the Company's proprietary rights or to establish the validity of the Company's proprietary rights. Litigation, either as plaintiff or defendant, could result in significant expense to the Company and divert the efforts of the Company's technical and management personnel from productive tasks, whether or not such litigation is resolved in favor of the Company. In the event of an adverse ruling in any such litigation, the Company might be required to pay substantial damages, discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to infringing technology, and the court might invalidate the Company's patents, trademarks or other proprietary rights. In the event of a successful claim against the Company and the failure of the Company to develop or license a substitute technology, the Company's business, financial condition and results of operations would be materially and adversely affected. As the number of software products increases and the functionality of these products further overlaps, the Company believes that software developers may become increasingly subject to infringement claims. Any such claims, with or without merit, can be time consuming and expensive to defend and could materially and adversely affect the Company's business, financial condition and results of operations. See "Business -- Intellectual Property and Other Proprietary Rights." RISK OF PRODUCT DEFECTS AND PRODUCT LIABILITY. Software products as complex as those offered by the Company often contain undetected errors or failures when first introduced or as new versions are released. In addition, to the extent that the Company may have to develop new products that operate in new environments, such as the Internet, the possibility for program errors and failures may increase due to factors such as the use of new technologies or the need for more rapid product development that is characteristic of the Internet market. Despite pre-release testing by the Company and by current and potential customers, there still may be errors in new products, even after commencement of commercial shipments. The occurrence of such errors could result in delay in, or failure to achieve, market acceptance of the Company's products, which could have a material adverse effect on the Company's business, financial condition and results of operations. Although the Company's license agreements with its customers typically contain provisions designed to limit the Company's exposure to potential product liability claims, it is possible that such limitation of liability provisions may not be effective as a result of existing or future laws or unfavorable judicial decisions. Because the Company's products are used in business-critical 12 108 applications, any errors or failures in such products may give rise to substantial product liability claims, which could have a material adverse effect on the Company's business, financial condition and results of operations. VOLATILITY OF COMMON STOCK PRICE. The Company's Common Stock has experienced significant price volatility and such volatility may recur in the future. Factors such as announcements of the introduction of new products by the Company or its competitors, acquisitions of businesses or products by the Company, quarter-to-quarter variations in the Company's operating results and the gain or loss of significant orders, as well as market conditions in the technology and emerging growth company sectors, may have a significant impact on the market price of the Company's Common Stock. Further, the stock market has experienced extreme volatility that has particularly affected the market prices of securities of many technology companies and that often has been unrelated or disproportionate to the operating performance of such companies. These market fluctuations may adversely affect the price of the Common Stock. The trading prices of many technology companies' stocks, including the Company's Common Stock, reflect price/earnings ratios substantially above historical norms. The trading price of the Company's Common Stock may not remain at or near its current level. See "Price Range of Common Stock." YEAR 2000 COMPLIANCE. Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than two years, computer systems and/or software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. Significant uncertainty exists in the software industry concerning the potential effects associated with such compliance. The Company anticipates that it will need to devote resources in the next two years to modify its CRLink product to properly process dates beyond December 31, 1999. The Company expects that the cost of making these modifications and distributing the modified product to existing customers will be approximately $500,000. These modifications and the resources that the Company expects to devote to such modifications may divert management and engineering attention from, or delay the development and introduction of, new products and enhancements to existing products. The inability of the Company to complete such modifications successfully and on a timely basis, or the inability of the Company to devote sufficient resources to continuing updates and enhancements to the CRLink product, could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to correct or patch their current software systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase software products such as those offered by the Company, which could result in a material adverse effect on the Company's business, financial condition and results of operations. FACTORS INHIBITING TAKEOVER. The Board of Directors is authorized to issue up to 4,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock, while providing 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 the outstanding voting stock of the Company. The Company has no current plans to issue shares of Preferred Stock. In addition, Section 203 of the Delaware General Corporation Law restricts certain business combinations with any "interested stockholder" as defined by such statute. The statute may have the effect of delaying, deferring or preventing a change in control of the Company. 13 109 USE OF PROCEEDS The net proceeds to the Company from the sale of the 20,000 shares of Common Stock offered by the Company hereby will not be material. The Company will not receive any proceeds from the sale of Common Stock by the Selling Stockholders. PRICE RANGE OF COMMON STOCK The Company's Common Stock has been traded on the Nasdaq National Market since June 1995 under the symbol "HNCS." The following table sets forth for the periods indicated the high and low sales prices of the Common Stock. Prior to June 1995, there was no established public trading market for the Common Stock. All prices have been adjusted to give effect to a two-for-one stock split effected in the form of a stock dividend paid in April 1996.
HIGH LOW ------ ---- 1996: First Quarter..................................... $ 38 3/4 $18 1/4 Second Quarter.................................... 51 31 1/4 Third Quarter..................................... 47 1/2 20 3/4 Fourth Quarter.................................... 45 1/4 26 1/4 1997: First Quarter..................................... $ 36 3/4 $23 1/4 Second Quarter.................................... 42 3/8 18 1/4 Third Quarter..................................... 43 5/8 33 3/4 Fourth Quarter.................................... 43 1/2 30 1998: First Quarter (through February 25, 1998)......... $ 43 $32 9/16
On February 25, 1998, the last reported sale price of the Common Stock on the Nasdaq National Market was $32 11/16 per share. As of February 13, 1998, there were approximately 186 holders of record of the Common Stock. DIVIDEND POLICY The Company has never declared or paid any cash dividends on its capital stock. The Company currently anticipates that it will retain all future earnings for use in its business and does not anticipate paying any cash dividends in the foreseeable future. The Company's bank credit agreement prohibits the Company from declaring or paying any cash dividends without the bank's consent. 14 110 CAPITALIZATION The following table sets forth the capitalization of HNC at December 31, 1997. The net proceeds to the Company from this offering will not result in a material change to the Company's capitalization as of December 31, 1997.
DECEMBER 31, 1997 ----------------- (IN THOUSANDS) Stockholders' equity: Preferred stock, $0.001 par value -- 4,000,000 shares authorized: no shares issued or outstanding........................................ $ -- Common stock, $0.001 par value -- 50,000,000 shares authorized: 24,537,550 shares issued and outstanding(1)......................... 25 Paid-in capital........................................................ 95,919 Unrealized loss on investments available for sale...................... (2) Foreign currency translation adjustment................................ (111) Retained earnings...................................................... 8,029 -------- Total stockholders' equity.......................................... 103,860 -------- Total capitalization........................................... $ 103,860 ========
- --------------- (1) Excludes the shares reserved for issuance upon conversion of the Notes, 4,591,133 shares of Common Stock subject to stock options outstanding at December 31, 1997 at a weighted average exercise price of $23.92 per share and an additional 393,075 shares of Common Stock reserved for issuance under the Company's stock option and stock purchase plans at such date. In February 1998, the Company adopted a nonqualified stock option plan and reserved 1,000,000 shares of Common Stock for issuance thereunder. The Underwriters are concurrently offering $90.0 million of convertible subordinated notes, which if sold will result in an increase of $90 million in the total capitalization of the Company. 15 111 SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data as of December 31, 1996 and 1997 and for each of the years in the three-year period ended December 31, 1997 have been derived from HNC's Consolidated Financial Statements included elsewhere in this Prospectus, which have been audited by Price Waterhouse LLP, independent accountants, as indicated in their report thereon appearing elsewhere herein. The selected consolidated financial data as of December 31, 1994 and 1995 and for the year ended December 31, 1994 have been derived from separate audited financial statements for HNC and CompReview not included herein. The selected consolidated financial data as of and for the year ended December 31, 1993 have been derived from separate financial data for HNC and CompReview not included herein. The data set forth below are qualified in their entirety by reference to, and should be read in conjunction with, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and related notes thereto included elsewhere in this Prospectus.
YEAR ENDED DECEMBER 31, ------------------------------- 1995 1996 1997 ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF INCOME DATA(1): Revenues: License and maintenance..................................................... $24,561 $48,890 $89,643 Installation and implementation............................................. 4,648 6,691 10,702 Contracts and other......................................................... 9,146 11,128 7,772 Service bureau.............................................................. 5,349 4,730 5,618 -------- ------- ------- Total revenues....................................................... 43,704 71,439 113,735 -------- ------- ------- Operating expenses: License and maintenance..................................................... 7,903 13,725 19,937 Installation and implementation............................................. 1,425 2,714 5,174 Contracts and other......................................................... 6,894 7,694 5,438 Service bureau.............................................................. 3,025 3,365 4,320 Research and development.................................................... 6,998 13,808 21,151 Sales and marketing......................................................... 7,276 11,923 22,049 General and administrative.................................................. 5,101 8,551 12,626 -------- ------- ------- Total operating expenses............................................. 38,622 61,780 90,695 -------- ------- ------- Operating income.............................................................. 5,082 9,659 23,040 Interest and other income..................................................... 912 2,178 2,003 Interest expense.............................................................. (428) (478) (81) Minority interest in income of consolidated subsidiary........................ -- -- (43) -------- ------- ------- Income before income tax (benefit) provision......................... 5,566 11,359 24,919 Income tax (benefit) provision................................................ (511) (534) 7,354 -------- ------- ------- Net income........................................................... $ 6,077 $11,893 $17,565 ======== ======= ======= Earnings per share: Basic net income per common share(2)........................................ $ 0.38 $ 0.50 $ 0.72 ======== ======= ======= Diluted net income per common share(2)...................................... $ 0.28 $ 0.47 $ 0.68 ======== ======= ======= Unaudited pro forma data(3): Income before income tax provision.......................................... $ 5,566 $11,359 $24,919 Income tax provision........................................................ 1,032 1,628 9,502 -------- ------- ------- Net income........................................................... $ 4,534 $ 9,731 $15,417 ======== ======= ======= Basic pro forma net income per common share(3).............................. $ 0.64 ======= Diluted pro forma net income per common share(3)............................ $ 0.60 ======= Shares used in computing basic net income per common share and unaudited basic pro forma net income per common share....................................... 15,195 23,552 24,275 ======== ======= ======= Shares used in computing diluted net income per common share and unaudited diluted pro forma net income per common share............................... 21,510 25,363 25,681 ======== ======= =======
16 112
YEAR ENDED DECEMBER 31, ------------------------------------------------ 1993 1994 1995 1996 1997 ------- ------- ------- ------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) ADDITIONAL STATEMENT OF INCOME DATA:(1) Total revenues............................... $16,167 $29,838 $43,704 $71,439 $113,735 Operating income............................. 1,034 2,881 5,082 9,659 23,040 Net income................................... 875 3,142 6,077 11,893 17,565 Basic net income per common share(2)......... 0.02 0.28 0.38 0.50 0.72 Diluted net income per common share(2)....... 0.02 0.17 0.28 0.47 0.68 Pro forma net income(3)...................... 641 2,137 4,534 9,731 15,417 Basic pro forma net income per common share(3)................................... 0.64 Diluted pro forma net income per common share(3)................................... 0.60 Shares used in computing unaudited basic net income per common share and basic pro forma net income per common share................ 8,591 8,642 15,195 23,552 24,275 Shares used in computing unaudited diluted net income per common share and diluted pro forma net income per common share.......... 9,289 18,142 21,510 25,363 25,681
DECEMBER 31, ------------------------------------------------ 1993 1994 1995 1996 1997 ------- ------- ------- ------- -------- (IN THOUSANDS) BALANCE SHEET DATA: Cash, cash equivalents and investments available for sale......................... $ 4,679 $ 7,827 $44,975 $34,849 $ 42,946 Total assets................................. 10,944 20,663 63,113 98,293 119,877 Long-term obligations, less current portion.................................... 367 917 1,373 264 63 Mandatorily redeemable convertible preferred stock...................................... 12,452 13,169 -- -- --
- --------------- (1) The selected consolidated financial data gives retroactive effect to the acquisitions of Risk Data, Retek and CompReview for all periods presented, accounted for as poolings of interests. (2) The computations of basic net income per common share for 1993, 1994 and 1995 include reductions of consolidated net income in the amounts of $717,000, $717,000 and $348,000, respectively, related to the accretion of dividends on mandatorily redeemable convertible Preferred Stock, which converted into Common Stock upon the closing of the Company's initial public offering on June 26, 1995. The computation of diluted net income per common share for 1993 does not include the assumed conversion of all outstanding shares of mandatorily redeemable convertible Preferred Stock into 7,675,000 shares of Common Stock or an increase to net income per common share related to the elimination of dividend accretion on such Preferred Stock as the impact would be antidilutive. (3) Pro forma net income and net income per common share reflect a provision for taxes on the income of CompReview, which was a subchapter S corporation prior to its acquisition by HNC, as if CompReview had been subject to corporate income taxes as a C corporation for all periods presented. 17 113 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Prospectus (including without limitation the following section regarding Management's Discussion and Analysis of Financial Condition and Results of Operations) contains forward-looking statements (within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act) regarding the Company and its business, financial condition, results of operations and prospects. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this Prospectus. Additionally, statements concerning future matters such as the development of new products, enhancements or technologies, possible changes in legislation and other statements regarding matters that are not historical are forward-looking statements. Although forward-looking statements in this Prospectus reflect the good faith judgment of the Company's management, such statements can only be based on facts and factors currently known by the Company. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include without limitation those discussed in "Risk Factors" as well as those discussed elsewhere in this Prospectus and in any documents that are incorporated into this Prospectus by reference. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Prospectus. The Company undertakes no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Prospectus. Readers are urged to carefully review and consider the various disclosures made by the Company in this Prospectus and in the Company's Annual Report on Form 10-K for the year ended December 31, 1997, as amended, filed with the Commission, which attempts to advise interested parties of the risks and factors that may affect the Company's business, financial condition, results of operations and prospects. OVERVIEW HNC develops, markets and supports predictive software solutions for leading service industries. These predictive software solutions employ proprietary neural-network predictive decision engines, profiles, traditional statistical modeling, business models, expert rules and context vectors to convert existing data and business experiences into meaningful recommendations and actions. HNC was founded in 1986 to provide software tools and contracted technology services using neural-network technology. In August 1996, HNC completed its acquisition of Risk Data in a transaction accounted for as a pooling of interests. Risk Data is based in Irvine, California and develops, markets and supports proprietary software decision products for use in the insurance industry. In 1996, HNC formed Aptex Software Inc. ("Aptex"), a majority-owned subsidiary located in San Diego, California that develops, markets and supports electronic text analysis technology in products designed for the Internet and other environments. In November 1996, HNC completed its acquisition of Retek in a transaction accounted for as a pooling of interests. Retek is based in Minneapolis, Minnesota and develops, markets and supports software products that provide merchandise management and other management tools to retailers and their vendors. In November 1997, the Company completed its acquisition of CompReview, in a transaction accounted for as a pooling of interests. CompReview is located in Costa Mesa, California and develops, markets and supports a software product and related services designed to assist in the management and containment of the medical costs of workers' compensation and automobile accident medical claims. CompReview provides its product and services primarily to insurance companies, managed care organizations, third party administrators and large self-insured employers. The Company anticipates that from time to time it 18 114 will consider acquisitions of other businesses in order to expand the markets served by the Company and to acquire complementary technologies, products and personnel. See "Risk Factors -- Acquisitions" and "Business -- HNC's Strategy." After giving retroactive effect to the Company's acquisitions of Risk Data, Retek and CompReview, HNC experienced compound annual growth in total revenues of 63% from 1993 through 1997. See "Risk Factors -- Risks Associated with Managing Growth." This revenue growth resulted primarily from increased license fees for the Retek Merchandising System, CRLink, Falcon, MIRA and ProfitMax products and, to a lesser extent, from increased license fees for the Active Retail Intelligence, Retek Data Warehouse, PMAdvisor, CompCompare, Capstone and AREAS products. Because of the long sales and development cycle associated with the Company's products, the Company has not received significant revenues to date from the SelectCast, SelectResponse, SelectResource, VeriComp or PMAdvisor products. See "Risk Factors -- Lengthy and Unpredictable Sales Cycle." The Company markets most of its predictive software solutions as an ongoing service that includes software licenses, decision model updates, application consulting and on-line or on-site support and maintenance. The Company's pricing for the CRLink, Falcon, MIRA, ProfitMax, AREAS, PMAdvisor, CompCompare and ProviderCompare products typically includes an annual or monthly usage fee and a one to seven year contract commitment. In 1995, 1996 and 1997, annual license and maintenance revenues from these contracts represented 61.2%, 56.1% and 55.2% of the Company's total revenues, respectively. The Company's revenues and operating results have varied significantly in the past and may do so in the future. Because the Company's expense levels are based in part on its expectations regarding future revenues and in the short term are fixed to a large extent, the Company may be unable to adjust its spending in time to compensate for any unexpected revenue shortfall. Factors affecting operating results include market acceptance of the Company's products; the relatively large size and small number of customer orders that may be received during a given period; customer cancellation of long-term contracts yielding recurring revenues or customers' ceasing their use of Company products for which the Company's fees are usage based; the length of the Company's sales cycle; the Company's ability to develop, introduce and market new products and product enhancements; the timing of new product announcements and introductions by the Company and its competitors; changes in the mix of distribution channels; changes in the level of operating expenses; the Company's ability to achieve progress on percentage-of-completion contracts; the Company's success in completing certain pilot installations for contracted fees; competitive conditions in the industry; domestic and international economic conditions; and market conditions in the Company's targeted markets. In addition, as a result of recently issued guidance on software revenue recognition, license agreements entered into during a quarter may not meet the Company's revenue recognition criteria. Therefore, even if the Company meets or exceeds its forecast of aggregate licensing and other contracting activity, it is possible that the Company's revenues would not meet expectations. Furthermore, the Company's operating results may be affected by factors unique to certain of its product lines. For example, the Company derives a substantial and increasing portion of its revenues from its retail products, which are generally priced as "perpetual" license transactions in which the Company receives a one-time license fee. The Company recognizes these fees as revenue upon delivery of the software and acceptance by the customer. Thus, failure to complete a perpetual license transaction during a fiscal quarter could have a disproportionate adverse impact on the Company's operating results for that quarter. The Company expects fluctuations in its operating results to continue for the foreseeable future. Accordingly, the Company believes that period-to-period comparisons of its financial results should not be relied upon as an indication of future performance. The Company may not be able to maintain profitability on a quarterly or annual basis in the future. Due to all of the foregoing factors, it is possible that in some future quarter the Company's operating results will be below the 19 115 expectations of public market analysts and investors. In that event, the price of the Company's Common Stock would likely be materially adversely affected. RESULTS OF OPERATIONS The Company's statements of income for all periods presented give retroactive effect to the acquisitions of Risk Data, Retek and CompReview in August 1996, November 1996 and November 1997, respectively, each of which was accounted for as a pooling of interests. Total Revenues The Company's revenues are comprised of license and maintenance revenues, installation and implementation revenues, contracts and other revenues and service bureau revenues. Total revenues increased by 63.5% to $71.4 million in 1996 and by 59.2% to $113.7 million in 1997. International operations and export sales represented 12.6%, 17.7% and 16.8% of total revenues in 1995, 1996 and 1997, respectively. The retail product line currently has more sales in international markets than the healthcare/insurance and financial services product lines combined. The Company believes that international sales represent a significant opportunity for revenue growth and expects international sales to increase as a percent of total revenue. License and Maintenance Revenues. The Company's license and maintenance revenues are derived from annual license fees, monthly license fees, perpetual license fees and annual maintenance fees. The Company typically licenses many of its products for an annual or monthly usage fee under long-term contracts that include software licenses, decision model updates, application consulting, and on-line or on-site support and maintenance. The Company's revenue from periodic software license and maintenance agreements is generally recognized ratably over the respective license or agreement periods. Revenue from certain short-term periodic software license and maintenance agreements with guaranteed minimum license fees is recognized as related services are performed. Transactional fees are recognized as revenue based on system usage or when fees based on system usage exceed the monthly minimum license fees. Revenue from perpetual licenses of the Company's software for which there are no significant continuing obligations and collection of the related receivables is probable is recognized on delivery of the software and acceptance by the customer. Recently issued guidance on software revenue recognition could lead to unanticipated changes in the Company's revenue recognition practices. See "Risk Factors -- Potential Fluctuations in Operating Results" and "-- New Accounting Pronouncements." License and maintenance revenues increased by 99.1% to $48.9 million in 1996 and by 83.4% to $89.6 million in 1997. The increase from 1995 to 1996 was due primarily to the growth of license fees in all markets, particularly from the Retek Merchandising System, CRLink and Falcon, and, to a lesser extent, MIRA and CompCompare. The increase from 1996 to 1997 was due primarily to the growth of license fee revenues from the Retek Merchandising System and CRLink. Also contributing to the increase were increased license fees from other retail products, such as ARI and Retek Data Warehouse, financial services products such as Falcon, ProfitMax and Capstone, and other healthcare/insurance products, such as PMAdvisor and MIRA. Installation and Implementation Revenues. Revenues from software installations and implementations are generally recognized as the services are performed using the percentage of completion method based on costs incurred to date compared to total estimated costs at completion. Amounts received in advance of performance under the contracts are recorded as deferred revenue and are generally recognized within one year from receipt. Installation and implementation revenues increased by 44.0% to $6.7 million in 1996 and by 59.9% to $10.7 million in 1997. Substantially all of the increase from 1995 to 1996 was due primarily to growth in the installations of Retek Data Forecasting as this product moved 20 116 from development into production. The increase from 1996 to 1997 was due primarily to growth in the installations of Capstone and ProfitMax. Contracts and Other Revenues. Contracts and other revenues are derived primarily from new product development contracts with commercial customers and research contracts with the United States Government. The Company typically contracts with one or two commercial partners for pilot development and installation of its new products and with the United States Government for additional research funds. Revenues from contract services are generally recognized as the services are performed using the percentage of completion method based on costs incurred to date compared to total estimated costs at completion. Revenue from hardware product sales, which is included in contracts and other revenue, is recognized upon shipment to the customer. Contracts and other revenues increased by 21.7% to $11.1 million in 1996 and decreased by 30.2% to $7.8 million in 1997. The increase in 1996 was primarily the result of greater revenues from commercial new product pilot installation contracts with customers in support of the Company's development of ProfitMax, SelectCast, Falcon Sentry and Capstone. The decrease in 1997 was primarily the result of products such as ProfitMax, Retek Data Forecasting and Capstone moving from development into production. During 1997, the Company had fewer new product development projects and new product pilot installations than during 1996. There can be no assurance that any of these product development projects or pilot installations will be successful or be completed within anticipated time schedules or that the customers who serve as pilot installation sites will be satisfied with these products or agree to license them. If the Company's new product development efforts are unsuccessful, are not completed on a timely basis or are not well received by pilot customers, the Company may be compelled to delay or discontinue the release of production versions of these products or bear increased expense to bring these pilot products to market, either of which would have a material adverse effect on the Company's business, financial condition and results of operations. Service Bureau Revenues. Service bureau revenues are derived from the Company's service bureau operations, which provide CRLink's functionality to customers that do not wish to obtain a license, that use this service until they can implement their own internal CRLink operation or that use this service when their volumes peak to high levels. Service bureau customers typically subscribe for services under month-to-month agreements. Service bureau fees are recognized as revenue when the processing services are performed. Service bureau revenues decreased by 11.6% to $4.7 million in 1996 and increased by 18.8% to $5.6 million in 1997. The decrease in 1996 was primarily a result of the significant increase in license revenues as the Company's sales efforts were focused on licensing CRLink to customers rather than marketing service bureau services. The increase in 1997 was primarily due to an increase in the number of customers utilizing service bureau operations. Gross Margin The following table sets forth the gross margin for each of the Company's revenue categories for each of the comparison periods.
YEARS ENDED DECEMBER 31, ------------------------ 1995 1996 1997 ---- ---- ---- License and maintenance........................... 67.8% 71.9% 77.8% Installation and implementation................... 69.3 59.4 51.7 Contracts and other............................... 24.6 30.9 30.0 Service bureau.................................... 43.4 28.9 23.1
21 117 License and Maintenance Gross Margin. License and maintenance costs primarily represent the Company's expenses for personnel engaged in customer support, travel to customer sites and documentation materials. The Company's gross margin on license and maintenance revenues was 67.8%, 71.9% and 77.8% in 1995, 1996 and 1997, respectively. In 1996, the improvement in gross margin was the result of the Company's ability to move from price discounts for early adopters of its products to full pricing for products sold to subsequent customers as well as a higher volume of international licenses, which generate relatively higher margins than domestic operations due, in part, to lower overhead expenses as a result of less corporate infrastructure. Gross margin improved in 1997 due primarily to license fees increasing at a higher rate than the costs associated with providing these licenses. This increase was primarily attributable to increased pricing producing higher margins in the retail and healthcare/insurance markets. Installation and Implementation Gross Margin. Installation and implementation costs consist primarily of personnel-related costs, travel and equipment. The Company's gross margin on installation and implementation revenues was 69.3%, 59.4% and 51.7% in 1995, 1996 and 1997, respectively. In 1996, the decrease in the gross margin was due primarily to new installations of Retek Data Forecasting, which have substantially lower margins than installations of Falcon products, which represented a majority of installations in 1995. Gross margin decreased in 1997 due primarily to an increase in Capstone implementations, which have substantially lower margins than implementations of Falcon products. Contracts and Other Gross Margin. Contracts and other costs consist primarily of personnel-related costs. The Company's gross margin on contracts and other revenues was 24.6%, 30.9% and 30.0% in 1995, 1996 and 1997, respectively. The improvement in gross margin during 1996 was due primarily to the Company's increased ability to better price its new pilot projects. The slight decrease in gross margin for 1997 was due to the decrease in new product development contracts, while government projects with substantially lower margins remained relatively constant in absolute dollars. Service Bureau Gross Margin. Service bureau costs consist primarily of the personnel and facilities costs of operating the service bureaus. The Company's gross margin on service bureau revenues was 43.4%, 28.9% and 23.1% in 1995, 1996 and 1997, respectively. The decrease in 1996 was a result of the loss of a customer in early 1996 for which the Company was able to recognize higher than usual margins during 1995. The decrease in 1997 was attributable to an increase in fixed costs and in labor costs required to support the service bureau business that outpaced the increase in revenue. This was the result of a more static customer base and higher fixed costs associated with the infrastructure necessary to run the service bureau operation. Other Operating Expenses Research and Development Expenses. Research and development expenses consist primarily of salaries and other personnel-related expenses, subcontracted development services, depreciation for development equipment and supplies. Research and development expenses increased from $7.0 million in 1995 to $13.8 million in 1996 and to $21.2 million in 1997, representing 16.0%, 19.3% and 18.6% of total revenues in 1995, 1996 and 1997, respectively. Research and development expenses increased in absolute dollars due to the development costs associated with new releases of several products in the retail and financial services product lines. The increased research and development expenses in absolute dollars and as a percentage of revenues in 1996 was primarily the result of greater staffing to support more new product development programs, primarily for ProfitMax, Capstone, CompCompare, ProviderCompare and the Retek Merchandising System. The 1996 costs also included the initial product development costs of the Company's Aptex business unit, which did not have a significant impact on revenues. Statement of Financial Accounting Standards No. 86, "Ac- 22 118 counting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," requires capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on the Company's product development process, technological feasibility is not established until completion of a working model. Costs incurred by the Company between completion of the working model and the point at which a product is ready for general release have been insignificant. As a result, no significant software development costs were capitalized through December 31, 1997. The Company anticipates that research and development expenses will increase in dollar amount and could increase as a percentage of total revenues for the foreseeable future. Sales and Marketing Expenses. Sales and marketing expenses consist primarily of salaries and benefits, commissions, travel, entertainment and promotional expenses. Sales and marketing expenses increased from $7.3 million in 1995 to $11.9 million in 1996 and to $22.0 million in 1997, representing 16.6%, 16.7% and 19.4% of total revenues in 1995, 1996 and 1997, respectively. The increases were primarily a result of increased staffing as the Company built its direct sales and marketing staff, opened sales offices in Japan and in several locations in Europe, and increased expenses for trade shows, advertising and other marketing programs. The Company expects sales and marketing expenses to continue to increase for the foreseeable future. Such expenses could also increase as a percentage of total revenues as the Company continues to develop a direct sales force in Europe and other international markets, expand its domestic sales and marketing organization and increase the breadth of its product lines. General and Administrative Expenses. General and administrative expenses consist primarily of personnel costs for finance, contract administration, human resources and general management, as well as acquisition, insurance and professional services expenses. General and administrative expenses increased from $5.1 million in 1995 to $8.6 million in 1996 and to $12.6 million in 1997, representing 11.7%, 10.3% and 9.8% of total revenues, respectively. General and administrative expenses included $1.2 million of acquisition expenses related to the acquisitions of Risk Data and Retek in 1996 and $1.4 million of acquisition expenses primarily related to the acquisition of CompReview in 1997. Excluding acquisition expenses, general and administrative expenses were $5.1 million, $7.4 million and $11.2 million in 1995, 1996 and 1997, respectively. The primary reason for these increases in absolute dollars was increased staffing to support the Company's growth and additional expenses associated with being a public company. Operating Income The above factors resulted in operating income of $5.1 million, constituting 11.6% of total revenues in 1995, $9.7 million, constituting 13.5% of total revenues in 1996, and $23.0 million, constituting 20.3% of total revenues in 1997. The Company does not expect that operating income will continue to increase significantly as a percentage of total revenues. Other Income (Expense) Net Interest and other income, net of interest expense, increased from $484,000 in 1995 to $1.7 million in 1996 and to $1.9 million in 1997. The increase in 1996 was primarily attributable to increased interest income in 1996 from higher cash and investment balances, which consisted primarily of the proceeds from the Company's initial public offering in June 1995 and secondary public offering in December 1995. The increase in 1997 was primarily due to a decrease in interest expense of approximately $397,000 primarily related to the repayment of Risk Data's bank notes payable during the third quarter of 1996, offset by a decrease in interest income of approximately $165,000. 23 119 Income Tax (Benefit) Provision The income tax benefit of $511,000 in 1995 was primarily attributable to the recognition of a $2.2 million deferred tax asset based on anticipated future utilization of all of the Company's remaining net operating loss carryforwards and research and development credit carryforwards. The income tax benefit of $534,000 in 1996 was primarily attributable to the recognition of a $2.7 million deferred tax asset based on anticipated future utilization of all of the remaining net operating loss carryforwards and research and development credit carryforwards relating to Risk Data and Retek. That deferred tax asset had previously been offset by a valuation allowance. The Company released the valuation allowance during the fourth quarter of 1996, based upon management's assessment that it was more likely than not that the Company would realize the asset in future periods. The 1997 income tax provision of $7.4 million, or 29.5% of pre-tax income, was lower than 1997 taxes at statutory rates primarily as a result of CompReview's subchapter S corporation status prior to the acquisition, which resulted in most of CompReview's tax liability being borne by its former stockholders. As of the date of the acquisition, CompReview's tax status was changed to C corporation. In the future, the Company expects that the effective tax rate will be reflective of the tax rate of other California-based companies. 24 120 SELECTED PRO FORMA QUARTERLY OPERATING RESULTS The following table presents unaudited pro forma quarterly financial information for each of the eight quarters in the period ended December 31, 1997. This information has been derived from the Company's unaudited financial statements. Pro forma net (loss) income reflects a provision for taxes on the income of CompReview, which was a subchapter S corporation prior to its acquisition by HNC, as if CompReview had been subject to corporate income taxes as a C corporation for all periods presented. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, have been included to present fairly the quarterly results. See "Risk Factors -- Potential Fluctuations in Operating Results" and "-- Lengthy and Unpredictable Sales Cycle."
THREE MONTHS ENDED -------------------------------------------------------------------------------- 1996 1997 --------------------------------------- -------------------------------------- MAR. 31 JUN. 30 SEPT. 30 DEC. 31 MAR. 31 JUN. 30 SEPT. 30 DEC. 31 ------- ------- -------- ------- ------- ------- -------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF INCOME DATA:(1) Revenues: License and maintenance................... $ 8,479 $11,163 $ 13,831 $15,417 $18,331 $22,311 $ 23,705 $25,296 Installation and implementation........... 1,200 1,214 1,399 2,878 1,946 2,188 3,069 3,499 Contracts and other....................... 2,979 3,051 2,784 2,314 2,726 1,805 1,671 1,570 Service bureau............................ 1,219 1,269 1,101 1,141 1,069 1,289 1,544 1,716 ------- ------- ------- ------- ------- ------- ------- ------- Total revenues...................... 13,877 16,697 19,115 21,750 24,072 27,593 29,989 32,081 ------- ------- ------- ------- ------- ------- ------- ------- Operating expenses: License and maintenance................... 3,180 3,120 3,689 3,736 3,994 5,036 4,957 5,950 Installation and implementation........... 589 597 560 968 801 1,251 1,499 1,623 Contracts and other....................... 2,071 1,938 1,860 1,825 1,850 1,454 1,111 1,023 Service bureau............................ 932 947 749 737 864 919 1,203 1,334 Research and development.................. 2,440 3,352 3,748 4,268 4,431 4,930 6,015 5,775 Sales and marketing....................... 2,485 2,981 3,041 3,416 4,553 5,233 5,691 6,572 General and administrative................ 1,829 1,961 2,351 2,410 2,459 2,768 3,142 4,257 ------- ------- ------- ------- ------- ------- ------- ------- Total operating expense............. 13,526 14,896 15,998 17,360 18,952 21,591 23,618 26,534 ------- ------- ------- ------- ------- ------- ------- ------- Operating income............................ 351 1,801 3,117 4,390 5,120 6,002 6,371 5,547 Interest income, net........................ 452 406 384 458 429 481 538 431 ------- ------- ------- ------- ------- ------- ------- ------- Income before pro forma income tax provision (benefit)..................... 803 2,207 3,501 4,848 5,549 6,483 6,909 5,978 Pro forma income tax provision (benefit).... 934 1,119 1,138 (1,563) 2,115 2,475 2,623 2,289 ------- ------- ------- ------- ------- ------- ------- ------- Pro forma net (loss) income............... $ (131) $ 1,088 $ 2,363 $ 6,411 $ 3,434 $ 4,008 $ 4,286 $ 3,689 ======= ======= ======= ======= ======= ======= ======= ======= AS A PERCENTAGE OF TOTAL REVENUES: Revenues: License and maintenance................... 61.1% 66.8% 72.3% 70.9% 76.2% 80.9% 79.1% 78.9% Installation and implementation........... 8.6 7.3 7.3 13.2 8.1 7.9 10.2 10.9 Contracts and other....................... 21.5 18.3 14.6 10.6 11.3 6.5 5.6 4.9 Service bureau............................ 8.8 7.6 5.8 5.3 4.4 4.7 5.1 5.3 ------- ------- ------- ------- ------- ------- ------- ------- Total revenues...................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 ------- ------- ------- ------- ------- ------- ------- ------- Operating expenses: License and maintenance................... 22.9 18.7 19.3 17.2 16.6 18.2 16.5 18.5 Installation and implementation........... 4.3 3.6 3.0 4.4 3.3 4.5 5.0 5.0 Contracts and other....................... 14.9 11.6 9.7 8.4 7.7 5.3 3.7 3.2 Service bureau............................ 6.7 5.7 3.9 3.4 3.6 3.3 4.0 4.2 Research and development.................. 17.6 20.1 19.6 19.6 18.4 17.9 20.1 18.0 Sales and marketing....................... 17.9 17.8 15.9 15.7 18.9 19.0 19.0 20.5 General and administrative................ 13.2 11.7 12.3 11.1 10.2 10.0 10.5 13.3 ------- ------- ------- ------- ------- ------- ------- ------- Total operating expense............. 97.5 89.2 83.7 79.8 78.7 78.2 78.8 82.7 ------- ------- ------- ------- ------- ------- ------- ------- Operating income............................ 2.5 10.8 16.3 20.2 21.3 21.8 21.2 17.3 Interest income, net........................ 3.3 2.4 2.0 2.1 1.8 1.7 1.8 1.3 ------- ------- ------- ------- ------- ------- ------- ------- Income before pro forma income tax provision (benefit)..................... 5.8 13.2 18.3 22.3 23.1 23.5 23.0 18.6 Pro forma income tax provision (benefit).... 6.7 6.7 5.9 (7.2) 8.8 9.0 8.7 7.1 ------- ------- ------- ------- ------- ------- ------- ------- Pro forma net (loss) income............... (0.9)% 6.5% 12.4% 29.5% 14.3% 14.5% 14.3% 11.5% ======= ======= ======= ======= ======= ======= ======= =======
- --------------- (1) The above table gives retroactive effect to the acquisitions of Risk Data, Retek and CompReview for all periods presented, accounted for as poolings of interests. 25 121 LIQUIDITY AND CAPITAL RESOURCES The $21.0 million of net cash provided by operating activities in 1997 represented net income before depreciation and amortization of approximately $22.4 million, further increased by a decrease in deferred income taxes of $6.9 million and offset by an increase in accounts receivable of $11.1 million. Net cash used in investing activities was $7.7 million in 1997 primarily due to $9.6 million expended for property and equipment during 1997, including $6.0 million for computer equipment to support the increased staffing across the Company, and $1.9 million for furniture and fixtures primarily related to the relocation of the Company's Minneapolis facility, offset by approximately $1.9 million of proceeds from sales and maturities of investments available for sale net of purchases of such investments. Net cash used in financing activities was $3.2 million in 1997 primarily due to $6.8 million in distributions to the former CompReview stockholders offset by $4.0 million in net proceeds from issuances of common stock. As of December 31, 1997, the Company had $42.9 million in cash, cash equivalents and investments. The Company believes that its current cash, cash equivalents and investments available for sale balances, together with the net proceeds from the sale of the Notes, borrowings under its credit facility and net cash provided by operating activities, will be sufficient to meet its working capital and capital expenditure requirements for at least the next 12 months. The credit facility will not be available following issuance of the Notes unless the Company obtains an appropriate consent or amendment from the bank. A portion of the Company's cash could be used to repurchase shares of the Company's Common Stock from time to time in the open market. Management intends to invest the Company's cash in excess of current operating requirements in short-term, interest-bearing, investment-grade securities. A portion of the Company's cash could also be used to acquire or invest in complementary businesses or products or otherwise to obtain the right to use complementary technologies or data. From time to time, in the ordinary course of business, the Company evaluates potential acquisitions of such businesses, products, technologies or data. The Company has no present understandings, commitments or agreements with respect to any material acquisition of businesses, products, technologies or data. YEAR 2000 COMPLIANCE The Company anticipates that it will need to devote resources in the next two years to modify its CRLink product to properly process dates beyond December 31, 1999. The Company expects that the cost of making these modifications and distributing the modified product to existing customers will be approximately $500,000. These modifications and the resources that the Company expects to devote to such modifications may divert management and engineering attention from, or delay the development and introduction of, new products and enhancements to existing products. The inability of the Company to complete such modifications successfully and on a timely basis, or the inability of the Company to devote sufficient resources to continuing updates and enhancements to the CRLink product, could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to correct or patch their current software systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase software products such as those offered by the Company, which could result in a material adverse effect on the Company's business, financial condition and results of operations. NEW ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130 ("FAS 130"), "Reporting Comprehensive Income," which the Company is required to adopt for 1998. This statement will require the Company to report in the financial statements, in addition to net income, comprehensive income and its 26 122 components including foreign currency items and unrealized gains and losses on certain investments in debt and equity securities. Upon adoption of FAS 130, the Company is also required to reclassify financial statements for earlier periods provided for comparative purposes. The adoption of FAS 130 will not have a significant impact on the Company's consolidated financial statement disclosures. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and Related Information," which the Company is required to adopt for its 1998 annual financial statements. This statement establishes standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. Under FAS 131, operating segments are to be determined consistent with the way that management organizes and evaluates financial information internally for making operating decisions and assessing performance. The Company has not determined the impact of the adoption of this new accounting standard on its consolidated financial statement disclosures. In October 1997, the American Institute of Certified Public Accountants issued Statement of Position No. 97-2 ("SOP 97-2"), "Software Revenue Recognition," which the Company is required to adopt for agreements entered into with customers beginning in 1998. This statement provides guidance for software revenue recognition matters primarily from a conceptual level and does not include specific implementation guidance. Based on its reading and interpretation of SOP 97-2, the Company believes that the adoption of SOP 97-2 will not have a significant impact on its financial statements; however, detailed implementation guidelines for this standard have not yet been issued. Once issued, such detailed implementation guidelines could lead to unanticipated changes in the Company's current revenue recognition practices, and such changes could be material to the Company's financial statements. 27 123 BUSINESS HNC develops, markets and supports predictive software solutions for leading service industries. These predictive software solutions employ proprietary neural-network predictive decision engines, profiles, traditional statistical modeling, business models, expert rules and context vectors to convert existing data and business experiences into meaningful recommendations and actions. Just as manufacturing organizations have implemented manufacturing resource planning ("MRP") software to automate routine transactions, leading service industries such as the health-care/insurance, financial services and retail industries are using predictive software solutions to improve profitability, competitiveness and customer satisfaction. INDUSTRY BACKGROUND Today's competitive business environment has forced many service companies to increase business efficiency while improving their flexibility and responsiveness to changing market conditions. Businesses continually seek new ways to make better decisions by collecting and analyzing data. Consequently, service companies have made, and continue to make, significant investments in computer systems designed to gather and electronically store ever increasing amounts of data. In most cases, these computerized systems automate manual tasks and activities, resulting in the conversion of significant amounts of corporate data from paper to electronic form. However, these systems generally do not synthesize data in ways that help businesses make better real-time decisions. Historically, the development of predictive software solutions was inhibited by the lack of computing standards and effective computational intelligence techniques. The emergence of client-server standards, including relational database management systems, the Windows operating system and network communications protocols, has fostered the increased transmission and dissemination of electronically stored data within and among businesses. MRP software systems were developed to automate production, accounting, human resources and distribution transactions for primarily manufacturing organizations. These systems manage and store large amounts of diverse business information, providing continuous and simultaneous availability of information to geographically dispersed employees, customers and suppliers. However, MRP systems generally do not provide businesses with the functionality and flexibility needed to utilize this data to simulate operations and make real-time decisions and recommendations in diverse and rapidly changing business environments. Several service industries have a particular need to leverage large volumes of real-time transactional and operational data in order to address systemic issues that have historically affected profitability, competitiveness and customer satisfaction. These industries and issues include: - HEALTHCARE/INSURANCE INDUSTRY. Workers' compensation fraud and abuse is currently receiving widespread attention in the healthcare/insurance industry. Conning & Co. recently estimated that 10%-25% of the dollar amount of filed workers' compensation claims in the United States are fraudulent. This translates to more than $5 billion lost each year to workers' compensation fraud. - FINANCIAL SERVICES INDUSTRY. Based on reports from Visa and Mastercard, Faulkner & Gray estimates that United States credit card credit losses and chargeoffs were $18 billion in 1996. - RETAIL INDUSTRY. Rapid changes in consumer buying patterns have caused merchants to place increased emphasis on predicting consumer demand and managing retail inventories. The change from mass to individual retail marketing has multiplied the number of promotional offers and stock-keeping units ("SKUs") required to address market opportunities. 28 124 The U.S. Department of Commerce estimates that the inventory carrying costs for retail inventories nationwide were $316 billion at the end of March 1997. Historically, many companies in the healthcare/insurance, financial services and retail industries have developed specialized in-house applications to address these issues. Such applications are generally designed to access large volumes of operational and transactional data stored on mainframe computers. However, such systems are expensive, costly to support and maintain, and do not offer flexible and enterprise-wide access to data. Furthermore, most of these systems are not designed to meet the need for real-time recommendations and actions. The widespread adoption of distributed client-server computing has provided organizations with a much greater ability to access and manipulate stored information but also has created the need for third-party vendors of packaged applications software solutions that provide the same degree of functionality and reliability as traditional in-house applications. These vendors are able to provide a higher degree of functionality and reliability than traditional in-house applications by combining the domain knowledge from their customers and partners with expertise in computational intelligence and client-server technologies. THE HNC SOLUTION HNC's predictive software solutions enable leading service industries, such as the healthcare/insurance, financial services and retail industries, to analyze and act upon operational and transactional data in real time. The Company's products provide the following benefits: Core predictive software technology. The Company's software includes a variety of computational intelligence technologies such as proprietary neural-network predictive decision engines, profiles, traditional statistical modeling, business models, expert rules and context vectors that can be customized to specific business applications. Neural networks can be adapted to changing environments and applications quickly and have proven to be accurate and effective in real-time operating environments. The Company's decision engine also includes a user-defined rule-based technology. The neural networks and rulebases are delivered through software that allows the Company's products to adapt to many customer-specific business needs without extensive custom programming. Adaptable functions include workflow queuing management, policy and procedure guidelines, input data modification, flexible graphical user interface ("GUI") display, decision criteria and report formats. Quick payback for customers. The Company's software solutions are designed for quick customer payback. The Company typically installs its products in two to six months, and customer payback periods for installation and first year usage fees are typically less than one year. Payback is rapid because the software products address applications that have a significant profit impact. HNC personnel focus not only on the technical integration, but also on delivering direct benefits to the customer throughout the service contract period. Transaction-based, real-time decision capability. HNC's software can operate in real time, providing an immediate, situation-specific response to each customer transaction. For example, the Falcon system for credit/debit card fraud detection can monitor millions of transactions each day, identify fraudulent transactions in progress and permit the card issuing bank to withhold an authorization before the perpetrator completes a purchase. The Falcon system differs from traditional modeling implementations, which operate in a batch or off-line mode on a collection of historical transactions. Flexible client-server solutions. HNC's solutions can be integrated into a customer's existing environment or architecture. The Company's products are available on industry-standard, client-server platforms, including Windows and UNIX clients, NetWare, Windows NT, UNIX and CICS servers and IBM, Oracle, Sybase and Informix databases. HNC's application products represent a complete software solution, including decision models, deployment software, communications interfaces and GUIs. The Company also supplies systems integration, ongoing performance 29 125 analysis, model rebuilding and application consulting services to help ensure ongoing success for the customer. The Company believes that this flexible combination of products, services and deployment platforms represents an advance that enables successful predictive software system deployment in many mission-critical applications. Turnkey, customized and user-developed model options. The choice of data source is important to customers because data are the fundamental building blocks used to create accurate predictive models. HNC provides various models built on industry-specific or customer-specific data to meet individual application requirements. Customers and data suppliers provide the Company with historical transaction data for turnkey models, trend analyses and product updates. This combination of proprietary turnkey (from data and individual consumer profiles), customized and user-developed models allows the Company to offer products that solve a broad range of predictive application problems. HNC'S STRATEGY HNC's objective is to be the leading supplier of predictive software solutions by leveraging its core computational intelligence technology across a series of product families targeted at specific service industries. The Company's strategy for achieving this objective contains the following key elements: Maintain and strengthen HNC's position at the core of its customers' applications infrastructure. Customers rely heavily on HNC's predictive software solutions to anticipate and react to rapidly changing business conditions. The Company's core computational intelligence technology serves as a platform upon which service businesses can deploy and combine the Company's products to manage and respond to operational and transactional data in real time. Therefore, HNC attempts to establish a strong position within the applications infrastructure of its customers. For example, the Company's first predictive solution product, Falcon, is a credit/debit card fraud detection system for monitoring individual credit card accounts. By adapting the core technology developed for Falcon, the Company later introduced ProfitMax, a transaction-based, real-time credit authorization system that manages the profitability of credit card portfolios. The Company believes that the opportunity exists for similar penetration within each of its core vertical markets, including opportunities such as retail banking within the financial services industry. As another example, the Company's context vectoring technology could profile visitors to a financial institution's Web site and send proactive direct e-mails regarding financial products. Leverage core predictive technologies to enter new market segments. Historically, the Company has applied its core predictive technology to the domain knowledge of companies it has acquired to introduce new products. For example, in August 1996, HNC acquired Risk Data, a developer of decision systems in the workers' compensation industry. By combining Risk Data's industry expertise with HNC's fraud detection technology, HNC is developing a VeriComp module that applies predictive technology to employer fraud in the workers' compensation industry. In addition, the Company is evaluating opportunities in other data-intensive industries, such as telecommunications, where predictive software may have the ability to improve business performance and profitability. Earn recurring revenues through long-term contracts. The Company markets most of its predictive software solutions as an ongoing service that includes software licenses, decision model updates, application consulting and on-line or on-site support and maintenance. Since many of the Company's applications are enhanced by periodic model updates, customers derive significant value from the Company's ongoing services. In addition, the mission-critical nature of many of HNC's predictive software solutions creates customer demand for long-term support commitments. Accordingly, the Company's customers typically pay for this package of software and service with a monthly usage fee and a three to seven year contract commitment. 30 126 Use strategic relationships to support direct distribution. In each of its primary markets, the Company uses strategic relationships with system integrators and third-party service providers to support its direct distribution efforts. These partners provide varying levels of distribution support, from lead generation to resale of the Company's products. The Company maintains such strategic relation\ships with Electronic Data Systems ("EDS"), Intracorp and Marsh McLennan, Inc. in healthcare/insurance, First Data and EDS in financial services, and Andersen Consulting and KPMG Peat Marwick LLP in retail. Growth through acquisitions. The Company acquired Risk Data, Retek and CompReview in 1996 and 1997, thereby significantly expanding its product offerings in its target markets. On January 30, 1998, the Company signed a definitive agreement to acquire Practical Control Systems Technologies, Inc. ("PCS"), a distribution center management software vendor based in Cincinnati, Ohio, subject to the satisfaction of certain closing conditions and the approval of PCS' shareholders. The Company expects to continue to review acquisitions of businesses, products and technologies as a means to expand its product offerings for existing and new target markets. 31 127 MARKETS AND PRODUCTS HNC has a broad family of predictive software products that provide specific solutions for each of the healthcare/insurance, financial services and retail markets. Revenues from each of the Company's three target markets accounted for more than one-quarter of the Company's total revenues in 1997. Revenues from three products, CRLink, Retek Merchandising System and Falcon, accounted for 57.9% of the Company's total revenues in 1997. See "Risk Factors -- Product Concentration." Healthcare/Insurance HNC offers and is developing products in the healthcare/insurance market. These products are targeted to insurance carriers, insurance providers, managed care organizations, state insurance funds, third-party administrators and large, self-insured employers. HNC has developed predictive software solutions that address 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. These solutions, CRLink, MIRA, CompCompare, ProviderCompare, PMAdvisor and VeriComp, allow users the ability to reduce fraud losses and streamline operations. HNC HEALTHCARE/INSURANCE INDUSTRY PRODUCTS ================================================================================
PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------- CRLink CRLink operates as the bill review engine that links all of the critical components of an effective cost containment program to help clients control the cost of workers' compensation, personal injury and other casualty risks. - ------------------------------------------------------------------------------------------------------- MIRA MIRA uses statistical predictive methods to automatically determine workers' compensation loss reserves based on historical data gathered from insurance carriers, third-party administrators and state insurance funds throughout the United States. - ------------------------------------------------------------------------------------------------------- CompCompare CompCompare enables clients to compare claims costs or the effectiveness of managed care programs by using benchmarking data from HNC's proprietary workers' compensation database. - ------------------------------------------------------------------------------------------------------- ProviderCompare ProviderCompare is a physician profiling product that provides on-line access to HNC's proprietary workers' compensation database. ProviderCompare enables clients to generate a detailed comparative analysis, such as treatment costs, among providers within the same specialty. - ------------------------------------------------------------------------------------------------------- PMAdvisor PMAdvisor enables claim payors to verify that the number of visits and type of treatment for claims involving physical medicine (primarily chiropractic and physical therapy) are appropriate for the diagnosis and severity of the injury and to identify chiropractic and physical therapy claims that exceed appropriate treatment guidelines. - ------------------------------------------------------------------------------------------------------- VeriComp VeriComp is a workers' compensation claimant system designed to assist in identifying claimant behavior that is likely to indicate the presence of fraud or abuse. - -------------------------------------------------------------------------------------------------------
Financial Services The increasing volume of electronic financial transactions requires mission-critical decision-making in real time for applications such as credit card charge authorization, that carry a substantial risk of consumer and merchant fraud. HNC's Falcon and ProfitMax product lines are targeted at bank and private label card issuers and payment processors. Falcon employs a client/server architecture that consists of an interface into the customer's legacy system, a decision engine, a cardholder profile database, a case management database and a fraud workstation. 32 128 HNC estimates that loan underwriting costs in the United States currently exceed $2.5 billion each year. Competitive pressures including cost reduction, rapid loan approval and the growth of on-line banking have compelled lenders to turn to software solutions that can automate loan origination in order to lower costs, improve customer service and provide remote access to lending services. HNC's predictive software solutions for the loan origination markets, Capstone and AREAS, allow lenders such as banks and private label card issuers, home equity lenders, auto lenders and mortgage lenders to automate the loan approval decision process. HNC FINANCIAL SERVICES INDUSTRY PRODUCTS ================================================================================
PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------- Falcon Product Line - ------------------------ Falcon Falcon products are neural network-based solutions that examine Falcon Expert transaction, cardholder and merchant data to detect a wide range of Falcon Select credit and debit card fraud. Using predictive software techniques, Falcon Debit Falcon captures relationships and patterns that often are missed by Falcon Retail traditional methods of detecting suspicious transactions. Falcon Sentry Eagle - ------------------------------------------------------------------------------------------------------- Capstone Product Line - ------------------------ Capstone for Payment Capstone is an intelligent, high-performance new account decision Cards processing solution. Based on expert rules, Capstone allows users to Capstone for automate lending decisions and design, test, implement and track Consumer Lending lending policies. Capstone for Mortgage Lending - ------------------------------------------------------------------------------------------------------- ProfitMax Product Line - ------------------------ ProfitMax ProfitMax provides transaction-based, real-time authorization and ProfitMax Bankruptcy action decisions from within a complete infrastructure for managing the profitability of credit card portfolios. ProfitMax uses neural networks, expert rules and HNC's cardholder behavior profiling technology to analyze the expected profitability of each account in an issuer's portfolio using the issuer's definition of financial profit. ProfitMax Bankruptcy uses the basic ProfitMax structure to predict the likelihood of cardholder bankruptcy even before the cardholder is delinquent. - ------------------------------------------------------------------------------------------------------- AREAS AREAS automated property valuation software uses neural networks and other computational intelligence to provide an objective prediction of the current market value of residential property. - -------------------------------------------------------------------------------------------------------
Retail Although retailers have made significant investments in customer information, point-of-sale and quick-response ordering systems, these applications often do not include the forecasting ability required to maximize profitability and respond to competition through timely "in-store" replenishment, electronic networking and quick response initiatives. HNC has developed a group of products that effectively addresses inventory control, merchandise management and financial control management. These software solutions allow retailers to build forecasting and marketing models to carry out day-to-day buying and selling activities, thereby reducing carrying costs for inventories and improving purchasing, promotion and logistics efficiencies. The target markets for the Company's retail products are department stores, mass merchandisers and specialty retail chains in multi-store and multi-warehouse environments with gross sales in excess of $200 million. 33 129 HNC RETAIL INDUSTRY PRODUCTS ================================================================================
PRODUCT PRODUCT DESCRIPTION - ------------------------------------------------------------------------------------------------------- Retek Merchandising The Retek Merchandising System provides inventory control, merchandise System management and financial control and addresses the definition and management of merchandise at the SKU level and reporting and financial control through stock ledgers. - ------------------------------------------------------------------------------------------------------- Retek Data Warehouse Retek Data Warehouse provides the transaction infrastructure needed for retailers to plan, buy, move, sell and pay for their merchandise. - ------------------------------------------------------------------------------------------------------- Active Retail Active Retail Intelligence identifies performance exceptions and Intelligence recommends the appropriate corrective action. - ------------------------------------------------------------------------------------------------------- Retek Demand Retek Demand Forecasting provides forecasts to retailers' supply chain Forecasting planning allocation and replenishment functions and uses predictive causal techniques with automated forecasting and multi-dimensional on-line analysis. - ------------------------------------------------------------------------------------------------------- Falcon Retail Falcon Retail provides proactive detection of private label card application and transaction fraud. - -------------------------------------------------------------------------------------------------------
EMERGING MARKET OPPORTUNITIES The Company's experience and technology capabilities in the healthcare/insurance, financial services and retail markets often lead to new product ideas and concepts. The Company also evaluates new market opportunities that arise through its commercial and government contract work. As contracts are completed, the end products are evaluated for commercialization. For example, contracts for the Advanced Research Projects Agency, United States Army Research Laboratory, United States Air Force, Office of Naval Research, DataTimes Corporation and Tracor Applied Sciences, Inc. generated a context-based text analysis technology called MatchPlus. This core text analysis technology has been under development at HNC for the last four years for Department of Defense applications. During 1996, the Company formed Aptex to commercialize HNC's MatchPlus text analysis technology for emerging markets. Aptex has developed a strategic partnership with InfoSeek Corporation, an Internet search and navigation service, to deliver products using this text analysis technology to the Internet market. To date, three new Internet products have been launched: SelectCast, SelectResponse and SelectResource. Substantially all of the Company's revenues in recent years have been attributable to sales of predictive software solutions and services, and these products and services are currently expected to continue to account for a substantial amount of the Company's future revenues. The market for predictive software solutions is still emerging. The rate at which businesses have adopted the Company's products has varied significantly by market and by product within each market, and the Company expects to continue to experience such variations with respect to its target markets and products in the future. The Company has introduced products for the healthcare/insurance, financial services and retail markets. The Company has recently announced several new products, including PMAdvisor, VeriComp, SelectCast, SelectResponse and SelectResource. To date, none of these products has achieved any significant degree of market acceptance, and there can be no assurance that such products will ever be widely accepted. Although businesses in the Company's target markets have recognized the advantages of using predictive software solutions to automate the decision-making process, many have developed decision automation systems internally rather than licensing them from outside vendors. There can be no assurance that the markets for the Company's products will continue to develop or that the Company's products will be widely accepted, if at all. If the markets for the Company's new or existing products fail to develop, or develop more slowly than anticipated, the Company's sales would be negatively impacted, which would have a material adverse effect on the Company's business, financial condition and results of operations. 34 130 CUSTOMER SERVICE AND SUPPORT A high level of continuing maintenance, service and support is critical to maintaining the performance of the Company's predictive software solutions. Service and support are also essential to the Company's objective of developing long-term relationships with, and obtaining recurring revenues from, customers. The Company's service and support activities are related to system installation, performance validation and ongoing consultation on the optimal use of HNC products. Model and Rule Updates. Most HNC product license agreements include periodic data, model and/or rule updates to maintain system performance. HNC technical personnel generally assist the customer with installation of updates. The Company makes commitments to update models and rules at varying intervals, from fixed times (such as quarterly and annually) to unscheduled times, provided the customer has met its commitments to provide data to HNC. Education. The Company offers comprehensive education and training programs to its customers. The Company provides on-site training services associated with many of its products. Fees for education and training services are generally included in usage-priced products, but may be charged separately in other cases. Consulting. The Company's consultants are available to work with customers' user application groups and information systems organizations. Customers that buy consulting services are usually planning large implementations or want to optimize performance of the Company's products in their operating environments. Fees for consulting are generally included in usage-priced products, but may be charged separately in other cases. PRICING The Company generally establishes prices in one of two ways: usage-based fees and fixed-fee licenses with maintenance. The Company generally employs usage-based pricing for its healthcare/insurance products, Falcon, ProfitMax and AREAS. Under the usage-based pricing structure, HNC generally provides a fixed-term software license, software maintenance, model updates (in the case of HNC-supplied models) and ongoing consulting services in exchange for recurring revenue based on usage. Usage-based term contracts typically include annual price index adjustments. In 1995, 1996 and 1997, annual license and maintenance revenues from these contracts represented 61.2%, 56.1% and 55.2% of the Company's total revenues, respectively. The Company generally employs fixed-fee license pricing for Capstone and all of the Company's retail products except Falcon Retail. Under the fixed-fee license pricing structure, the Company generally licenses the product for the customer's internal use on a perpetual basis. In most cases, the user can separately contract for maintenance services on an annual basis. The Company typically offers early adopter pricing for its usage-based products to customers that agree to be part of pilot or other early product life cycle installations. Early adopter pricing might include reduced-fee perpetual licenses, reduced-fee services or both. The Company often contracts for installation services associated with its predictive software solutions. The Company provides user-specific proposals priced at either fixed-fee levels or on a time and materials basis. In nearly all cases, travel expenses are billed separately at cost. The Company offers contract consulting services. Because of the complexity associated with predictive software solutions, users often request that HNC help them to develop models or analyze problems. Also, the Company from time to time accepts engagements not associated with current product offerings in order to become more familiar with a new application area and determine the potential for new product development. Although consulting services are included with many of the Company's usage-based products, customers may request additional consulting, often associated with custom modeling. 35 131 SALES AND MARKETING The Company sells and markets its software and services in North America and internationally through its direct sales organization, joint marketing and distribution agreements. The Company's worldwide sales and marketing organization consisted of 125 employees as of December 31, 1997. The domestic sales staff is based at the Company's corporate headquarters in San Diego and in United States field offices in California, Colorado, Connecticut, Georgia, Minnesota, New York, Pennsylvania, Texas and Virginia. Internationally, the Company has field sales offices in Australia, Canada, France, Germany, Japan, Singapore, South Africa and the United Kingdom. To support its sales force, the Company conducts comprehensive marketing programs, which include direct mail, public relations, advertising, seminars, trade shows and ongoing customer communication programs. The sales staff is generally product-based, and each representative is assigned a geographic territory. The Company has licensed First Data and EDS to act as service bureaus to provide an alternate channel of distribution for end-users to utilize the Falcon product to process credit card receipts for banks and other credit card issuers. The Company generally assists its service bureau partners in the sales effort, often employing the Company's direct sales force in the process. Company sales representatives earn a commission for service bureau sales in their territory. These service bureaus pay the Company monthly usage fees based on the volume of transactions processed for such credit card issuers. Product licenses to First Data, the largest provider of credit card charge receipt processing services to banks, accounted for 8.7%, 8.6% and 7.6% of the Company's total revenues in 1995, 1996 and 1997, respectively. The Company has licensed First Data to provide its customers with access to the Company's ProfitMax product pursuant to the ProfitMax Contract entered into in January 1996. The Company's revenues under the ProfitMax Contract represented approximately one-quarter of the Company's revenues from First Data in 1997. In late January 1998, First Data asserted that certain restrictive covenants under the ProfitMax Contract violated certain intellectual property laws. First Data also asserted that the existence of such restrictions made the ProfitMax Contract at least temporarily unenforceable and that First Data is therefore not obligated to pay the Company license fees due under the ProfitMax Contract. The Company disputed First Data's claim, released and waived the above-mentioned restrictive covenants in the ProfitMax Contract and gave First Data written notice that the Company intended to terminate the ProfitMax Contract pursuant to its terms unless First Data cured its failure to pay the delinquent license fees in a timely manner. Currently, First Data and the Company are working to resolve their dispute regarding the ProfitMax Contract by negotiating a new agreement. First Data has resumed making license fee payments on a delayed basis, and HNC has agreed to extend the date for First Data to pay past due license fees until mid-April 1998. Although HNC expects to reach a new agreement with First Data that will resolve the pending dispute, there can be no assurance that such an agreement will be reached or that the terms of such an agreement would be as favorable to HNC as its existing contractual arrangements with First Data. If no such agreement can be reached and First Data maintains its current position, it is possible that litigation or arbitration could ensue, which would likely result in a loss of anticipated revenue to the Company under the ProfitMax Contract and possibly other agreements between the Company and First Data, which could have a material adverse effect on the Company's business, financial condition and results of operation. The Company also uses representative agents for certain products in certain territories outside of North America. The Company has agents covering Australia, Austria, France, Germany, Italy, New Zealand, Spain and Switzerland. In 1995, 1996 and 1997, international operations and export sales (includes sales in Canada) represented 12.6%, 17.7% and 16.8% of the Company's total revenues, respectively. International sales result primarily from Falcon product sales and sales of retail products. The Company intends to continue to expand its operations outside the United States and to enter additional international markets, including by adding sales and support offices in Europe and Japan, which will require significant management attention and financial resources. The Company has committed and continues to commit significant time and development resources 36 132 to customizing certain of its products for selected international markets and to developing international sales and support channels. There can be no assurance that the Company's efforts to develop products, databases and models for targeted international markets or to develop additional international sales and support channels will be successful. The failure of such efforts, which can entail considerable expense, could have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Risks Associated with International Sales." International sales are subject to 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. The Company's international sales are currently denominated predominantly in United States dollars and a small portion are denominated in British pounds sterling. An increase in the value of the United States dollar relative to foreign currencies could make the Company's products more expensive, and therefore potentially less competitive, in foreign markets. In the future, to the extent the Company's international sales are denominated in local currencies, foreign currency translations may contribute to significant fluctuations in the Company's business, financial condition and results of operations. If for any reason exchange or price controls or other restrictions on foreign currencies are imposed, the Company's business, financial condition and results of operations could be materially adversely affected. Due in part to the mission-critical nature of certain of the Company's applications, potential customers perceive high risk in connection with adoption of the Company's products. As a result, customers have been cautious in making decisions to acquire the Company's products. In addition, because the purchase of the Company's 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 affect key operations. For these and other reasons, the sales cycle associated with the purchase of the Company's products is typically lengthy, unpredictable and subject to a number of significant risks over which the Company has little or no control, including customers' budgetary constraints and internal acceptance reviews. The sales cycle associated with the licensing of the Company's 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, the Company's ability to forecast the timing and amount of specific sales is limited. A lost or delayed sale could have a material adverse effect on the Company's business, financial condition and results of operations. TECHNOLOGY The Company seeks to develop innovative products by combining industry and application knowledge with its core neural-network technology to address specific market needs. The Company's systems also employ rule-based technology to implement customer strategy, policy and procedures. These technologies are incorporated in computer software and hardware architectures, including client-server hardware, relational databases and object-oriented programming. The Company intends to continue to develop state-of-the-art technologies to enhance its current products and broaden development opportunities. Neural-Network Technology. Neural networks have predictive power that can be improved with experience as the historical database increases in size. The term "neural network" refers to a family of nonlinear, statistical modeling techniques, sometimes called "computational intelligence." These techniques distinguish themselves through a process of automated "learning" or "training" that replaces the time-consuming manual techniques of traditional nonlinear, statistical modeling. The neural-network architecture itself consists of groups of "processing elements," or equations with several inputs and a single output. The output of each element becomes either the 37 133 input to another element or part of the dependent output. Each input receives a "weight" or value, in the equation, which is adjusted during the training process. The actual result from each training record is compared with the answer from the neural network, and the weights are adjusted to reduce the error between the two. This process can become computationally intensive, as millions of training data records must be processed hundreds or thousands of times. HNC has developed proprietary high-speed and parallel-processor boards to accelerate training and execution of its neural-network software. The Company believes that the rapid model development afforded by its technology provides a competitive advantage in the development of predictive software solutions. Rule-Based Technology. The Company's systems also employ rule-based technology to implement customer strategy, policy and procedures. The rules are implemented as part of predictive processes. The Company believes that its combination of neural networks and rule bases in a single decision engine represents a significant competitive advantage over more traditional approaches to decision automation. Context Vector Technology. Context vector technology that originated at HNC and is being commercialized at Aptex is a way to explore, analyze and model unstructured textual data. Context vector technology automatically discovers the underlying structure of free form symbolic data. This structure enables modeling from data elements previously considered impossible to include in predictive software applications. Context vector technology also models behavior. Just as relationships are discovered in unstructured data, observing electronic transaction behavior identifies patterns. Compatibility predictions can be made between information, behavior, people and products. When combined with other HNC technologies, such as neural networks and rule-based systems, the Company believes that context vectors can improve the performance of existing applications while opening new market opportunities. Context vector technology has been demonstrated to increase banner advertising click rates on the Internet, automate e-mail responses and discover unknown relationships in credit card transaction data. The Company's success depends upon its ability to enter new markets by successfully developing new products for such markets on a timely and cost-effective basis. The Company's products often require customer data for decision model development and system installation. As a result, completion of new products (particularly new products for markets not previously served by the Company) may be delayed while the Company extracts sufficient amounts of statistically relevant data and develops the models. During this development process, the Company relies on its potential customers in the new market to provide data and to help train Company personnel in the use and meaning of the data in the specific industry. These relationships also assist the Company in establishing a market presence and credibility in the new market. These potential customers, most of which have significantly greater financial and marketing resources than the Company, may compete with the Company in the future or otherwise discontinue their relationships with or support of the Company, either during development of the Company's products or thereafter. The failure by the Company to obtain adequate third-party support for new product development would have a material adverse effect on the Company's ability to enter new markets and, consequently, on the Company's business, financial condition and results of operations. See "Risk Factors -- Risks Associated with Technological Change and Delays in Developing New Products." RESEARCH AND DEVELOPMENT The Company believes that its future success depends in part on its ability to maintain and improve its core technologies, enhance its existing products and develop new products that meet an expanding range of markets and customer requirements. The Company intends to expand its existing product offerings and to introduce new predictive software solutions. In the development of new products and enhancements to existing products, the Company uses its own tools extensively. Until 1996, the Company relied primarily on internal development of its products. Based on timing and cost considerations, however, the Company has acquired, and in the future 38 134 may consider acquiring, technology or products from third parties. For example, the Company acquired technology and products in connection with its acquisitions of Risk Data and Retek in 1996 and CompReview in 1997. The Company performs all quality assurance and develops documentation internally. The Company intends to continue to support industry standard operating environments, client-server architectures and network protocols. The Company's 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 HNC predictive software solutions. The marketing services organization is responsible for authoring and updating all user documentation and other publications. See "Risk Factors -- Risks Associated with Technological Change and Delays in Developing New Products." The Company strategically targets its long-term research projects. In addition to funds allocated by the Company for research, HNC receives research contracts from a range of commercial sources and the United States Government. Government and commercial contract customers have included the Advanced Research Projects Agency, United States Air Force, Office of Naval Research and Tracor Applied Sciences, Inc. The Company believes that these contracts augment its ability to maintain existing technologies and investigate new technologies that may or may not become part of its products. The United States Government typically retains certain intellectual property rights and licenses in the technologies the Company develops under research contracts directly or indirectly sponsored by the government, and in some cases can terminate the Company's rights in such technologies if the Company fails to commercialize them on a timely basis. Historically, these contracts have not resulted in development of products contributing to the Company's revenues in the fiscal year in which the research contract is performed, or in the subsequent fiscal year. The market for the Company's predictive software solutions for service industries is characterized by rapidly changing technology and improvements in computer hardware, network operating systems, programming tools, programming languages, operating systems and database technology. The Company's success will depend upon its ability to continue to develop and maintain competitive technologies, enhance its 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. For example, the rapid growth of the Internet environment creates new opportunities, risks and uncertainties for businesses, such as the Company, which develop software solutions that now may have to be designed to operate in Internet, intranet and other on-line environments. The Company may not be able to develop and market, on a timely basis, or at all, product enhancements or new products that respond to changing technologies. The Company has 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. Any significant delay in the completion of new products, or the failure of such products, if and when installed, to achieve any significant degree of market acceptance, would have a material adverse effect on the Company's business, financial condition and results of operations. Any failure by the Company to anticipate or to respond adequately to changing technologies, or any significant delays in product development or introduction, could cause customers to delay or decide against purchases of the Company's products and would have a material adverse effect on the Company's business, financial condition and results of operations. 39 135 INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS The Company relies on a combination of patent, copyright, trademark and trade secret laws and confidentiality procedures to protect its proprietary rights. The Company currently owns seven issued United States patents and has four United States patent applications pending. The Company has applied for additional patents for its Falcon technology in Canada, Europe and Japan and for its MIRA product in Australia, Canada and Europe. There can be no assurance that patents will be issued with respect to pending or future patent applications or that the Company's patents will be upheld as valid or will prevent the development of competitive products. The Company seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. As part of its confidentiality procedures, the Company generally enters into invention assignment and proprietary information agreements with its employees and independent contractors and nondisclosure agreements with its distributors, corporate partners and licensees, and limits access to and distribution of its 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 the Company's products or technology without authorization, or to develop similar technology independently. In addition, to ensure that customers will not be adversely affected by an interruption in the Company's business, the Company places source code for certain of its products into escrow, which may increase the likelihood of misappropriation or other misuse of the Company's intellectual property. Moreover, effective protection of intellectual property rights may be unavailable or limited in certain foreign countries in which the Company has done and may do business. Also, the Company has developed technologies under research projects conducted under agreements with various United States Government agencies or subcontractors to such agencies. Although the Company has acquired certain commercial rights to such technologies, the United States Government typically retains ownership of certain intellectual property rights and licenses in the technologies developed by the Company under such contracts, and in some cases can terminate the Company's rights in such technologies if the Company fails to commercialize them on a timely basis. In addition, under certain United States Government contracts, the results of the Company's research may be made public by the government, which could limit the Company's competitive advantage with respect to future products based on such research. In the past, the Company has received communications from third parties asserting that Company trademarks infringe such other parties' trademarks, none of which has resulted in litigation or losses to the Company. Given the Company's ongoing efforts to develop and market new technologies and products, the Company may receive communications from third parties asserting that the Company's products infringe, or may infringe, their intellectual property rights. If as a result of any such claims the Company were precluded from using certain technologies or intellectual property rights, licenses to such disputed third-party technology or intellectual property rights might not be available on reasonable commercial terms, if at all. Furthermore, the Company may initiate claims or litigation against third parties for infringement of the Company's proprietary rights or to establish the validity of the Company's proprietary rights. Litigation, either as plaintiff or defendant, could result in significant expense to the Company and divert the efforts of the Company's technical and management personnel from productive tasks, whether or not such litigation is resolved in favor of the Company. In the event of an adverse ruling in any such litigation, the Company might be required to pay substantial damages, discontinue the use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to infringing technology, and the court might invalidate the Company's patents, trademarks or other proprietary rights. In the event of a successful claim against the Company and the failure of the Company to develop or license a substitute technology, the Company's business, financial condition and results of operations would be materially and adversely affected. As the number of software products increases and the functionality of these products further overlaps, the Company believes that software developers may become increasingly subject to 40 136 infringement claims. Any such claims, with or without merit, can be time consuming and expensive to defend and could materially and adversely affect the Company's business, financial condition and results of operations. COMPETITION The market for predictive software solutions for service industries is intensely competitive and subject to rapid change. Competitors, many of which have substantially greater financial resources than the Company, vary in size and in the scope of the products and services they offer. The Company encounters competition from a number of sources, including (i) other application software companies, (ii) management information systems departments of customers and potential customers, including banks, insurance companies and retailers, (iii) third party professional services organizations, including without limitation, consulting divisions of public accounting firms, (iv) hardware suppliers that bundle or develop complementary software, (v) network and service providers that seek to enhance their value-added services, (vi) neural-network tool suppliers and (vii) managed care organizations. In the healthcare/insurance market, the Company has experienced competition primarily from NCCI, Corporate Systems and CSC Incorporated. In the workers' compensation and medical cost administration market, the Company has experienced competition from MediCode, Medata, Inc. and Embassy Software with regard to software licensing, and Intracorp and Corvel Corporation in the service bureau operations market. Additionally, the Company has faced competition from ADP in the automobile accident medical claims market. In the financial services market, the Company has experienced competition from Fair, Isaac & Co., Inc., Cogensys (a subsidiary of Policy Management Systems Corporation), Fannie Mae, Freddie Mac, IBM, Nestor, Inc., NeuralTech Inc., Neuralware Inc., PMI Mortgage Services Co., VISA International and others. In the retail market, the Company has experienced competition from JDA Software Group, Inc., SAP AG, PeopleSoft, Inc., IBM, Manugistics Group, Inc. and others. The Company expects to experience additional competition from other established and emerging companies, as well as other technologies. For example, the Company's Falcon product competes against other methods of preventing credit card fraud, such as card activation 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, reduced gross margins and loss of market share, any of which could materially adversely affect the Company's business, financial condition and results of operations. The Company believes that most of its products are currently priced at a premium when compared to its competitors' products. The market for the Company's products is highly competitive, and the Company expects that it will face increasing pricing pressures from its current competitors and new market entrants. In particular, increased competition could reduce or eliminate such premiums and cause further price reductions. In addition, such competition could adversely affect the Company's ability to obtain new long-term contracts and renewals of existing long-term contracts on terms favorable to the Company. Any reduction in the price of the Company's products could materially adversely affect the Company's business, financial condition and results of operations. The Company believes that the principal competitive factors affecting its market include technical performance (for example, accuracy in detecting credit card fraud or evaluating workers' compensation claims), access to unique proprietary databases and product attributes such as adaptability, scalability, ability to integrate with products produced by other vendors, functionality, ease-of-use, product reputation, quality, performance, price, customer service and support, the effectiveness of sales and marketing efforts and Company reputation. Although the Company believes that its products currently compete favorably with respect to such factors, there can be no assurance that the Company can maintain its competitive position against current and potential 41 137 competitors, especially those with significantly greater financial, marketing, service, support, technical and other resources. Some of the Company's current, and many of the Company's potential, competitors have significantly greater financial, technical, marketing and other resources than the Company. 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 the Company. 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 the Company's prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly gain significant market share. Also, the Company relies upon its customers to provide data, expertise and other support for the ongoing updating of the Company's models. The Company's customers, most of which have significantly greater financial and marketing resources than the Company, may compete with the Company in the future or otherwise discontinue their relationships with or support of the Company. There can be no assurance that the Company will be able to compete successfully against current and future competitors or that competitive pressures faced by the Company will not materially adversely affect its business, financial condition and results of operations. EMPLOYEES As of December 31, 1997, the Company had 706 employees, including 316 in product development and support, 87 in customer service, 125 in sales and marketing and 178 in finance, administration and MIS. Most of these employees are located in the United States. None of the Company's employees are represented by a labor union. The Company has experienced no work stoppages and believes that its employee relationships are generally good. The Company's success depends to a significant degree upon the continued service of members of the Company's senior management and other key research, development, sales and marketing personnel. Accordingly, the loss of any of the Company's senior management or key research, development, sales or marketing personnel could have a material adverse effect on the Company's business, financial condition and results of operations. Only a small number of employees have employment agreements with the Company, and there can be no assurance that such agreements will result in the retention of these employees for any significant period of time. In addition, the untimely loss of a member of the management team or a key employee of a business acquired by the Company could have a material adverse effect on the Company's business, financial condition and results of operations, particularly if such loss occurred before the Company has had adequate time to familiarize itself with the operating details of that business. In the past, the Company has experienced difficulty in recruiting a sufficient number of qualified sales and technical employees. In addition, competitors may attempt to recruit the Company's key employees. There can be no assurance that the Company will be successful in attracting, assimilating and retaining such personnel. The failure to attract, assimilate and retain key personnel could have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Risks Associated with Managing Growth." 42 138 FACILITIES The Company's principal administrative, sales, marketing, support, research and development facilities are located in approximately 85,000 square feet of space in San Diego, California. The Company and its subsidiaries also lease an aggregate of approximately 95,000 square feet of additional office space elsewhere in San Diego and in Atlanta, Georgia; Minneapolis, Minnesota; Costa Mesa, California; and Irvine, California. The Company and its subsidiaries also maintain numerous field offices in the United States and in foreign countries. The Company believes that its current facilities are adequate to meet its needs for the foreseeable future. The Company believes that suitable additional or alternative space will be available in the future on commercially reasonable terms as needed. 43 139 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The names, ages and positions of the Company's directors and executive officers as of February 17, 1998 are as follows:
NAME AGE POSITION ------------------------------------------ --- ----------------------------------------------- Robert L. North........................... 62 President, Chief Executive Officer and Director Raymond V. Thomas......................... 55 Vice President, Finance and Administration, Chief Financial Officer and Secretary John Mutch................................ 41 Vice President, Marketing Todd W. Gutschow.......................... 37 Vice President, Technology Development Michael A. Thiemann....................... 41 President, Aptex Software Inc. Edward K. Chandler(1)..................... 39 Director Oliver D. Curme(2)........................ 44 Director Thomas F. Farb(1)......................... 41 Director Charles H. Gaylord, Jr.(2)................ 52 Director
- --------------- (1) Member of the Audit Committee (2) Member of the Compensation Committee Mr. North has been President and Chief Executive Officer and a director of the Company since June 1987. Mr. North is also a director of Peerless Systems Corporation. Mr. North holds Bachelor of Science and Master of Science degrees in Electrical Engineering from Stanford University. Mr. Thomas has been Vice President, Finance and Administration and Chief Financial Officer of the Company since February 1995 and Secretary of the Company since May 1995. From May 1993 to February 1995, he served as Executive Vice President and Chief Financial Officer of Golden Systems, Inc., a power supply manufacturer, and from September 1994 to February 1995 he also served as Chief Operating Officer. From April 1991 to May 1993, Mr. Thomas served as Senior Vice President of Finance and Administration and Chief Financial Officer of Vitesse Semiconductor Corporation, a semiconductor manufacturer. Mr. Thomas holds a Bachelor of Science degree in Industrial Management from Purdue University and attended the Wharton School of Business at the University of Pennsylvania. Mr. Mutch joined the Company in July 1997 as Vice President, Marketing. He was a founder of MVenture Holdings, Inc., a private equity fund that invests in start-up technology companies, and served as a General Partner from June 1994 to July 1997. From December 1986 to June 1994, Mr. Mutch held a variety of positions with Microsoft Corporation, including Director of Organization Marketing. He holds a Bachelor of Science degree in Applied Economics from Cornell University and a Masters degree in Business Administration from the University of Chicago. Mr. Gutschow is a co-founder of the Company and has been Vice President, Technology Development of the Company since October 1990. He was also Secretary of the Company from January 1993 to May 1995. Mr. Gutschow holds a Bachelor of Arts degree in Physics from Harvard University and attended the University of California at San Diego. Mr. Thiemann joined the Company in June 1989. He ran the Company's Aptex text analysis division from January 1996 to September 1996 and in September 1996 was named President and Chief Executive Officer of Aptex Software Inc. From May 1993 to January 1996, he served as Executive Vice President, Sales and Marketing of the Company. He has also served as Executive Vice President and General Manager, Decision Systems of the Company from January 1993 to May 1993, Vice President and General Manager, Decision Systems of the Company from February 1990 to January 1993 and Vice President, New Business Development of the Company from June 1989 to February 1990. Mr. Thiemann holds a Bachelor of Arts degree in Art, a Bachelor of Science degree in Electrical Engineering and a Masters degree in Electrical 44 140 Engineering from Stanford University and a Masters degree in Business Administration from Harvard University. Mr. Chandler has been a director of the Company since August 1991. Since July 1991, he has been President of Prairie-EKC, Inc., a partner of the general partner of PCE 1991 Limited Partnership, a venture capital firm. Since November 1996, Mr. Chandler has also been a Managing Director of Graystone Venture Partners, LLC, a venture capital firm. Mr. Chandler holds a Bachelor of Arts degree in Economics from Yale University and a Masters degree in Business Administration from Harvard University. Mr. Curme has been a director of the Company since June 1987. Since January 1988, he has been a general partner of the general partner of Battery Ventures, L.P., a national venture capital firm. Mr. Curme also serves as a director of several privately held technology companies. Mr. Curme is also a director of InfoSeek Corporation, an Internet search and navigation service company. He holds a Bachelor of Science degree in Biochemistry from Brown University and a Masters degree in Business Administration from Harvard University. Mr. Farb has been a director of the Company since November 1987. Since April 1994, he has been Senior Vice President, Chief Financial Officer and Treasurer of Interneuron Pharmaceuticals, Inc., a publicly-held diversified pharmaceutical company, and an officer of several of its subsidiaries. From October 1992 to March 1994, Mr. Farb served as Vice President of Corporate Development, Chief Financial Officer and Controller of Cytyc Corporation, a medical device and diagnostics company. Mr. Farb also serves as a director of Redwood Trust, Inc., a California-based publicly-held Real Estate Investment Trust. He holds a Bachelor of Arts degree in Sociology from Harvard College. Mr. Gaylord has been a director of the Company since May 1995. He is currently a private technology investor and a director of Stac Inc., a publicly-held software company. From December 1993 to September 1994, Mr. Gaylord served as Executive Vice President of Intuit Inc., a publicly-held personal and small business finance software company, following Intuit's acquisition of ChipSoft, Inc., a tax preparation software company. Prior to that acquisition, from June 1990 to December 1993, he served first as President and Chief Executive Officer and a director of ChipSoft and then as Chairman of the Board of Directors and Chief Executive Officer. He holds Bachelor of Science and Master of Science degrees in Aerospace Engineering from Georgia Institute of Technology and a Masters degree in Business Administration from Harvard University. 45 141 SELLING STOCKHOLDERS The following table sets forth certain information known to the Company regarding beneficial ownership of the Company's Common Stock by each Selling Stockholder as of December 31, 1997, and as adjusted to reflect the sale of shares offered pursuant to this Prospectus.
SHARES BENEFICIALLY NUMBER OF SHARES BENEFICIALLY OWNED PRIOR TO SHARES BEING OWNED AFTER OFFERING(1) OFFERED OFFERING(1)(2) -------------------- ------------ -------------------- NAME OF BENEFICIAL OWNER NUMBER PERCENT NUMBER PERCENT - ---------------------------------- --------- ------- --------- ------- Robert L. Kaaren(3)............... 2,442,780 9.9% 1,035,000 1,407,780 5.7% Michael E. Munayyer, Trustee of the Michael Munayyer Trust dated August 11, 1995(4).............. 2,442,780 9.9 1,035,000 1,407,780 5.7% Oliver D. Curme(5)................ 21,586 * 10,000 11,586 *
- --------------- * Less than 1.0%. (1) Based upon a total of 24,537,550 shares of Common Stock outstanding as of December 31, 1997. Unless otherwise indicated below, the persons and entities named in the table have sole voting and sole investment power with respect to all shares beneficially owned, subject to community property laws where applicable. Shares of Common Stock subject to options that are currently exercisable or exercisable within 60 days of December 31, 1997 are deemed to be outstanding and to be beneficially owned by the person holding such options for the purpose of computing the percentage ownership of such person but are not treated as outstanding for the purpose of computing the percentage ownership of any other person. (2) Assumes that the Underwriters' over-allotment option to purchase up to an aggregate of 315,000 shares is not exercised. If the over-allotment option is exercised, Mr. Kaaren and the Michael Munayyer Trust will each sell 1,192,500 shares, and own 1,250,280 shares or 6.5% of the Company's outstanding Common Stock following this offering. (3) Dr. Kaaren is the Chairman and Chief Executive Officer of CompReview. The address of Dr. Kaaren is c/o CompReview, Inc., 3200 Park Center Drive, 5th Floor, Costa Mesa, CA 92626. (4) Mr. Munayyer is the Chief Technical Officer of CompReview. The address of Mr. Munayyer and the Michael Munayyer Trust is c/o CompReview, Inc., 3200 Park Center Drive, 5th Floor, Costa Mesa, CA 92626. (5) Includes 10,000 shares of Common Stock subject to options exercisable within 60 days of December 31, 1997. Mr. Curme is a director of the Company. 46 142 DESCRIPTION OF CAPITAL STOCK The authorized capital stock of the Company consists of 50,000,000 shares of Common Stock and 4,000,000 shares of Preferred Stock. As of December 31, 1997, there were 24,537,550 outstanding shares of Common Stock held of record by approximately 186 stockholders and options to purchase 4,591,133 shares of Common Stock. COMMON STOCK Subject to preferences that may apply to any Preferred Stock outstanding at the time, the holders of outstanding shares of Common Stock are entitled to receive dividends out of assets legally available therefor at such times and in such amounts as the Board of Directors may from time to time determine. Each stockholder is entitled to one vote for each share of Common Stock held on all matters submitted to a vote of stockholders. Cumulative voting for the election of directors is not provided for in the Company's Certificate of Incorporation, which means that the holders of a majority of the shares voted can elect all of the directors then standing for election. The Common Stock is not entitled to preemptive rights and is not subject to conversion or redemption. Upon liquidation, dissolution or winding-up of the Company, the assets legally available for distribution to stockholders are distributable ratably among the holders of the Common Stock and any participating Preferred Stock outstanding at that time after payment of liquidation preferences, if any, on any outstanding Preferred Stock and payment of other claims of creditors. Each outstanding share of Common Stock is fully paid and nonassessable. The Company's Common Stock is traded on the Nasdaq National Market under the symbol "HNCS." PREFERRED STOCK The Board of Directors is authorized, subject to any limitations prescribed by Delaware law, to provide for the issuance of additional shares of Preferred Stock in one or more series, to establish from time to time the number of shares to be included in each such series, to fix the powers, designations, preferences and rights of the shares of each wholly unissued series and any qualifications, limitations or restrictions thereon, and to increase or decrease the number of shares of any such series (but not below the number of shares of such series then outstanding), without any further vote or action by the stockholders. The Board of Directors may authorize the issuance of Preferred Stock with voting or conversion rights that could adversely affect the voting power of other rights of the holders of Common Stock. Thus, the issuance of Preferred Stock could have the effect of delaying, deferring or preventing a change in control of the Company. The Company has no current plan to issue any shares of Preferred Stock. DELAWARE GENERAL CORPORATION LAW SECTION 203 As a corporation organized under the laws of the State of Delaware, the Company is subject to Section 203 of the Delaware General Corporation Law (the "DGCL"), which restricts certain business combinations between the Company and an "interested stockholder" (in general, a stockholder owning 15% or more of the Company's outstanding voting stock) or its affiliates or associates for a period of three years following the date on which the stockholder becomes an "interested stockholder." The restrictions do not apply if (i) prior to an interested stockholder becoming such, the Board of Directors approves either the business combination or the transaction in which the stockholder becomes an interested stockholder, (ii) upon consummation of the transaction in which the stockholder becomes an interested stockholder, such interested stockholder owns at least 85% of the voting stock of the Company outstanding at the time the transaction commences (excluding shares owned by certain employee stock ownership plans and persons who are both directors and officers of the Company) or (iii) on or subsequent to the date an interested stockholder becomes such, the business combination is both approved by the Board of Directors and authorized at an annual or special meeting of the Company's stockholders, not by 47 143 written consent, but by the affirmative vote of at least 66 2/3% of the outstanding voting stock not owned by the interested stockholder. REGISTRATION RIGHTS; EXISTING SHELF REGISTRATION 1994 Registration Rights Agreement. Certain holders of outstanding shares of Common Stock who are parties to the Company's Third Amended Registration Rights Agreement dated April 26, 1994 (the "1994 Registration Rights Agreement") have contractual rights to have certain shares of the Company's Common Stock registered under the Securities Act. To the Company's best knowledge, based solely on its review of its current stockholders of record, parties to the 1994 Registration Rights Agreement together own approximately 412,666 shares of Common Stock that may be registered pursuant to the 1994 Registration Rights Agreement (the "Registrable Shares"). If requested by holders of at least 50% of the outstanding Registrable Shares, the Company must file a registration statement under the Securities Act covering all Registrable Shares requested to be included by all holders thereof. For purposes of exercising such demand registration rights, the Registrable Shares do not include any shares of Common Stock that were issued upon the conversion of formerly outstanding shares of the Company's Series A Preferred Stock. The Company may be required to effect up to four such demand registrations of Registrable Shares, plus one additional such registration for each registration that does not include at least 80% of the Registrable Shares requested to be included. All expenses incurred in connection with such registrations (other than underwriters' discounts and commissions) will be borne by the Company until there have been two such registrations that include at least 80% of the Registrable Shares requested to be included. In addition, if the Company proposes to register any of its securities under the Securities Act (other than in connection with a Company employee benefit plan or a business combination), the holders of Registrable Shares may require the Company to include all or a portion of such shares in such registration, although the managing underwriter of any such offering has certain rights to limit the number of shares in such registration. All expenses incurred in connection with such registrations (other than underwriters' discounts and commissions) will be borne by the Company. If the Company is eligible to use Form S-3 to register its shares, any holder or holders of Registrable Shares who hold at least 10% of the Registrable Shares originally issued may request the Company to register such shares on a Form S-3 registration statement, provided the reasonably anticipated aggregate offering price of such shares exceeds $500,000. The Company is not obligated to effect more than two such Form S-3 registrations in any calendar year. All expenses of such Form S-3 registrations must be borne by the selling stockholders. The registration rights under the 1994 Registration Rights Agreement expire in July 2000. Risk Data Registration Rights. Pursuant to a Registration Rights Agreement dated August 30, 1996, former stockholders of Risk Data who hold at least 30% of the shares of the Company's Common Stock that were issued in the Risk Data acquisition and have not been publicly resold ("Risk Data Shares") may request the Company to register such shares under the Securities Act on a Form S-3 registration statement, provided the aggregate public offering price of such shares is at least $2,000,000. The Company is not obligated to register any holder's Risk Data Shares if all such shares may be resold within a three-month period under Rule 144 or Rule 145(d) under the Securities Act. The Company may be required to effect up to two such Form S-3 registrations and will bear all expenses incurred in connection with such registrations. These registration rights expire on August 31, 1998. CompReview Registration Rights. Pursuant to a Registration Rights Agreement dated November 28, 1997, the former stockholders of CompReview are entitled to have the shares of the Company's Common Stock that were issued to them in the CompReview acquisition ("CompReview Shares") registered, at the Company's expense, on a shelf registration statement on Form S-3 pursuant to Rule 415 under the Securities Act (the "CompReview Shelf Registration"). The Company expects to file the CompReview Shelf Registration in the near future. Under 48 144 the CompReview Registration Rights Agreement, once the former CompReview stockholders have together sold an aggregate combined total of 1,250,000 CompReview Shares, sales of CompReview Shares may be made pursuant to the CompReview Shelf Registration only during certain time periods after advance notice to the Company. The Company is not obligated to maintain the effectiveness of the CompReview Shelf Registration after November 28, 1998 unless, pursuant to the CompReview registration rights agreement, the Company exercises its rights to defer a requested sale of CompReview Shares, in which case the time period during which the CompReview Shelf Registration must be kept effective must be extended by a period of time equal to the period of deferral. Retek Shelf Registration. Pursuant to a Registration Rights Agreement dated October 25, 1996, as amended, the Company has filed a Form S-3 registration statement pursuant to Rule 415 under the Securities Act (the "Retek Shelf Registration"), covering the sale of the shares of the Company's Common Stock issued in the Retek acquisition (the "Retek Shares"). Sales of Retek Shares may be made pursuant to the Retek Shelf Registration only during certain time periods after advance notice to the Company. The Company is not obligated to maintain the effectiveness of the Retek Shelf Registration after November 29, 1998 unless, pursuant to the Retek registration rights agreement, the Company exercises its rights to defer a requested sale of Retek Shares, in which case the time period during which the Retek Shelf Registration must be kept effective must be extended by a period of time equal to the period of deferral. TRANSFER AGENT AND REGISTRAR The Transfer Agent and Registrar for the Company's Common Stock is BancBoston, N.A. 49 145 UNDERWRITING The Underwriters named below have severally agreed, subject to the terms and conditions contained in the Underwriting Agreement (the form of which is filed as an exhibit to the Company's Registration Statement, of which this Prospectus is a part), to purchase from the Company and the Selling Stockholders the respective number of shares of Common Stock indicated below opposite their respective names. The Underwriters are committed to purchase all of the shares (other than those covered by the Underwriters' over-allotment option described below), if they purchase any.
NUMBER OF NAME SHARES ------------------------------------------------------- --------- Deutsche Morgan Grenfell Inc........................... BancAmerica Robertson Stephens......................... Smith Barney Inc....................................... --------- Total........................................ 2,100,000 =========
The Underwriting Agreement provides that the obligations of the several Underwriters thereunder are subject to approval of certain legal matters by counsel and to various other conditions. The Underwriters have advised the Company that the Underwriters propose initially to offer the Common Stock to the public on the terms set forth on the cover page of this Prospectus. The Underwriters may allow to selected dealers (who may include the Underwriters) a concession of not more than $ per share. The selected dealers may reallow a concession of not more than $ per share to certain other dealers. After the initial offering of the shares, the price and concessions and re-allowances to dealers and other selling terms may be changed by the Underwriters. The Common Stock is offered subject to receipt and acceptance by the Underwriters, and to certain other conditions, including the right to reject orders in whole or in part. The Underwriters do not intend to sell any of the shares of Common Stock offered hereby to accounts for which they exercise discretionary authority. Certain of the Selling Stockholders have granted an option to the Underwriters to purchase up to a maximum of 315,000 additional shares of Common Stock to cover over-allotments, if any, at the public offering price, less the underwriting discount set forth on the cover page of this Prospectus. Such option may be exercised at any time until 30 days after the date of the Underwriting Agreement. To the extent the Underwriters exercise this option, each of the Underwriters will be committed, subject to certain conditions, to purchase such additional shares in approximately the same proportion as set forth in the above table. The Underwriters may purchase such shares only to cover over-allotments made in connection with this offering. In connection with this offering, the Company, the directors and executive officers of the Company and the Selling Stockholders have agreed, during the period ending 90 days after the date of this Prospectus, not to (i) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or offer to sell, grant any option, right or warrant to purchase, or otherwise transfer, lend or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock or (ii) enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the Common Stock, whether any such transaction described in clause (i) or (ii) above is to be settled by delivery of Common Stock or such other securities, in cash or otherwise, except under certain limited circumstances or without the prior written consent of Deutsche Morgan Grenfell Inc. The Underwriters are also currently offering $90.0 million of the Company's Notes and intend to enter into an Underwriting Agreement (the form of which is filed as an exhibit to the Company's Registration Statement, of which this Prospectus is a part) for that purpose. Pursuant to that 50 146 agreement, the Underwriters will be entitled to exercise an over-allotment option for $10.0 million of the Notes, will receive customary underwriters' compensation for an offering of that size and type and will be indemnified by the Company. The Underwriting Agreement provides that the Company and the Selling Stockholders will indemnify the several Underwriters against certain liabilities, including civil liabilities under the Securities Act, as amended, or will contribute to payments the Underwriters may be required to make in respect thereof. Certain persons participating in this offering may over-allot or effect transactions which stabilize, maintain or otherwise affect the market price of the Common Stock at levels above those which might otherwise prevail in the open market, including by entering stabilizing bids, imposing penalty bids or otherwise. A stabilizing bid means the placing of any bid or effecting of any purchase for the purpose of pegging, fixing or maintaining the price of the Common Stock. A syndicate covering transaction means the placing of any bid on behalf of the underwriting syndicate or the effecting of any purchase to reduce a short position created in connection with this offering. A penalty bid means an arrangement that permits the Underwriters to reclaim a selling concession from an Underwriter when shares of Common Stock sold by the Underwriter are purchased in stabilization transactions. Such transactions may be effected on the Nasdaq Stock Market, in the over-the-counter market, or otherwise. Such stabilizing, if commenced, may be discontinued at any time. The Underwriters and dealers may engage in passive market making transactions in the Common Stock in accordance with Rule 103 of Regulation M promulgated by the Commission. In general, a passive market maker may not bid for, or purchase, the Common Stock at a price that exceeds the highest independent bid. In addition, the net daily purchases made by any passive market maker generally may not exceed 30% of its average daily trading volume in the Common Stock during a specified two month prior period, or 200 shares, whichever is greater. A passive market maker must identify passive market making bids as such on the Nasdaq electronic inter-dealer reporting system. Passive market making may stabilize or maintain the market price of the Common Stock above independent market levels. Underwriters and dealers are not required to engage in passive market making and may end passive market making activities at any time. LEGAL MATTERS The validity of the issuance of the shares of Common Stock offered hereby will be passed upon for the Company and the Selling Stockholders by Fenwick & West LLP, Palo Alto, California. Certain legal matters will be passed upon for the Underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. EXPERTS The consolidated financial statements as of December 31, 1996 and 1997 and for each of the three years in the period ended December 31, 1997 included in this Prospectus have been so included in reliance on the report of Price Waterhouse LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. 51 147 HNC SOFTWARE INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Report of Independent Accountants..................................................... F-2 Consolidated Balance Sheet............................................................ F-3 Consolidated Statement of Income...................................................... F-4 Consolidated Statement of Cash Flows.................................................. F-5 Consolidated Statement of Changes in Stockholders' Equity............................. F-6 Notes to Consolidated Financial Statements............................................ F-7
F-1 148 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of HNC Software Inc. In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, of cash flows and of changes in stockholders' equity present fairly, in all material respects, the financial position of HNC Software Inc. and its subsidiaries at December 31, 1996 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. 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 generally accepted auditing standards 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 the opinion expressed above. PRICE WATERHOUSE LLP San Diego, California January 29, 1998, except as to Note 11 which is as of February 13, 1998 F-2 149 HNC SOFTWARE INC. CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT PER SHARE DATA) ASSETS
DECEMBER 31, -------------------- 1996 1997 ------- -------- Current assets: Cash and cash equivalents......................................... $ 8,121 $ 18,068 Investments available for sale.................................... 26,728 24,878 Accounts receivable, net.......................................... 21,856 32,980 Current portion of deferred income taxes.......................... 6,383 11,310 Other current assets.............................................. 2,553 2,802 ------- -------- Total current assets...................................... 65,641 90,038 Deferred income taxes, less current portion......................... 22,966 15,322 Property and equipment, net......................................... 6,339 12,102 Other assets........................................................ 3,330 2,415 ------- -------- $98,276 $119,877 ======= ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.................................................. $ 4,368 $ 5,728 Accrued liabilities............................................... 4,433 5,933 Deferred revenue.................................................. 3,377 3,883 Other current liabilities......................................... 445 191 ------- -------- Total current liabilities................................. 12,623 15,735 Non-current liabilities............................................. 683 239 Minority interest in consolidated subsidiary........................ -- 43 Commitments and contingencies (Notes 5 and 10) Stockholders' equity: Preferred stock, $0.001 par value -- 4,000 shares authorized: no shares issued or outstanding................................ -- -- Common stock, $0.001 par value -- 50,000 shares authorized: 24,012 and 24,538 shares issued and outstanding, respectively.................................................. 24 25 Paid-in capital................................................... 83,991 95,919 Unrealized loss on investments available for sale................. (59) (2) Foreign currency translation adjustment........................... 54 (111) Retained earnings................................................. 960 8,029 ------- -------- Total stockholders' equity................................ 84,970 103,860 ------- -------- $98,276 $119,877 ======= ========
See accompanying notes to consolidated financial statements F-3 150 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, -------------------------------- 1995 1996 1997 -------- ------- ------- Revenues: License and maintenance.............................. $ 24,561 $48,890 $89,643 Installation and implementation...................... 4,648 6,691 10,702 Contracts and other.................................. 9,146 11,128 7,772 Service bureau....................................... 5,349 4,730 5,618 -------- ------- ------- Total revenues............................... 43,704 71,439 113,735 -------- ------- ------- Operating expenses: License and maintenance.............................. 7,903 13,725 19,937 Installation and implementation...................... 1,425 2,714 5,174 Contracts and other.................................. 6,894 7,694 5,438 Service bureau....................................... 3,025 3,365 4,320 Research and development............................. 6,998 13,808 21,151 Sales and marketing.................................. 7,276 11,923 22,049 General and administrative........................... 5,101 8,551 12,626 -------- ------- ------- Total operating expenses..................... 38,622 61,780 90,695 -------- ------- ------- Operating income....................................... 5,082 9,659 23,040 Interest and other income.............................. 912 2,178 2,003 Interest expense....................................... (428) (478) (81) Minority interest in income of consolidated subsidiary........................................... -- -- (43) -------- ------- ------- Income before income tax (benefit) provision.................................. 5,566 11,359 24,919 Income tax (benefit) provision......................... (511) (534) 7,354 -------- ------- ------- Net income................................... $ 6,077 $11,893 $17,565 ======== ======= ======= Earnings per share: Basic net income per common share.................... $ 0.38 $ 0.50 $ 0.72 ======== ======= ======= Diluted net income per common share.................. $ 0.28 $ 0.47 $ 0.68 ======== ======= ======= Unaudited pro forma data (Note 1): Income before income tax provision................... $ 5,566 $11,359 $24,919 Income tax provision................................. 1,032 1,628 9,502 -------- ------- ------- Net income................................... $ 4,534 $ 9,731 $15,417 ======== ======= ======= Basic pro forma net income per common share.......... $ 0.64 ======= Diluted pro forma net income per common share........ $ 0.60 ======= Shares used in computing basic net income per common share and unaudited basic pro forma net income per common share (Notes 1 and 8)......................... 15,195 23,552 24,275 ======== ======= ======= Shares used in computing diluted net income per common share and unaudited diluted pro forma net income per common share (Notes 1 and 8)......................... 21,510 25,363 25,681 ======== ======= =======
See accompanying notes to consolidated financial statements. F-4 151 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------ 1995 1996 1997 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income....................................................... $ 6,077 $ 11,893 $ 17,565 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization.................................. 1,874 3,605 4,833 Tax benefit from stock option transactions..................... 800 896 3,848 Changes in assets and liabilities: Accounts receivable, net..................................... (1,658) (10,978) (11,124) Other assets................................................. (674) (1,207) (295) Deferred income taxes........................................ (1,551) (1,324) 6,909 Accounts payable............................................. 1,172 2,167 1,360 Accrued liabilities.......................................... 1,756 625 (2,348) Deferred revenue............................................. 1,337 1,472 375 Other liabilities............................................ 22 (441) (116) -------- -------- -------- Net cash provided by operating activities................. 9,155 6,708 21,007 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of investments available for sale....................... (28,666) (26,113) (26,517) Maturities of investments available for sale..................... 4,182 18,125 24,666 Proceeds from sales of investments available for sale............ 2,467 3,707 3,716 Acquisitions of property and equipment........................... (2,246) (3,978) (9,593) -------- -------- -------- Net cash used in investing activities..................... (24,263) (8,259) (7,728) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from issuances of common stock...................... 33,726 1,935 4,039 Proceeds from issuances of notes payable to stockholders......... 1,000 -- -- Repayments of notes payable to stockholders...................... -- (1,000) -- Proceeds from bank line of credit................................ 1,085 309 -- Repayments of bank line of credit................................ (265) (2,504) -- Repayments of debt from asset purchases.......................... -- (4,710) -- Capital lease payments........................................... (502) (553) (408) Proceeds from issuances of bank notes payable.................... -- 1,999 -- Repayments of bank notes payable................................. (687) (1,999) -- Distributions to CompReview stockholders......................... (3,845) (5,908) (6,798) -------- -------- -------- Net cash provided by (used in) financing activities....... 30,512 (12,431) (3,167) -------- -------- -------- Effect of exchange rate changes on cash............................ -- 54 (165) -------- -------- -------- Net increase (decrease) in cash and cash equivalents............... 15,404 (13,928) 9,947 Cash and cash equivalents at beginning of period................... 6,645 22,049 8,121 -------- -------- -------- Cash and cash equivalents at end of period......................... $ 22,049 $ 8,121 $ 18,068 ======== ======== ======== SIGNIFICANT NON-CASH INVESTING AND FINANCING ACTIVITIES: Assets purchased through issuance of debt........................ $ -- $ 4,710 $ -- ======== ======== ======== Acquisitions of property and equipment under capital leases...... $ 411 $ 344 $ -- ======== ======== ======== Conversion of preferred stock.................................... $ 13,518 $ -- $ -- ======== ======== ======== Accretion of dividends on mandatorily redeemable convertible preferred stock................................................ $ 348 $ -- $ -- ======== ======== ======== SUPPLEMENTAL CASH FLOW DISCLOSURE: Interest paid.................................................... $ 390 $ 448 $ 101 ======== ======== ======== Income taxes paid................................................ $ 190 $ 165 $ 547 ======== ======== ========
See accompanying notes to consolidated financial statements F-5 152 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (IN THOUSANDS)
CONVERTIBLE PREFERRED STOCK --------------------------------- SERIES A SERIES E COMMON STOCK --------------- --------------- --------------- SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT ------ ------ ------ ------ ------ ------ BALANCE AT DECEMBER 31, 1994......... 380 $ -- 1,282 $ 1 8,656 $ 9 Common stock options exercised....... 207 Accretion of dividends............... Issuance of common stock in initial public offering, net of issuance costs............................... 2,376 2 Conversion of convertible preferred stock into common stock............. (380) -- (1,282) (1) 8,956 9 Issuance of common stock in follow-on public offering, net of issuance costs............................... 1,116 2 Issuance of common stock at inception of Retek (Note 1)................... 1,367 1 Tax benefit from stock option transactions........................ Unrealized gain on investments....... Stock warrant exercised.............. 100 Distributions to CompReview stockholders........................ Net income........................... ---- ----- ------ --- ------ --- BALANCE AT DECEMBER 31, 1995......... -- -- -- -- 22,778 23 Common stock options exercised....... 1,140 1 Common stock issued under Employee Stock Purchase Plan................. 94 Tax benefit from stock option transactions........................ Tax benefit from Retek taxable pooling (Note 7).................... Unrealized loss on investments....... Foreign currency translation adjustment.......................... Distributions to CompReview stockholders........................ Net income........................... ---- ----- ------ --- ------ --- BALANCE AT DECEMBER 31, 1996......... -- -- -- -- 24,012 24 Common stock options exercised....... 475 1 Common stock issued under Employee Stock Purchase Plan................. 51 Tax benefit from stock option transactions........................ Unrealized gain on investments....... Foreign currency translation adjustment.......................... Distributions to CompReview stockholders........................ CompReview contribution to capital... Net income........................... ---- ----- ------ --- ------ --- BALANCE AT DECEMBER 31, 1997......... -- $ -- -- $ -- 24,538 $ 25 ==== ===== ====== === ====== === UNREALIZED GAIN (LOSS) ON FOREIGN (ACCUMULATED INVESTMENTS CURRENCY DEFICIT) TOTAL PAID-IN AVAILABLE TRANSLATION RETAINED STOCKHOLDERS' CAPITAL FOR SALE ADJUSTMENT EARNINGS EQUITY -------- -------------- ----------- ------------ ------------- < BALANCE AT DECEMBER 31, 1994.........$ 10,980 $ -- $ -- $(10,149) $ 841 Common stock options exercised....... 85 85 Accretion of dividends............... (348) (348) Issuance of common stock in initial public offering, net of issuance costs............................... 14,329 14,331 Conversion of convertible preferred stock into common stock............. 10,618 2,892 13,518 Issuance of common stock in follow-on public offering, net of issuance costs............................... 19,184 19,186 Issuance of common stock at inception of Retek (Note 1)................... (1) -- Tax benefit from stock option transactions........................ 800 800 Unrealized gain on investments....... 92 92 Stock warrant exercised.............. 124 124 Distributions to CompReview stockholders........................ (3,845) (3,845) Net income........................... 6,077 6,077 ------- ----- ----- -------- -------- BALANCE AT DECEMBER 31, 1995......... 55,771 92 -- (5,025) 50,861 Common stock options exercised....... 1,095 1,096 Common stock issued under Employee Stock Purchase Plan................. 839 839 Tax benefit from stock option transactions........................ 7,889 7,889 Tax benefit from Retek taxable pooling (Note 7).................... 18,397 18,397 Unrealized loss on investments....... (151) (151) Foreign currency translation adjustment.......................... 54 54 Distributions to CompReview stockholders........................ (5,908) (5,908) Net income........................... 11,893 11,893 ------- ----- ----- -------- -------- BALANCE AT DECEMBER 31, 1996......... 83,991 (59) 54 960 84,970 Common stock options exercised....... 2,845 2,846 Common stock issued under Employee Stock Purchase Plan................. 1,193 1,193 Tax benefit from stock option transactions........................ 4,192 4,192 Unrealized gain on investments....... 57 57 Foreign currency translation adjustment.......................... (165) (165) Distributions to CompReview stockholders........................ (6,798) (6,798) CompReview contribution to capital... 3,698 (3,698) -- Net income........................... 17,565 17,565 ------- ----- ----- -------- -------- BALANCE AT DECEMBER 31, 1997.........$ 95,919 $ (2) $(111) $ 8,029 $ 103,860 ======= ===== ===== ======== ========
See accompanying notes to consolidated financial statements F-6 153 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 1 -- THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES The Company Headquartered in San Diego, California, HNC Software Inc. (the "Company" or "HNC") develops, markets and supports predictive software solutions in client/server environments. HNC provides innovative predictive software systems in the healthcare/insurance, financial services and retail markets. Acquisitions On August 30, 1996, the Company completed an acquisition of all of the outstanding shares of Risk Data Corporation ("Risk Data"). Risk Data is an insurance information technology services firm that develops, markets and supports analytical benchmarking and risk management software products primarily for insurance carriers, state insurance funds and third party administrators primarily in the workers' compensation insurance field. Under the terms of the acquisition, accounted for as a pooling of interests, the Company exchanged 1,891 shares of common stock for all of the then outstanding shares of Risk Data preferred and common stock. On November 29, 1996, the Company completed an acquisition of all of the outstanding shares of Retek Distribution Corporation ("Retek"). Retek develops, markets and supports inventory management system software primarily for customers in the retail industry. Under the terms of the acquisition, accounted for as a pooling of interests, the Company exchanged 1,367 shares of common stock for all of the then outstanding shares of Retek common stock. On November 28, 1997, the Company completed an acquisition of all of the outstanding shares of CompReview, Inc. ("CompReview"). CompReview develops, markets and supports cost containment software for workers' compensation insurance carriers and for insurers that handle automobile accident personal injury claims. Under the terms of the acquisition, accounted for as a pooling of interests, the Company exchanged 4,886 shares of common stock for all of the then outstanding shares of CompReview common stock. The consolidated financial statements and related notes give retroactive effect to all three acquisitions for all of the periods presented. The consolidated balance sheet as of December 31, 1996 and 1997 includes the accounts of Risk Data, Retek and CompReview as of December 31, 1996 and 1997. The consolidated statements of income, of cash flows and of changes in stockholders' equity for each of the three years in the period ended December 31, 1997 include the results of Risk Data, Retek and CompReview for each of the years then ended. The term "Company" as used in these consolidated financial statements refers to HNC and its subsidiaries, including Risk Data, Retek and CompReview. F-7 154 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) No adjustments to conform the accounting methods of the acquired companies to the accounting methods of HNC were required. Certain amounts have been reclassified with regard to presentation of the financial information of the acquired companies. Revenues and net income (loss) for each of the previously separate companies for the periods prior to their respective acquisition dates are as follows:
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SIX MONTHS SEPTEMBER 30, ---------------------------- ENDED ----------------- 1995 1996 1997 JUNE 30, 1996 1997 ------- ------- -------- 1996 ------- ------- ---------- (UNAUDITED) (UNAUDITED) Revenues: HNC............... $25,174 $53,833 $113,735 $ 16,478 $31,423 $62,683 Risk Data......... 4,577 -- -- 2,600 -- -- Retek............. 921 -- -- 3,377 5,635 -- CompReview........ 13,032 17,606 -- 8,119 12,631 18,971 ------- ------- -------- ------- ------- ------- $43,704 $71,439 $113,735 $ 30,574 $49,689 $81,654 ======= ======= ======== ======= ======= ======= Net income (loss): HNC............... $ 4,457 $ 6,376 $ 17,565 $ 1,780 $ 975 $ 7,597 Risk Data......... (1,952) -- -- (2,184) -- -- Retek............. (382) -- -- 43 93 -- CompReview........ 3,954 5,517 -- 2,123 3,679 6,702 ------- ------- -------- ------- ------- ------- $ 6,077 $11,893 $ 17,565 $ 1,762 $ 4,747 $14,299 ======= ======= ======== ======= ======= =======
Transaction costs of $563, $515 and $1,440 were incurred to complete the acquisitions of Risk Data, Retek and CompReview, respectively. Transaction costs were deferred and charged to income when the related transactions were consummated. Transaction costs consisted primarily of investment banker, legal and accounting fees, and printing, mailing and registration expenses. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. During 1996, the Company established Aptex Software Inc. ("Aptex"), a majority owned subsidiary, in order to develop, market and support certain text analysis technology that is being used to develop products for the Internet market. The minority stockholders' interest in Aptex's financial position and results of operations is presented as a minority interest in the Company's consolidated financial statements. Financial Statement Preparation 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. F-8 155 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Cash Equivalents Cash equivalents are highly liquid investments and consist of investments in money market accounts and commercial paper purchased with maturities of three months or less. Investments Management determines the appropriate classification of its investments in marketable debt and equity securities at the time of purchase and re-evaluates such designation as of each balance sheet date. The Company classifies all securities as "available for sale" and carries them at fair value with unrealized gains or losses related to these securities included in stockholders' equity in the Company's consolidated balance sheet. Property and Equipment Property and equipment are recorded at cost. The Company computes depreciation and amortization using either the straight-line method over the estimated useful lives of the assets of three to seven years or an accelerated method over the estimated useful lives of the assets of five to seven years. The Company amortizes leasehold improvements over the shorter of their estimated useful lives or the remaining term of the related lease. Repair and maintenance costs are charged to expense as incurred. Software Costs Software costs are recorded at cost and amortized over their estimated useful lives of 36 to 42 months. Software costs are comprised of purchased software and other rights that are stated at the lower of cost or net realizable value. At December 31, 1996 and 1997, software costs of $2,561 and $2,581, respectively, were included in other assets in the consolidated balance sheet net of accumulated amortization of $642 and $1,451, respectively. Development costs for 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, 1997, no significant amounts were expended subsequent to reaching technological feasibility. Long-Lived Assets The Company investigates potential impairments of long-lived assets, certain identifiable intangibles and associated goodwill when events or changes in circumstances have made recovery of an asset's carrying value unlikely. An impairment loss would be recognized if the sum of the expected future net cash flows were less than the carrying amount of the asset. No such impairments of long-lived assets existed through December 31, 1997. Stock-Based Compensation The Company measures compensation expense for its stock-based employee compensation plans using the intrinsic value method and provides pro forma disclosures of net income and earnings per share as if the fair value-based method had been applied in measuring compensation expense. F-9 156 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Revenue Recognition The Company's revenue from periodic software license and maintenance agreements is generally recognized ratably over the respective license periods. Revenue from certain short-term periodic software license and maintenance agreements with guaranteed minimum license fees is recognized as related services are performed. Transactional fees are recognized as revenue based on system usage or when fees based on system usage exceed the monthly minimum license fees. Revenue from perpetual licenses of the Company's software for which there are no significant continuing obligations and collection of the related receivables is probable is recognized on delivery of the software and acceptance by the customer. Revenue from hardware product sales, which is included in contracts and other revenue, is recognized upon shipment to the customer. The Company's revenue from software installation and implementation and from contract services is generally recognized as the services are performed using the percentage of completion method based on costs incurred to date compared to total estimated costs at completion. Amounts received under contracts in advance of performance are recorded as deferred revenue and are generally recognized within one year from receipt. Contract losses are recorded as a charge to income in the period such losses are first identified. Unbilled accounts receivable are stated at estimated realizable value. Service bureau fees are from review and repricing of customers' medical bills and are assessed to customers on the basis of volume of bills processed and are recognized as revenue when the processing services are performed. Income Taxes The Company's current income tax expense is the amount of income taxes expected to be payable for the current year. 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 carryforwards. 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 are reflected in income during the period such changes are enacted. Net Income Per Common Share The Company adopted Statement of Financial Accounting Standard No. 128 ("FAS 128"), "Earnings per Share," for fiscal 1997 and retroactively restated all prior periods to conform with FAS 128 as required. Basic net income per common share is computed as net income less accretion of dividends on mandatorily redeemable convertible preferred stock divided by the weighted average number of common shares outstanding during the period. Diluted net income per common share is computed as net income divided by the weighted average number of common shares and potential common shares, using the treasury stock method, outstanding during the period and assumes conversion into common stock at the beginning of each period of all outstanding shares of convertible preferred stock (Note 8). Unaudited Pro Forma Data Prior to the acquisition of CompReview by HNC on November 28, 1997, CompReview had elected subchapter S corporation status for income tax purposes; therefore, its income was included in the tax returns of its stockholders, and no income tax provision was recorded for F-10 157 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) CompReview other than certain minimum state taxes on subchapter S corporations. As a result of the acquisition, beginning November 29, 1997, CompReview became subject to corporate income taxes on its taxable income. For comparative purposes, the consolidated statement of income includes unaudited pro forma adjusted data with respect to the merged companies' income tax provision as if CompReview had been subject to corporate income taxes on its taxable income for all periods presented. Foreign Currency Translation The financial statements of the Company's international operations are 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 stockholders' equity. Gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the entity's local currency) are included in the consolidated statement of income and are not material. Diversification of Credit Risk The Company's financial instruments that are subject to concentrations of credit risk consist primarily of cash equivalents, investments available for sale and accounts receivable, which are generally not collateralized. The Company's policy is to place its cash, cash equivalents and investments available for sale with high credit quality financial institutions and commercial companies and government agencies in order to limit the amount of its credit exposure. The Company's software license and installation agreements and commercial development contracts are primarily with large customers in the healthcare/insurance, financial services and retail industries. The Company maintains reserves for potential credit losses. The Company has one major product or product line in each of its three target markets. In the healthcare/insurance market, revenues from one product accounted for 29.8%, 24.6% and 23.0% of the Company's total revenues for 1995, 1996 and 1997, respectively. During those same periods, one product in the retail market accounted for 2.2%, 13.6% and 18.9%, respectively, of the Company's total revenues, and one product line in the financial services market accounted for 28.0%, 20.9% and 16.0%, respectively, of the Company's total revenues. Revenues from international operations and export sales, primarily to Western Europe and Canada, represented approximately 12.6%, 17.7% and 16.8% of total revenues in 1995, 1996 and 1997, respectively. Export sales were $4,595, $7,310 and $7,896 in 1995, 1996 and 1997, respectively. Disclosures About Fair Value of Financial Instruments The carrying amounts of cash and cash equivalents and accrued liabilities approximate fair value because of the short-term maturities of these financial instruments. The carrying amounts of capital lease obligations approximate their fair values based on interest rates currently available to the Company for borrowings with similar terms and maturities. Reincorporation and Stock Split In May 1995, the Company's stockholders approved an Agreement and Plan of Merger whereby the Company merged with and into a newly incorporated Delaware corporation ("HNC Delaware"), which is the surviving corporation. In conjunction with the merger, each share of the F-11 158 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Company's common stock, preferred stock and options and warrants to purchase the Company's common stock was exchanged for one-half share of HNC Delaware's common stock, preferred stock and options and warrants to purchase HNC Delaware's common stock, at twice the exercise price for options and warrants. In April 1996, the Company consummated a two-for-one stock split effected in the form of a common stock dividend. All references to share and per share amounts of common and preferred stock and other data in these financial statements have been retroactively restated to reflect the reincorporation and stock split. New Accounting Pronouncements In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130 ("FAS 130"), "Reporting Comprehensive Income," which the Company is required to adopt for 1998. This statement will require the Company to report in the financial statements, in addition to net income, comprehensive income and its components including foreign currency items and unrealized gains and losses on certain investments in debt and equity securities. Upon adoption of FAS 130, the Company is also required to reclassify financial statements for earlier periods provided for comparative purposes. The adoption of FAS 130 will not have a significant impact on the Company's consolidated financial statement disclosures. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and Related Information," which the Company is required to adopt for its 1998 annual financial statements. This statement establishes standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. Under FAS 131, operating segments are to be determined consistent with the way that management organizes and evaluates financial information internally for making operating decisions and assessing performance. The Company has not determined the impact of the adoption of this new accounting standard on its consolidated financial statement disclosures. In October 1997, the American Institute of Certified Public Accountants issued Statement of Position No. 97-2 ("SOP 97-2"), "Software Revenue Recognition," which the Company is required to adopt for agreements entered into with customers beginning in 1998. This statement provides guidance for software revenue recognition matters primarily from a conceptual level and does not include specific implementation guidance. Based on its reading and interpretation of SOP 97-2, the Company believes that the adoption of SOP 97-2 will not have a significant impact on its financial statements; however, detailed implementation guidelines for this standard have not yet been issued. Once issued, such detailed implementation guidelines could lead to unanticipated changes in the Company's current revenue recognition practices, and such changes could be material to the Company's financial statements. F-12 159 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Reclassifications Certain prior year balances have been reclassified to conform to the current year presentation. NOTE 2 -- COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
DECEMBER 31, ------------------- 1996 1997 ------- ------- Accounts receivable, net: Billed............................................. $13,266 $27,812 Unbilled........................................... 9,299 8,368 ------- ------- 22,565 36,180 Less allowance for doubtful accounts................. (709) (3,200) ------- ------- $21,856 $32,980 ======= =======
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.
DECEMBER 31, ------------------- 1996 1997 ------- ------- Property and equipment, net: Computer equipment................................. $ 9,302 $15,611 Furniture and fixtures............................. 2,210 4,632 Leasehold improvements............................. 273 1,012 ------- ------- 11,785 21,255 Less accumulated depreciation and amortization....... (5,446) (9,153) ------- ------- $ 6,339 $12,102 ======= =======
DECEMBER 31, ------------------- 1996 1997 ------- ------- Accrued liabilities: Payroll and related benefits....................... $ 1,645 $ 3,456 Vacation........................................... 860 927 Other.............................................. 1,928 1,550 ------- ------- $ 4,433 $ 5,933 ======= =======
F-13 160 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 3 -- INVESTMENTS At December 31, 1996 and 1997, the amortized cost and estimated fair value of investments available for sale were as follows:
DECEMBER 31, 1996 --------------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- ------- U.S. government and federal agencies........................ $ 18,212 $ -- $ (38) $18,174 Foreign government debt........... 1,006 -- (2) 1,004 U.S. corporate debt............... 4,851 -- (14) 4,837 Foreign corporate debt............ 2,718 -- (5) 2,713 ------- ------- ------- ------- $ 26,787 $ -- $ (59) $26,728 ======= ======= ======= =======
DECEMBER 31, 1997 --------------------------------------------- AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- ------- U.S. government and federal agencies........................ $ 20,682 $ -- $ (1) $20,681 U.S. corporate debt............... 1,894 -- (1) 1,893 Foreign corporate debt............ 2,304 -- -- 2,304 ------- ------- ------- ------- $ 24,880 $ -- $ (2) $24,878 ======= ======= ======= =======
No significant gains or losses were realized during the years ended December 31, 1996 and 1997. The cost of securities sold is determined by the specific identification method. NOTE 4 -- NOTES PAYABLE The Company has a Credit Agreement with a bank which provides for a $15,000 revolving line of credit through July 11, 1999. The agreement requires that the Company maintain certain financial ratios and levels of working capital, tangible net worth and profitability, and also restricts the Company's ability to pay cash dividends and make loans, advances or investments without the bank's consent. At December 31, 1997, the Company had no amounts outstanding under the revolving line of credit. Interest is payable monthly at the bank's prime rate or LIBOR rate plus 1.5%. The applicable interest rate was 7.22% at December 31, 1997. The Risk Data credit facilities were comprised of a revolving line of credit secured by eligible accounts receivable, as well as a bridge loan that was secured by the guarantees of certain stockholders. The revolving line of credit matured on January 5, 1997. The bridge loan matured on September 5, 1996. All outstanding amounts were repaid during 1996, and neither credit facility was renewed. During 1995, the preferred stockholders of Risk Data loaned the Company $1,000 under subordinated note agreements (secured by the assets of Risk Data but subordinated to borrowings under the Risk Data line of credit) bearing interest at 9%. All outstanding amounts were repaid during 1996. F-14 161 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 5 -- LEASES At December 31, 1997, the Company was obligated through 2004 under noncancelable operating leases for its facilities and certain equipment as follows:
NET FUTURE FUTURE MINIMUM LESS SUBLEASE MINIMUM LEASE LEASE PAYMENTS INCOME PAYMENTS -------------- ------------- ------------- 1998............................. $2,984 $ 127 $ 2,857 1999............................. 3,047 -- 3,047 2000............................. 3,043 -- 3,043 2001............................. 2,994 -- 2,994 2002............................. 2,884 -- 2,884 thereafter....................... 1,535 -- 1,535
The lease for the Company's corporate headquarters provides for scheduled rent increases and an option to extend the lease for five years with certain changes to the terms of the lease agreement and a refurbishment allowance. Rent expense under operating leases for the years ended December 31, 1995, 1996 and 1997 was approximately $1,503, $1,623 and $2,687, respectively, net of sublease income of $83, $125 and $477, respectively. Risk Data maintains a lease line of credit with a leasing company for the acquisition of equipment under capital lease arrangements. Future minimum payments are $222 for 1998 and $66 for 1999 with a total of $34 of such amounts representing interest. The gross value of assets under capital leases at December 31, 1996 and 1997 was $1,481 and $714, and accumulated amortization was $599 and $556, respectively. Amortization expense for assets acquired under capital leases is included in depreciation expense. NOTE 6 -- CAPITAL STOCK During June 1995, the Company completed its initial public offering of 5,176 shares of common stock (of which 2,376 shares were sold by the Company and 2,800 shares were sold by certain selling stockholders) at a price to the public of $7.00 per share, which resulted in net proceeds to the Company of $15,461 after the payment of underwriters' commissions but before the deduction of offering expenses. Upon the closing of the Company's initial public offering, all outstanding shares of Series A, B, C, D and E convertible preferred stock were automatically converted into shares of common stock at their then effective conversion prices. Upon conversion, the preferred stockholders were no longer entitled to any undeclared cumulative dividends and all class voting rights terminated. During December 1995, the Company completed a follow-on public offering of 3,000 shares of common stock (of which 1,116 shares were sold by the Company and 1,884 shares were sold by certain selling stockholders) at a price to the public of $18.50 per share, which resulted in net proceeds to the Company of $19,606 after the payment of underwriters' commissions but before the deduction of offering expenses. The Company's Board of Directors is authorized to issue up to 4,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to the rights of the holders of any preferred stock that may be issued in the future. F-15 162 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 7 -- INCOME TAXES Income (loss) before income tax (benefit) provision was taxed under the following jurisdictions:
YEAR ENDED DECEMBER 31, ------------------------------ 1995 1996 1997 ------ ------- ------- Domestic.................................. $5,764 $ 8,599 $23,907 Foreign................................... (198) 2,760 1,012 ------ ------- ------- $5,566 $11,359 $24,919 ====== ======= =======
The income tax (benefit) provision is summarized as follows:
YEAR ENDED DECEMBER 31, ------------------------------ 1995 1996 1997 ------ ------- ------- CURRENT: Federal................................. $ 97 $ 1,132 $ 2,257 State................................... 143 204 537 Foreign................................. -- 51 233 DEFERRED: Federal................................. (521) (1,569) 3,197 State................................... (186) (56) 985 Foreign................................. (44) (296) 145 ------ ------- ----- $ (511) $ (534) $ 7,354 ====== ======= =====
Deferred tax assets are summarized as follows:
YEAR ENDED DECEMBER 31, ------------------- 1996 1997 ------- ------- Taxable pooling basis difference..................... $18,397 $16,955 Net operating loss carryforwards..................... 8,587 7,404 Tax credit carryforwards............................. 1,878 2,059 Other................................................ 487 214 ------- ------- Gross deferred tax assets............................ 29,349 26,632 Deferred tax asset valuation allowance............... -- -- ------- ------- Net deferred tax asset..................... $29,349 $26,632 ======= =======
During 1995, the Company released the valuation allowance related to its deferred tax assets based on management's assessment that it was more likely than not that the Company would realize a portion of those assets in future periods due to improvements in the Company's operating results. During 1996, the Company released the valuation allowances related to Risk Data's and Retek's deferred tax assets based on management's assessment that it was more likely than not that the Company would realize those assets in future periods due to improvements in the operating results of those subsidiaries. During 1995, 1996 and 1997, the Company realized certain tax benefits related to stock option transactions in the amount of $800, $7,889 and $4,192, respectively. The benefit from the stock option tax deduction is credited directly to paid-in capital. F-16 163 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) During 1996, in connection with the acquisition of Retek, the Company made an Internal Revenue Code Section 338 election for federal and state tax purposes, resulting in the treatment of the acquisition as a taxable transaction, whereby the tax bases of the acquired assets and liabilities were adjusted to their fair values as of the date of the acquisition. As the purchase price exceeded the carrying value of the net assets acquired by approximately $46,000, the Company recorded a deferred tax asset in the amount of $18,397. A reconciliation of the income tax (benefit) provision to the amount computed by applying the statutory federal income tax rate to income before income tax provision is summarized as follows:
YEAR ENDED DECEMBER 31, ------------------------------- 1995 1996 1997 ------- ------- ------- Amounts computed at statutory federal rate................................... $ 1,892 $ 3,862 $ 8,472 State income taxes.................. 465 554 1,407 Subchapter S corporation earnings... (1,366) (1,901) (2,888) Change in tax status of S corporation....................... -- -- 869 Tax credit carryforwards generated......................... (68) (334) (284) Release of valuation allowance...... (2,223) (2,717) -- Foreign income taxes................ (44) (296) 27 Losses without tax benefit.......... 794 -- -- Other............................... 39 298 (249) ------- ------- ------- Income tax (benefit) provision........... $ (511) $ (534) $ 7,354 ======= ======= =======
Prior to the acquisition of CompReview by the Company on November 28, 1997, CompReview had elected subchapter S corporation status and the cash basis of accounting for income tax purposes; therefore, its cash basis income was included in the tax returns of its stockholders, and no income tax provision was recorded for CompReview other than certain minimum state taxes on subchapter S corporations. As of the date of CompReview's acquisition, its tax status was changed to C corporation status with the accrual basis of accounting. As a result of this change in tax status, the Company recorded a deferred tax liability in the amount of $869 based on the cumulative income recognition differences as of the date of acquisition between CompReview's former and prospective tax accounting methods. At December 31, 1997, the Company had federal, state and foreign net operating loss carryforwards of approximately $19,992, $7,785 and $352, respectively. The net operating loss carryforwards expire as follows: 2001...................................... $ 6,982 2003...................................... 84 2005...................................... 123 2006...................................... 1,670 2007...................................... 17 2008...................................... 1,692 2009...................................... 1,370 2010...................................... 1,840 2011...................................... 14,086
The Company also has approximately $1,295 of federal research and development credit carryforwards, which expire from 2000 to 2012, $711 of state research and development credit F-17 164 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) carryforwards, which have no expiration date, and $53 of foreign tax credit carryforwards, which expire from 1999 to 2002. Certain of these net operating loss and research and development credit carryforwards generated by Risk Data, Retek and CompReview prior to their acquisitions by HNC are subject to annual limitations on their utilization and also are limited to utilization solely by the company that generated them. Should a substantial change in HNC's ownership occur, as defined by the Tax Reform Act of 1986, there will be an annual limitation on its utilization of net operating loss and research and development credit carryforwards. NOTE 8 -- RECONCILIATION OF NET INCOME AND SHARES USED IN PER SHARE COMPUTATIONS
YEAR ENDED DECEMBER 31, ------------------------------- 1995 1996 1997 ------- ------- ------- NET INCOME USED: Net income used in computing basic net income per common share..... $ 5,729 $11,893 $17,565 Add back accretion of dividends on mandatorily redeemable convertible preferred stock...................................... 348 -- -- ------- ------- ------- Net income used in computing diluted net income per common share... $ 6,077 $11,893 $17,565 ======= ======= ======= SHARES USED: Weighted average common shares outstanding used in computing basic net income per common share...................................... 15,195 23,552 24,275 Weighted average options and warrants to purchase common stock as determined by application of the treasury stock method......... 1,995 1,796 1,383 Incremental shares for assumed conversion of convertible preferred stock................................................ 4,265 -- -- Purchase Plan common stock equivalents........................... 55 15 23 ------- ------- ------- Shares used in computing diluted net income per common share....... 21,510 25,363 25,681 ======= ======= =======
All outstanding shares of the Company's preferred stock automatically converted into shares of common stock upon the closing of the Company's initial public offering on June 26, 1995. Shares used in computing diluted net income per common share for 1995 assume conversion of all outstanding shares of convertible preferred stock were converted at the beginning of that year. NOTE 9 -- EMPLOYEE BENEFIT PLANS During 1987, the Company adopted the 1987 Stock Option Plan and reserved 2,500 shares of the Company's common stock for issuance pursuant to nonqualified and incentive stock options to its officers, directors, key employees and consultants. The plan, as amended, is administered by the Board of Directors or its designees and provides generally that, for incentive stock options and nonqualified stock options, the exercise price must not be less than the fair market value of the shares as determined by the Board of Directors at the date of grant. The options expire no later than ten years from the date of grant and may be exercised in installments based upon stipulated timetables (not in excess of seven years). At December 31, 1997, options to purchase 490 shares were exercisable. During 1995, the Company adopted the 1995 Directors Stock Option Plan (the "Directors Plan"), the 1995 Equity Incentive Plan (the "Incentive Plan") and the 1995 Employee Stock Purchase Plan (the "Purchase Plan"). For purposes of the discussion contained in the three paragraphs below, "fair market value" means the closing price of the Company's common stock on the Nasdaq National Market on the grant date. F-18 165 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The Directors Plan provides for the issuance of up to 300 nonqualified stock options to the Company's outside directors. Under the provisions of the Directors Plan, options to purchase 25 shares of the Company's common stock are granted to outside directors upon their respective dates of becoming members of the Board of Directors and options to purchase ten shares of such stock will be granted on each anniversary of such dates. Options under the Directors Plan are granted at the fair market value of the stock at the grant date and vest at specific times over a four-year period. At December 31, 1997, options to purchase 72 shares were exercisable. The Incentive Plan provides for the issuance of up to 3,550 shares of the Company's common stock in the form of nonqualified or incentive stock options, restricted stock or stock bonuses. In addition, all shares that remained unissued under the 1987 Stock Option Plan on the effective date of the Incentive Plan, and all shares issuable upon exercise of options granted pursuant to the 1987 Stock Option Plan that expire or become unexercisable for any reason without having been exercised in full are available for issuance under the Incentive Plan. 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 term of up to ten years. The Company has the discretion to provide for restrictions and the lapse thereof 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, the Company may, at its discretion, implement a different vesting schedule with respect to any new stock option grant. At December 31, 1997, 316 shares were exercisable. The Purchase Plan provides for the issuance of a maximum of 400 shares of common stock. Each purchase period, eligible employees may designate between 2% and 10% of their cash compensation, subject to certain limitations, to be deducted from their compensation for the purchase of common stock under the Purchase Plan. The purchase price of the shares under the 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. Approximately 60% of eligible employees have participated in the Purchase Plan in the last two years. Risk Data's stock option plan is administered by HNC's Board of Directors. All outstanding Risk Data options were converted into options to purchase HNC common stock and adjusted to give effect to the acquisition exchange ratio in the Risk Data acquisition. No changes were made to the terms of the Risk Data options in connection with the exchange. Options granted under the Risk Data stock option plan generally vest at the rate of 25% of the total grant per year and expire ten years after the date of grant. At December 31, 1997, 30 shares were exercisable under the Risk Data plan. Retek's stock options are administered by HNC's Board of Directors. All outstanding Retek options were converted into options to purchase the Company's common stock and adjusted to give effect to the acquisition exchange ratio in the Retek acquisition. No changes were made to the terms of the Retek options in connection with the exchange. Options granted vest ratably over periods from one to four years and have a term of up to ten years. At December 31, 1997, options to purchase 32 shares were exercisable. The CompReview 1995 Stock Option Plan is administered by HNC's Board of Directors. All outstanding CompReview stock options were converted into options to purchase HNC common stock in the CompReview acquisition and adjusted to give effect to the acquisition exchange ratio. No changes were made to the terms of the CompReview options in connection with the exchange. Options granted under the CompReview Stock Option Plan generally vest ratably over periods from F-19 166 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) two to four years and expire ten years after the date of grant. At December 31, 1997, options to purchase 156 shares were exercisable. Transactions under the Company's stock option and purchase plans during the years ended December 31, 1995, 1996 and 1997, including options under the Risk Data stock option plan, options under the Retek stock option plan and options under the CompReview Stock Option Plan, but excluding options to purchase stock of Aptex, a subsidiary of the Company, are summarized as follows.
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------ 1995 1996 1997 ------------------------ ------------------------ ------------------------ WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE ------ ---------------- ------ ---------------- ------ ---------------- Outstanding at beginning of year.... 2,080 $ 0.49 2,868 $ 2.84 3,215 $15.65 Options granted...... 1,272 6.08 1,645 27.98 2,177 32.61 Options exercised.... (207) 0.52 (1,140) 0.96 (475) 6.16 Options canceled..... (277) 1.80 (158) 17.62 (326) 26.33 ------ ------ Outstanding at end of year................. 2,868 2.84 3,215 15.65 4,591 23.92 ====== ====== Options exercisable at end of year.......... 1,437 841 1,096 Weighted average fair value of options granted during the year................. $ 3.10 $14.50 $19.79
The following table summarizes information about employee stock options outstanding at December 31, 1997:
OPTIONS OUTSTANDING ------------------------------------------- OPTIONS EXERCISABLE WEIGHTED ------------------------- NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED OUTSTANDING AT REMAINING AVERAGE OUTSTANDING AT AVERAGE RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE EXERCISE PRICES 1997 LIFE (IN YEARS) PRICE 1997 PRICE ---------------------- -------------- --------------- -------- -------------- -------- $ 0.02 to $ 3.00...... 1,002 5.90 $ 1.90 702 $ 1.60 4.50 25.38..... 793 8.21 19.22 188 15.69 25.60 30.75...... 791 8.86 29.39 147 30.33 30.81 31.50...... 944 9.57 31.40 1 30.94 31.88 39.00...... 774 9.42 36.03 32 34.24 39.09 49.50...... 287 9.27 41.42 26 42.64 ----- ----- 0.02 49.50..... 4,591 8.37 23.92 1,096 9.82 ===== =====
During 1996, Aptex adopted the 1996 Equity Incentive Plan (the "Aptex Plan") whereby 2,000 shares of Aptex common stock were reserved for issuance pursuant to nonqualified and incentive stock options and restricted stock awards. The plan is administered by the Board of Directors of Aptex or its designees and provides generally that nonqualified stock options and restricted stock may be awarded at a price not less than 85% of the fair market value, as determined by the Board of Directors, 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, or 110% of fair market value for awards to more than 10% stockholders. Options granted under the Incentive Plan may have a term of up to ten years. The Company has the F-20 167 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) discretion to provide for restrictions and the lapse thereof in respect of restricted stock awards, and options typically vest at the rate of 25% of the total grant per year. However, the Company may, at its discretion, implement a different vesting schedule with respect to any new stock option grant. During 1996, Aptex issued 1,000 shares of common stock at fair market value under the Aptex Plan for cash consideration of $0.03 per share. At December 31, 1997, options to purchase 79 shares were exercisable under the Aptex Plan. The Company applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for its stock-based compensation. No compensation expense has been recognized for its employee stock option grants, which are fixed in nature, as the options have been granted at fair market value. No compensation expense has been recognized for the Purchase Plan. Had compensation cost for the Company's stock-based compensation awards issued during 1997 and 1996 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 ("FAS 123"), the Company's net income and basic and diluted pro forma net income per common share would have been reduced to the pro forma amounts indicated below:
YEAR ENDED DECEMBER 31, -------------------------- 1995 1996 1997 ------ ------- ------- Net income: As reported................................. $6,077 $11,893 $17,565 Pro forma................................... 5,126 6,122 2,232 Basic net income per common share: As reported................................. 0.38 0.50 0.72 Pro forma................................... 0.31 0.26 0.09 Diluted net income per common share: As reported................................. 0.28 0.47 0.68 Pro forma................................... 0.24 0.24 0.09
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants during the years ended December 31, 1995, 1996 and 1997, respectively: dividend yield of 0.0% for all three years, risk-free interest rates of 6.29%, 6.03% and 6.10%, expected volatilities of 75%, 70% and 65% (0% for 1995 and 1996 options granted by Risk Data, Retek and CompReview prior to their acquisition by HNC), and expected lives of 3.5, 3.5 and 3.0 years. The fair value of the employees' purchase rights pursuant to the Purchase Plan is estimated using the Black-Scholes model with the following assumptions: dividend yield of 0.0% for all three years, risk-free interest rates of 5.66%, 5.36% and 5.32%, expected volatilities of 75%, 70% and 65%, and an expected life of 6 months for all three years. The weighted average fair value of those purchase rights granted in 1995, 1996 and 1997 was $2.75, $9.61 and $14.10, respectively. The fair value of each option granted under the Aptex Plan is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants during the years ended December 31, 1996 and 1997: dividend yield of 0.0% for both years, risk-free interest rates of 6.42% and 6.33%, expected volatility of 90% for both years, and expected lives of 9.25 and 8.0 years. Options to purchase 704 shares and 214 shares were granted during 1996 and 1997, with weighted average exercise prices per share of $0.03 and $0.08, respectively. During 1997, options to purchase 173 shares with a weighted average exercise price of $0.03 per share were exercised. During 1997, options to purchase 58 shares F-21 168 HNC SOFTWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) with a weighted average exercise price of $0.03 per share were cancelled. The weighted average fair value per share of options granted during 1996 and 1997 was $0.03 and $0.07, respectively. The following table summarizes information about Aptex employee stock options outstanding at December 31, 1997:
OPTIONS OUTSTANDING ------------------------------------------- OPTIONS EXERCISABLE WEIGHTED ------------------------- NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED OUTSTANDING AT REMAINING AVERAGE OUTSTANDING AT AVERAGE RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE EXERCISE PRICES 1997 LIFE (IN YEARS) PRICE 1997 PRICE ------------------- -------------- --------------- -------- -------------- -------- $0.03 to $0.03 497 8.75 $ 0.03 79 $ 0.03 0.05 0.05 39 9.40 0.05 -- -- 0.10 0.10 151 9.82 0.10 -- -- ----- --- 0.03 0.10 687 9.03 0.05 79 0.03 ========== ==========
NOTE 10 -- CONTINGENCIES Various claims arising in the course of business, seeking monetary damages and other relief, are pending. The amount of the liability, if any, from such claims cannot be determined with certainty; however, in the opinion of management, the ultimate liability for such claims will not have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows. NOTE 11 -- SUBSEQUENT EVENTS On January 30, 1998, the Company signed a definitive agreement to acquire Practical Control Systems Technologies, Inc. ("PCS"), a distribution center management software vendor based in Cincinnati, Ohio, subject to the satisfaction of certain closing conditions and the approval of PCS' shareholders. If consummated, the acquisition of PCS will be accounted for under the purchase method and will not be considered a "significant" acquisition pursuant to regulations set forth by the Securities and Exchange Commission. On February 13, 1998, the Company adopted the 1998 Stock Option Plan (the "1998 Plan"), under which 1,000,000 shares of HNC Common Stock were reserved for issuance pursuant to nonqualified stock options. The 1998 Plan is administered by the Board of Directors of HNC or a committee appointed by the Board and provides that nonqualified stock options granted under the plan must be awarded at an exercise price of not less than 100% of the fair market value of the stock at the date of grant. Options granted under the 1998 Plan may have a term of up to ten years. No options have been granted under the 1998 Plan to date. F-22 169 NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS. IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, THE SELLING STOCKHOLDERS OR ANY OF THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, SUCH SECURITIES BY ANYONE IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATES AS OF WHICH INFORMATION IS GIVEN IN THIS PROSPECTUS. TABLE OF CONTENTS
PAGE ---- Available Information.................. 2 Incorporation of Certain Documents by Reference............................ 2 Prospectus Summary..................... 3 Risk Factors........................... 4 Use of Proceeds........................ 14 Price Range of Common Stock............ 14 Dividend Policy........................ 14 Capitalization......................... 15 Selected Consolidated Financial Data... 16 Management's Discussion and Analysis of Financial Condition and Results of Operations........................... 18 Business............................... 28 Management............................. 44 Selling Stockholders................... 46 Description of Capital Stock........... 47 Underwriting........................... 50 Legal Matters.......................... 51 Experts................................ 51 Index to Consolidated Financial Statements........................... F-1
- ------------------------------------------------------------ LOGO 2,100,000 SHARES COMMON STOCK DEUTSCHE MORGAN GRENFELL BANCAMERICA ROBERTSON STEPHENS SALOMON SMITH BARNEY PROSPECTUS , 1998 170 PART II INFORMATION NOT REQUIRED IN THE PROSPECTUS ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the costs and expenses to be paid by the Registrant in connection with the issuance and distribution of the Securities being registered. All amounts are estimates except for the Securities and Exchange Commission registration fee, the NASD filing fee and the Nasdaq National Market filing fee. Securities and Exchange Commission registration fee..... $ 42,917 NASD filing fee......................................... 15,048 Nasdaq National Market filing fee....................... 3,000 Accounting fees and expenses............................ 175,000 Legal fees and expenses................................. 195,000 Trustee fee............................................. 15,000 Rating Agency fee....................................... 50,000 Transfer Agent fee...................................... 5,000 Printing and engraving expenses......................... 200,000 Blue sky fees and expenses.............................. 10,000 Miscellaneous........................................... 89,035 -------- Total......................................... $800,000 ========
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS As permitted by Section 145 of the Delaware General Corporation Law, the Registrant's Certificate of Incorporation includes a provision that eliminates the personal liability of its directors to the Registrant or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law or (iv) for any transaction from which the director derived an improper personal benefit. In addition, as permitted by Section 145 of the Delaware General Corporation Law, the Bylaws of the Registrant provide that: (i) the Registrant is required to indemnify its directors and officers, as well as directors and officers of any other corporation, partnership, joint venture, trust, employee benefit plan or other enterprise when they are serving in such capacities at the request of the Registrant, to the fullest extent permitted by the Delaware General Corporation Law; (ii) the Registrant may, in its discretion, indemnify other officers, employees and agents as set forth in the Delaware General Corporation Law; (iii) upon receipt of an undertaking to repay such advances if indemnification is determined to be unavailable, the Registrant is required to advance expenses, as incurred, to its directors and officers to the fullest extent permitted by the Delaware General Corporation Law in connection with a proceeding (except that the Registrant is not required to advance expenses to a person against whom it brings a claim for breach of the duty of loyalty, failure to act in good faith, intentional misconduct, knowing violation of law or deriving an improper personal benefit); (iv) the rights conferred in the Bylaws are not exclusive and the Registrant is authorized to enter into indemnification agreements with its directors, officers, employees and agents; (v) the Registrant may not retroactively amend the Bylaw provisions in a way that adversely affects the indemnification provided thereunder. The Registrant's policy is to enter into indemnity agreements with each of its directors and officers. The indemnity agreements provide that directors and executive officers will be indemnified and held harmless against all expenses (including attorneys' fees), judgments, fines, ERISA excise taxes or penalties and settlement amounts paid or reasonably incurred by them in any II-1 171 action, suit or proceeding, including any derivative action by or in the right of Registrant, on account of their services as a director or officer of the Registrant or as directors or officers of any other corporation, partnership or enterprise when they are serving in such capacities at the request of the Registrant; except that no indemnity is provided in a derivative action in which such director or officer is finally adjudged by a court to be liable to the Registrant due to willful misconduct in the performance of his or her duty to the Registrant, unless the court determines that such director or officer is entitled to indemnification. The Registrant will not be obligated pursuant to the agreements to indemnify or advance expenses to an indemnified party with respect to proceedings or claims (i) initiated voluntarily by the indemnified party and not by way of defense, except with respect to a proceeding authorized by the Board of Directors and successful proceedings brought to enforce a right to indemnification and/or advancement of expenses under the indemnity agreements; (ii) for any amounts paid in settlement of a proceeding unless the Registrant consents to such settlement; (iii) on account of any suit in which judgment is rendered against the indemnified party for an accounting of profits made from the purchase or sale by the indemnified party of securities of the Registrant pursuant to the provisions of Section 16(b) of the Securities Exchange Act of 1934 and related laws and regulations; (iv) on account of conduct by an indemnified party that is finally adjudged to have been in bad faith or conduct that the indemnified party did not reasonably believe to be in, or not opposed to, the best interests of the Registrant; (v) on account of any criminal action or proceeding arising out of conduct that the indemnified party had reasonable cause to believe was unlawful; or (vi) if a final decision by a court having jurisdiction in the matter shall determine that such indemnification is not lawful. The indemnity agreement requires a director or officer to reimburse the Registrant for expenses advanced only if and to the extent it is ultimately determined that the director or executive officer is not entitled, under Delaware law, the Registrant's Certificate of Incorporation, the Registrant's Bylaws, his or her indemnity agreement or otherwise to be indemnified for such expenses. The indemnity agreement provides that it is not exclusive of any rights a director or executive officer may have under the Certificate of Incorporation, the Bylaws, other agreements, any majority-in-interest vote of the stockholders or vote of disinterested directors, Delaware law, or otherwise. The indemnification provision in the Bylaws, and the indemnity agreements entered into between the Registrant and its directors and executive officers, may be sufficiently broad to permit indemnification of the Registrant's directors and executive officers for liabilities arising under the Securities Act. The indemnity agreements require the Registrant to maintain director and officer liability insurance to the extent readily available. The Registrant currently carries a director and officer insurance policy. II-2 172 ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES The following exhibits are filed herewith or incorporated by reference herein:
EXHIBIT NUMBER EXHIBIT TITLE ---------- ---------------------------------------------------------------------------- 1.01 Form of Underwriting Agreement for the Note offering.* 1.02 Form of Underwriting Agreement for the Common Stock offering.* 2.01 Agreement and Plan of Reorganization dated as of July 19, 1996 by and among the Registrant, HNC Merger Corp. and Risk Data Corporation, as amended. (Incorporated by reference to Exhibit Number 2.01 to Registrant's Current Report on Form 8-K filed on September 12, 1996, as amended (the "Risk Data 8-K").) 2.02 Agreement of Merger dated August 30, 1996 by and between HNC Merger Corp. and Risk Data Corporation. (Incorporated by reference to Exhibit Number 2.02 to the Risk Data 8-K.) 2.03 Exchange Agreement dated as of October 25, 1996 by and among the Registrant, Retek Distribution Corporation and the shareholders of Retek Distribution Corporation. (Incorporated by reference to Exhibit Number 2.01 to Registrant's Current Report on Form 8-K filed on December 12, 1996 (the "Retek 8-K").) 2.04 Form of Option Exchange Agreement between the Registrant and each person who held outstanding options to purchase shares of Retek Distribution Corporation on November 29, 1996. (Incorporated by reference to Exhibit Number 2.02 to the Retek 8-K.) 2.05 Agreement and Plan of Reorganization dated as of July 14, 1997 by and among the Registrant, FW1 Acquisition Corp., CompReview, Inc., Robert L. Kaaren and Mishel E. Munnayer, a.k.a. Michael Munayyer, Trustee of the Michael Munayyer Trust dated August 11, 1995. (Pursuant to Item 601(b)(2) of Regulation S-K, certain schedules have been omitted but will be furnished supplementally to the Commission upon request.) (Incorporated by reference to Exhibit Number 2.01 to Registrant's Current Report on Form 8-K filed on December 15, 1997 (the "CompReview 8-K").) 2.06 Agreement of Merger dated as of November 28, 1997 by and between FW1 Acquisition Corp. and CompReview, Inc. (Incorporated by reference to Exhibit Number 2.02 to the CompReview 8-K.) 3(i).01 Registrant's Restated Certificate of Incorporation filed with the Secretary of State of Delaware on June 13, 1996. (Incorporated by reference to Exhibit Number 3(i).04 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996 (the "Second Quarter 1996 10-Q").) 3(ii).02 Registrant's Bylaws, as amended. (Incorporated by reference to Exhibit Number 3(ii).05 to the Second Quarter 1996 10-Q.) 4.01 Form of Specimen Certificate for Registrant's Common Stock. (Incorporated by reference to Exhibit Number 4.01 to Registrant's Form S-1 Registration Statement, as amended (File No. 33-91932) (the "IPO S-1").) 4.02 Third Amended Registration Rights Agreement dated March 10, 1993, as amended. (Incorporated by reference to Exhibit Number 4.02 to the IPO S-1.) 4.03 Second Waiver and Amendment to Third Amended Registration Rights Agreement. (Incorporated by reference to Exhibit Number 4.03 to Registrant's Form S-1 Registration Statement, as amended (File No. 33-99980). 4.04 Registration Rights Agreement dated as of August 30, 1996 by and among the Company and the former shareholders of Risk Data Corporation. (Incorporated by reference to Exhibit Number 4.01 to the Risk Data 8-K.) 4.05 Registration Rights Agreement dated as of October 25, 1996 by and among registrant and the former shareholders of Retek Distribution Corporation. (Incorporated by reference to Exhibit Number 4.01 to the Retek 8-K.)
II-3 173
EXHIBIT NUMBER EXHIBIT TITLE ---------- ---------------------------------------------------------------------------- 4.06 Amendment No. 1 to the Registration Rights Agreement dated as of February 24, 1997 by and between the Registrant and the former shareholders of Retek Distribution Corporation. (Incorporated by reference to Exhibit Number 4.06 to Registrant's Annual Report on Form 10-K, as amended, for the year ended December 31, 1996.) 4.07 Registration Rights Agreement dated as of November 28, 1997 by and among the Registrant and the former shareholders of CompReview, Inc. (Incorporated by reference to Exhibit Number 4.01 to the CompReview 8-K.) 4.08 Form of Indenture between the Registrant and State Street Bank and Trust Company of California, N.A., as Trustee, including the form of Notes.* 5.01 Opinion of Fenwick & West LLP for the Note offering.* 5.02 Opinion of Fenwick & West LLP for the Common Stock offering.* 12.01 Computation of Ratio of Earnings to Fixed Charges. 23.01 Consent of Price Waterhouse LLP.* 23.02 Consent of Fenwick & West LLP (included in Exhibits 5.01 and 5.02).* 24.01 Power of Attorney (See page II-5 of original filing). 25.01 Statement of Eligibility of Trustee.*
- --------------- * Filed herewith. ITEM 17. UNDERTAKINGS The undersigned Registrant hereby undertakes that, for purposes of determining any liability under the Securities Act of 1933, each filing of the registrant's annual report pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 that is incorporated by reference in the registration statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the provisions described under Item 15 above, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-4 174 SIGNATURES Pursuant to the requirements of the Securities Act, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-3 and has duly caused this Amendment to Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized in the City of San Diego, State of California, on February 25, 1998. HNC SOFTWARE INC. By: /s/ RAYMOND V. THOMAS ------------------------------------ Raymond V. Thomas Vice President, Finance and Administration, Chief Financial Officer and Secretary Pursuant to the requirements of the Securities Act of 1933, this Amendment to Registration Statement has been signed below by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - --------------------------------------------- --------------------------- ------------------ PRINCIPAL EXECUTIVE OFFICER: /s/ ROBERT L. NORTH* President, Chief Executive February 25, 1998 - --------------------------------------------- Officer and a Director Robert L. North PRINCIPAL FINANCIAL AND PRINCIPAL ACCOUNTING OFFICER: /s/ RAYMOND V. THOMAS Vice President, Finance and February 25, 1998 - --------------------------------------------- Administration, Chief Raymond V. Thomas Financial Officer and Secretary ADDITIONAL DIRECTORS: /s/ EDWARD K. CHANDLER* Director February 25, 1998 - --------------------------------------------- Edward K. Chandler /s/ OLIVER D. CURME* Director February 25, 1998 - --------------------------------------------- Oliver D. Curme Director February , 1998 - --------------------------------------------- Thomas F. Farb /s/ CHARLES H. GAYLORD, JR.* Director February 25, 1998 - --------------------------------------------- Charles H. Gaylord, Jr. *By: /s/ RAYMOND V. THOMAS - --------------------------------------------- Raymond V. Thomas Attorney-In-Fact
II-5 175 EXHIBIT INDEX
SEQUENTIALLY EXHIBIT NUMBERED NUMBER EXHIBIT TITLE PAGE -------- --------------------------------------------------------------- ------------ 1.01 Form of Underwriting Agreement for the Note offering.*......... 1.02 Form of Underwriting Agreement for the Common Stock offering.*..................................................... 2.01 Agreement and Plan of Reorganization dated as of July 19, 1996 by and among the Registrant, HNC Merger Corp. and Risk Data Corporation, as amended. (Incorporated by reference to Exhibit Number 2.01 to Registrant's Current Report on Form 8-K filed on September 12, 1996, as amended (the "Risk Data 8-K").)......... 2.02 Agreement of Merger dated August 30, 1996 by and between HNC Merger Corp. and Risk Data Corporation. (Incorporated by reference to Exhibit Number 2.02 to the Risk Data 8-K.)........ 2.03 Exchange Agreement dated as of October 25, 1996 by and among the Registrant, Retek Distribution Corporation and the shareholders of Retek Distribution Corporation. (Incorporated by reference to Exhibit Number 2.01 to Registrant's Current Report on Form 8-K filed on December 12, 1996 (the "Retek 8-K").)........................................................ 2.04 Form of Option Exchange Agreement between the Registrant and each person who held outstanding options to purchase shares of Retek Distribution Corporation on November 29, 1996. (Incorporated by reference to Exhibit Number 2.02 to the Retek 8-K.).......................................................... 2.05 Agreement and Plan of Reorganization dated as of July 14, 1997 by and among the Registrant, FW1 Acquisition Corp., CompReview, Inc., Robert L. Kaaren and Mishel E. Munnayer, a.k.a. Michael Munayyer, Trustee of the Michael Munayyer Trust dated August 11, 1995. (Pursuant to Item 601(b)(2) of Regulation S-K, certain schedules have been omitted but will be furnished supplementally to the Commission upon request.) (Incorporated by reference to Exhibit Number 2.01 to Registrant's Current Report on Form 8-K filed on December 15, 1997 (the "CompReview 8-K").)........................................................ 2.06 Agreement of Merger dated as of November 28, 1997 by and between FW1 Acquisition Corp. and CompReview, Inc. (Incorporated by reference to Exhibit Number 2.02 to the CompReview 8-K.)............................................... 3(i).01 Registrant's Restated Certificate of Incorporation filed with the Secretary of State of Delaware on June 13, 1996. (Incorporated by reference to Exhibit Number 3(i).04 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996 (the "Second Quarter 1996 10-Q").).........
176
SEQUENTIALLY EXHIBIT NUMBERED NUMBER EXHIBIT TITLE PAGE -------- --------------------------------------------------------------- ------------ 3(ii).02 Registrant's Bylaws, as amended. (Incorporated by reference to Exhibit Number 3(ii).05 to the Second Quarter 1996 10-Q.)...... 4.01 Form of Specimen Certificate for Registrant's Common Stock. (Incorporated by reference to Exhibit Number 4.01 to Registrant's Form S-1 Registration Statement, as amended (File No. 33-91932) (the "IPO S-1").)................................ 4.02 Third Amended Registration Rights Agreement dated March 10, 1993, as amended. (Incorporated by reference to Exhibit Number 4.02 to the IPO S-1.).......................................... 4.03 Second Waiver and Amendment to Third Amended Registration Rights Agreement. (Incorporated by reference to Exhibit Number 4.03 to Registrant's Form S-1 Registration Statement, as amended (File No. 33-99980).................................... 4.04 Registration Rights Agreement dated as of August 30, 1996 by and among the Company and the former shareholders of Risk Data Corporation. (Incorporated by reference to Exhibit Number 4.01 to the Risk Data 8-K.)......................................... 4.05 Registration Rights Agreement dated as of October 25, 1996 by and among registrant and the former shareholders of Retek Distribution Corporation. (Incorporated by reference to Exhibit Number 4.01 to the Retek 8-K.)................................. 4.06 Amendment No. 1 to the Registration Rights Agreement dated as of February 24, 1997 by and between the Registrant and the former shareholders of Retek Distribution Corporation. (Incorporated by reference to Exhibit Number 4.06 to Registrant's Annual Report on Form 10-K, as amended, for the year ended December 31, 1996.)................................. 4.07 Registration Rights Agreement dated as of November 28, 1997 by and among the Registrant and the former shareholders of CompReview, Inc. (Incorporated by reference to Exhibit Number 4.01 to the CompReview 8-K.)................................... 4.08 Form of Indenture between the Registrant and State Street Bank and Trust Company of California, N.A., as Trustee, including the form of Notes.*............................................ 5.01 Opinion of Fenwick & West LLP for the Note offering.*.......... 5.02 Opinion of Fenwick & West LLP for the Common Stock offering.*.. 12.01 Computation of Ratio of Earnings to Fixed Charges.............. 23.01 Consent of Price Waterhouse LLP.*.............................. 23.02 Consent of Fenwick & West LLP (included in Exhibits 5.01 and 5.02).*........................................................ 24.01 Power of Attorney (See page II-5 of original filing)........... 25.01 Statement of Eligibility of Trustee.*..........................
- --------------- * Filed herewith. EX-1.01 2 FORM OF UNDERWRITING AGREEMENT - NOTE OFFERING 1 EXHIBIT 1.01 Dated ____________, 1998 HNC SOFTWARE INC. __% CONVERTIBLE SUBORDINATED NOTES DUE 2003 UNDERWRITING AGREEMENT 2 $90,000,000 HNC SOFTWARE INC. ___% Convertible Subordinated Notes due 2003 UNDERWRITING AGREEMENT ___________, 1998 To: DEUTSCHE MORGAN GRENFELL INC. and the other Representatives named in Schedule I hereto of the several Underwriters named in Schedule II hereto c/o Deutsche Morgan Grenfell Inc. 31 West 52nd Street New York, New York 10019 Dear Sirs: HNC Software, Inc., a Delaware corporation (the "Company"), hereby confirms its agreement with the several underwriters named in Schedule II hereto (the "Underwriters"), for whom you have been duly authorized to act as representatives (the one or more firms acting in such capacities, the "Representatives"), as set forth below. If you are the only Underwriters, all references herein to the Representatives shall be deemed to be references to the Underwriters. Section 1. Underwriting. Subject to the terms and conditions contained herein: (a) The Company proposes to issue and sell to the several Underwriters an aggregate of $90,000,000 principal amount of ___% Convertible Subordinated Notes due 2003 (the "Firm Notes"). The Company also proposes to issue and sell to the several Underwriters not more than an aggregate of an additional $10,000,000 principal amount of ___% Convertible Subordinated Notes due 2003 (the "Option Notes"), if requested by the Representatives as provided in Section 2(b) hereof. The Firm Notes and the Option Notes are sometimes collectively referred to herein as the "Notes". The Notes are to be issued under an Indenture dated as of __________, 1998 (the "Indenture") by and between the Company and State Street Bank and Trust Company of California, N.A., as trustee (the "Trustee"), pursuant to which the Notes will be convertible at the option of the holders thereof into the Company's Common Stock, par value $0.001 per share (the "Common Stock"). The Notes and the shares of Common Stock into which the Notes are convertible are herein collectively called the "Securities." 3 (b) Upon your authorization of the release of the Firm Notes, the Underwriters propose to make a public offering (the "Offering") of the Firm Notes upon the terms set forth in the Prospectus (as defined below) as soon after the Registration Statement (as defined below) and this Agreement have become effective as in the Representatives' sole judgment is advisable. As used in this Agreement, the term "Effective Date" shall mean each date that the registration statement and any post-effective amendment or amendments thereto became or become effective; the term "Original Registration Statement" means the registration statement referred to in Section 5(a)(i) below, as amended at the time when it was or is declared effective, including incorporated documents, financial schedules and exhibits thereto, including any Rule 430A Information (as defined below) deemed to be included therein at the Effective Date as provided by Rule 430A and, in the event any post-effective amendment thereto becomes effective prior to the Closing Date (as defined below), also means such registration statement as so amended; the term "Rule 430A Information" means information permitted to be omitted from the Original Registration Statement when it becomes effective pursuant to Rule 430A; the term "Rule 462(b) Registration Statement" means any registration statement filed with the Commission pursuant to Rule 462(b) under the Securities Act of 1933, as amended (the "Securities Act") (including the Registration Statement and any Preliminary Prospectus (as defined below) or Prospectus incorporated therein at the time such Registration Statement becomes effective); the term "Registration Statement" includes both the Original Registration Statement and any Rule 462(b) Registration Statement (but in any case excludes the Statement of Eligibility and Qualification of the Trustee on Form T-1); the term "Basic Prospectus" shall mean the prospectus referred to in Section 5(a)(i) below contained in the Registration Statement at the Effective Date including, in the case of a Rule 430A Offering (as defined below), any Preliminary Prospectus; the term "Preliminary Prospectus" means the preliminary prospectus supplement to the Basic Prospectus used prior to the filing of the Prospectus; the term "Prospectus" means: (i) if the Company relies on Rule 434 under the Securities Act, the Term Sheet (as defined below) relating to the Securities that is first filed pursuant to Rule 424(b) under the Securities Act, together with the Preliminary Prospectus identified therein that such Term Sheet supplements; (ii) the prospectus supplement to the Basic Prospectus first filed with the Commission pursuant to Rule 424(b) under the Securities Act, together with the Basic Prospectus; (iii) if, in the case of a Rule 430A Offering, no prospectus supplement is required to be filed pursuant to Rule 424(b) under the Securities Act, the form of final prospectus supplement to the Basic Prospectus, including the Basic Prospectus, included in the Registration Statement at the Effective Date; or (iv) for purposes of the representations and warranties in Section 5 hereof, if the prospectus is not in existence, the Basic Prospectus and the most recent Preliminary Prospectus, if any. "Rule 415", "Rule 424" and "Rule 430A" refer to such rules or regulations under the Securities Act, and the term "Term Sheet" means any term sheet that satisfies the requirements of Rule 434 under the Securities Act. Any reference herein to the Registration Statement, the Basic Prospectus, any Preliminary Prospectus or the Prospectus shall be deemed to refer to and include the documents incorporated by reference therein pursuant to Item 12 of Form S-3 which were filed under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), on or before the Effective Date of the Registration Statement or the issue date of the Basic Prospectus, any Preliminary Prospectus or the Prospectus, as the case may be; and any reference herein to the terms "amend", "amendment" or "supplement" with respect to the Registration Statement, the Basic Prospectus, any Preliminary Prospectus or the Prospectus shall be deemed to refer to and include the filing of any document under the Exchange Act after the Effective Date of the Registration Statement or the issue date of the Basic Prospectus, any Preliminary Prospectus or the Prospectus, as the case may be, deemed to be -2- 4 incorporated therein by reference. A "Rule 430A Offering" means an offering of securities which is intended to commence promptly after the effective date of a registration statement, with the result that, pursuant to Rules 415 and 430A, all information (other than Rule 430A Information) with respect to the securities so offered must be included in such registration statement at the effective date thereof. A "Rule 415 Offering" means an offering of securities pursuant to Rule 415 which does not commence promptly after the effective date of a registration statement, with the result that only information required pursuant to Rule 415 need be included in such registration statement at the effective date thereof with respect to the securities so offered. Whether the offering of the Notes is a Rule 430A Offering or a Rule 415 Offering shall be set forth in Schedule I hereto. (c) For purposes of this Agreement, all references to the Registration Statement, any Preliminary Prospectus, the Prospectus, the Term Sheet or the Basic Prospectus, or any amendment or supplement to any of the foregoing shall be deemed to include the copy filed with the Commission pursuant to its Electronic Data Gathering, Analysis and Retrieval system ("EDGAR"). Section 2. Purchase and Closing. (a) On the basis of the representations, warranties, agreements and covenants herein contained and subject to the terms and conditions herein set forth, the Company agrees to issue and sell to each of the Underwriters, and each of the Underwriters, severally and not jointly, agrees to purchase from the Company, at the purchase price of ___% of the principal amount thereof, less accrued interest since _________, 1998, if any (the "Purchase Price"), the principal amount of Firm Notes set forth opposite the name of such Underwriter in Schedule II hereto. Firm Notes shall be registered by State Street Bank and Trust Company of California, N.A., in the name of the nominee of the Depository Trust Company ("DTC"), Cede & Co. ("Cede & Co."), and credited to the accounts of such of its participants as the Representatives shall request, upon notice to the Company at least 48 hours prior to the First Closing Date (as defined below), with any transfer taxes payable in connection with the transfer of the Firm Notes to the Underwriters duly paid, against payment by or on behalf of the Underwriters to the account of the Company of the aggregate Purchase Price therefor by wire transfer in immediately available funds. Delivery of and payment for the Firm Notes shall be made at the office of, on the date and at the time specified in Schedule I hereto, or at such other place, time or date as the Representatives and the Company may agree upon. Such time and date of delivery against payment are herein referred to as the "First Closing Date", and the implementation of all the actions described in this Section 2(a) is herein referred to as the "First Closing". (b) For the purpose of covering any over-allotments in connection with the distribution and sale of the Firm Notes as contemplated by the Prospectus, the Company hereby grants to the several Underwriters an option to purchase, severally and not jointly, the Option Notes. The purchase price to be paid for any Option Notes shall be the same as the Purchase Price for the Firm Notes set forth above in paragraph (a) of this Section 2. The option granted hereby may be exercised as to all or any part of the Option Notes from time to time within thirty (30) days after the date of the Prospectus (or, if such 30th day shall be a Saturday or Sunday or a holiday, on the next business day thereafter when the New York Stock Exchange and the Nasdaq Stock Market's National Market (the "Nasdaq National Market") are open for trading). The Underwriters shall not be under any obligation to purchase any of the Option Notes prior to the exercise of such option. The Representatives may from time to time exercise the option granted hereby by giving notice in writing or by telephone (confirmed in writing) to the Company setting forth the aggregate principal amount of Option Notes as to which the several Underwriters are then exercising the option and the date and time for delivery or registry of and payment for such Option Notes. Any such date of delivery or registry shall be determined by the Representatives but shall not be earlier than two business days or later than five business days after such exercise of the option unless otherwise agreed to by the Company and the Representatives and, in any event, shall not be earlier than the First Closing Date. The time and date set forth in such notice, or such other time or date as the Representatives and the Company may agree upon, is herein called an "Option Closing Date" and -3- 5 the implementation of all the actions described in this Section 2(b) is herein referred to as the "Option Closing". As used in this Agreement, the term "Closing Date" means either the First Closing Date or any Option Closing Date, as applicable, and the term "Closing" means either the First Closing or any Option Closing, as applicable. If the option is exercised as to all or any portion of the Option Notes, then the Option Notes shall be delivered or, if such Option Notes are to be held through DTC, such Option Notes shall be registered and credited, on the related Option Closing Date in the same manner, and upon the same terms and conditions, set forth in paragraph (a) of this Section 2, except that reference therein to the Firm Notes and the First Closing Date shall be deemed, for purposes of this paragraph (b), to refer to such Option Notes and Option Closing Date, respectively. Upon exercise of the option as provided herein, the Company shall become obligated to sell to each of the several Underwriters, and, on the basis of the representations, warranties, agreements and covenants herein contained and subject to the terms and conditions herein set forth, each of the Underwriters (severally and not jointly) shall become obligated to purchase from the Company, that number of Option Notes as to which the several Underwriters are then exercising the option, as the number of Firm Notes such Underwriter is obligated to purchase is to the aggregate number of Firm Notes, as adjusted by the Representatives in such manner as they deem advisable to avoid fractional notes. (c) The Company hereby acknowledges that the payment of monies pursuant to Section 2(a) or 2(b) hereof (a "Payment") by or on behalf of the Underwriters of the aggregate Purchase Price for any Notes does not constitute closing of a purchase and sale of the Notes. Only execution and delivery, by facsimile or otherwise, of a receipt for Notes by the Underwriters indicates completion of the closing of a purchase of the Notes. Furthermore, in the event that the Underwriters make a Payment to the Company prior to the completion of the closing of a purchase of Notes, the Company hereby acknowledges that until the Underwriters execute and deliver such receipt for the Notes, the Company will not be entitled to the Payment and shall return the Payment to the Underwriters as soon as practicable (by wire transfer of same-day funds) upon demand. In the event that the closing of a purchase of Notes is not completed and the Payment is not returned by the Company to the Underwriters on the same day the Payment was received by the Company, the Company agrees to pay to the Underwriters in respect of each day the Payment is not returned to any one of them, in same-day funds, interest on the amount of such Payment not returned by such party in an amount representing the Underwriters' cost of financing as reasonably determined by the Representatives. (d) It is understood that any of you, individually and not as one of the Representatives, may (but shall not be obligated to) make Payment on behalf of any Underwriter or Underwriters for any of the Notes to be purchased by such Underwriter or Underwriters. No such Payment shall relieve such Underwriter or Underwriters from any of its or their obligations hereunder. Section 3. Covenants. (a) The Company covenants and agrees with the several Underwriters that: (i) The Company will: (A) use its best efforts to cause the Registration Statement, if not effective at the time of execution of this Agreement, and any amendments thereto, to become effective as promptly as possible. If required, the Company will file the Prospectus or any Term Sheet that constitutes a part thereof and any amendment or supplement thereto with the Commission in the manner and within the time period required by Rule 424(b) under the Securities Act. During any time when a prospectus relating to the Notes is required to be delivered under the Securities Act, the Company (x) will comply with all requirements imposed upon it by the Securities Act and the rules and regulations of the Commission thereunder to the extent necessary to permit -4- 6 the continuance of sales of or dealings in the Notes in accordance with the provisions hereof and of the Prospectus, as then amended or supplemented, and (y) will not, prior to the earlier of the date upon which the over-allotment option is fully exercised or the date thirty (30) days after the date of Prospectus, file with the Commission the Basic Prospectus, Term Sheet or any amendment or supplement to such Basic Prospectus (including the Prospectus or any Preliminary Prospectus), any amendment or supplement to such Term Sheet, any amendment to the Registration Statement (including the amendment referred to in the second sentence of Section 5(a)(i)) or any Rule 462(b) Registration Statement unless the Representatives previously have been advised of, and furnished with a copy within a reasonable period of time prior to, the proposed filing and the Representatives shall have given their consent to such filing which consent shall not be unreasonably withheld. The Company will prepare and file with the Commission, in accordance with the rules and regulations of the Commission, promptly upon request by the Representatives or counsel for the Underwriters, any amendments to the Registration Statement or amendments or supplements to the Prospectus that may be necessary or advisable in connection with the distribution of the Notes by the several Underwriters. The Company will advise the Representatives, promptly after receiving notice thereof, of the time when the Registration Statement or any amendment thereto has been filed or declared effective or the Prospectus or Term Sheet or any amendment or supplement thereto has been filed and will provide evidence satisfactory to the Representatives of each such filing or effectiveness. (B) without charge, provide (x) to the Representatives and to counsel for the Underwriters, an executed and a conformed copy of the Original Registration Statement and each amendment thereto or any Rule 462(b) Registration Statement (in each case including exhibits thereto), (y) to each other Underwriter, a conformed copy of the Original Registration Statement and each amendment thereto or any Rule 462(b) Registration Statement (in each case without exhibits thereto), and (z) so long as a prospectus relating to the Notes is required to be delivered under the Securities Act, as many copies of each Preliminary Prospectus or the Prospectus or any amendment or supplement thereto as the Representatives may reasonably request. Without limiting the application of clause (z) of the preceding sentence, the Company, not later than (I) 9:00 A.M., New York City time, on the business day following the date of determination of the public offering price, if such determination occurred at or prior to 12:00 noon, New York City time, on such date or (II) 6:00 P.M., New York City time, on the business day following the date of determination of the public offering price, if such determination occurred after 12:00 noon, New York City time, on such date, will deliver to the Underwriters, without charge, as many copies of the Prospectus and any amendment or supplement thereto as the Representatives may reasonably request for purposes of confirming orders that are expected to settle on the First Closing Date. The copies of each Original Registration Statement, 462(b) Registration Statement, Preliminary Prospectus, Term Sheet and Prospectus, and any amendments to the foregoing documents, shall be identical to the electronically transmitted copies thereof filed with the Commission pursuant to EDGAR, except to the extent permitted by Regulation S-T. (C) advise the Representatives, promptly after receiving notice or obtaining knowledge thereof, of (w) the issuance by the Commission of any stop order suspending the effectiveness of the Original Registration Statement or any amendment thereto or any Rule 462(b) Registration Statement or any order preventing or suspending the use of any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto, (x) the suspension of the qualification of the Notes for offering or sale in any jurisdiction, (y) the institution, threatening or contemplation of any proceeding for any purpose identified in the preceding clause (w) or (x), or (z) any request made by the Commission for amending the Original Registration Statement or any Rule 462(b) Registration Statement, for amending or supplementing the Prospectus or for additional information. The Company will use its best efforts to prevent the issuance of any such stop order and, if any such stop order is issued, to obtain the withdrawal thereof as promptly as possible. -5- 7 (ii) The Company will endeavor in good faith, in cooperation with the Representatives, to arrange for the qualification of the Notes for offering and sale in each jurisdiction as the Representatives shall reasonably designate including, but not limited to, pursuant to applicable state securities ("Blue Sky") laws of certain states of the United States of America or other U.S. jurisdictions, and the Company shall use its best reasonable efforts to maintain such qualifications in effect for so long as may be necessary in order to complete the placement of the Notes; provided, however, that the Company shall not be obliged to file any general consent to service of process or to qualify as a foreign corporation or as a securities dealer in any jurisdiction or to subject itself to taxation in respect of doing business in any jurisdiction in which it is not otherwise so subject. (iii) If, at any time prior to the final date when a prospectus relating to the Notes required to be delivered under the Securities Act, any event occurs as a result of which the Prospectus, as then amended or supplemented, would include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading, or if for any other reason it shall be necessary at any time to amend the Registration Statement or amend or supplement the Prospectus to comply with the Securities Act or the rules or regulations of the Commission thereunder or applicable law, the Company will promptly notify the Representatives thereof and will promptly, at its own expense: (x) prepare and file with the Commission an amendment to the Registration Statement or amendment or supplement to the Prospectus which will correct such statement or omission or effect such compliance; and (y) supply any amended Registration Statement or amended or supplemented Prospectus to the Underwriters in such quantities as the Underwriters may reasonably request. (iv) The Company will make generally available to the Company's security holders and to the Representatives as soon as practicable an earnings statement that satisfies the provisions of Section 11(a) of the Securities Act, including Rule 158 thereunder. (v) The Company will not, and will not allow any majority-owned subsidiary (each a "Subsidiary" and collectively, the "Subsidiaries") to publicly announce any intention to, and will not itself, and will not allow any Subsidiary to, without the prior written consent of Deutsche Morgan Grenfell Inc., on behalf of the Underwriters, (i) offer, pledge, sell, offer to sell, contract to sell, sell any option or contract to purchase, purchase any option to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into, or exercisable or exchangeable for, Common Stock, or (ii) enter into any swap or other agreement that transfers, in whole or in part, any of the economic consequences of ownership of the shares of Common Stock or securities convertible into, or exercisable or exchangeable for, shares of Common Stock (whether any such transaction described in clause (i) or (ii) above is to be settled by delivery of shares of Common Stock or such other securities, in cash or otherwise), for a period beginning from the date hereof and continuing to and including the date which is the number of days after the date hereof specified in Schedule I hereto, except (v) shares of Common Stock issuable upon conversion of the Notes, (w) shares of Common Stock issued by the Company pursuant to the Underwriting Agreement referenced in the last sentence of Section 7, (x) shares of Common Stock (or any securities exercisable for, convertible into or exchangeable for shares of Common Stock) issued or issuable pursuant to any employee benefit plans, qualified and non qualified stock option plans or other employee compensation plans which are disclosed in the Prospectus, (y) shares of Common Stock that may be issued to shareholders of Practical Control Systems Technologies, Inc. or Financial Technologies, Inc. and (z) shares of Common Stock (or any securities convertible into or exchangeable for shares of Common Stock) issued by the Company in connection with any other acquisition, joint venture, strategic partnership or similar strategic arrangement, provided that the recipient of such shares or convertible securities, at or prior to such issuance, -6- 8 agrees to be bound by the transfer restrictions described above with respect to such shares of Common Stock or convertible securities. (vi) Neither the Company nor any of its affiliates, nor any person acting on behalf of any of them will, directly or indirectly, (i) take any action designed to cause or to result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Notes or (ii) (x) sell, bid for, purchase, or pay anyone any compensation for soliciting purchases of, the Notes or (y) pay or agree to pay to any person any compensation for soliciting another to purchase any other securities of the Company. (vii) The Company shall obtain the agreements described in Section 7(f) hereof prior to the First Closing Date. (viii) If at any time during the period prior to the First Closing Date, any rumor, publication or event relating to or affecting the Company shall occur as a result of which in the Representatives' reasonable judgment the market price of the Notes has been or is likely to be materially affected (regardless of whether such rumor, publication or event necessitates a supplement to or amendment of the Prospectus), the Company will, after notice from the Representatives advising the Company to the effect set forth above, forthwith prepare, consult with the Representatives concerning the substance of, and disseminate a press release responding to or commenting on such rumor, publication or event or other public statement, that is reasonably satisfactory to the Representatives. (ix) If the Company elects to rely on Rule 462(b), the Company shall both file the Rule 462(b) Registration Statement with the Commission in compliance with Rule 462(b) and pay the applicable fees in accordance with Rule 111 promulgated under the Securities Act by the earlier of (i) 10:00 p.m. New York City time on the date of this Agreement and (ii) the time confirmations are sent or given, as specified by Rule 462(b)(2) under the Securities Act. (x) The Company will use all reasonable efforts to ensure that the Common Stock remains included for quotation on the Nasdaq National Market, or is included for quotation on the New York Stock Exchange or the American Stock Exchange, for a period of five years following the First Closing Date (and that the shares of Common Stock issuable upon conversion of the Notes are so included). Section 4. Expenses. (a) The Company shall bear and pay all costs and expenses incurred incident to the performance of its obligations under this Agreement, whether or not the transactions contemplated herein are consummated or this Agreement is terminated pursuant to Section 9 hereof, including: (i) the fees and expenses of its counsel, accountants and any other experts or advisors retained by the Company; (ii) fees and expenses incurred in connection with the registration of the Securities under the Securities Act and the preparation and filing of the Registration Statement, the Prospectus and all amendments and supplements thereto; (iii) the printing and distribution of the Prospectus and any Preliminary Prospectus and the printing and production of all other documents connected with the Offering (including this Agreement and any other related agreements); (iv) expenses related to the qualification of the Securities under the state securities or Blue Sky laws, including filing fees and the fees and disbursements of counsel for the Underwriters in connection therewith and in connection with the preparation of any Blue Sky memoranda; (v) the filing fees and expenses, if any, incurred with respect to any filing with the National Association of Securities Dealers, Inc. (the "NASD"), including the -7- 9 fees and disbursements of counsel for the Underwriters in connection therewith; (vi) all arrangements relating to the preparation, issuance and delivery of the Securities, including the costs and charges of the Trustee and any transfer agent, conversion agent, registrar or depository with respect to the Securities; and (vii) the costs and expenses of travel, lodging and meals of the Company's employees in connection with associated with the "roadshow" and any other meetings with prospective investors in the Securities (other than as shall have been specifically approved by the Representatives to be paid for by the Underwriters). Subject to the provisions of Section 10, the Underwriters agree to pay, whether or not the transactions contemplated hereby are consummated or this Agreement is terminated, all costs and expenses incident to the performance of obligations under this Agreement not payable by the Company pursuant to the preceding sentence, including, without limitation, all costs associated with the "roadshow" (other than as set forth in clause (viii) above) and the fees and disbursements of counsel to the Underwriters. Section 5. Representations And Warranties. (a) As a condition of the obligation of the Underwriters to underwrite and pay for the Notes, the Company represents and warrants to, and agrees with, each of the several Underwriters as follows: REGISTRATION STATEMENT AND PROSPECTUS (i) If the Offering is a Rule 415 Offering (as specified in Schedule I hereto), paragraph (x) below is applicable and, if the Offering is a Rule 430A Offering (as so specified), paragraph (y) below is applicable. (x) The Company meets the requirements for use of Form S-3 under the Securities Act and has filed with the Commission the Original Registration Statement (the file number of which is set forth in Schedule I hereto) on such Form, including a Basic Prospectus, for registration under the Act of the offering and sale of the Notes one or more amendments to such Registration Statement may have been so filed, and the Company may have used a Preliminary Prospectus. Such Registration Statement, as so amended, has become effective. The Offering is a Rule 415 Offering and, although the Basic Prospectus may not include all the information with respect to the Notes, and the offering thereof required by the Securities Act and the rules thereunder to be included in the Prospectus, the Basic Prospectus includes all such information required by the Securities Act and the rules thereunder to be included therein as of the Effective Date. After the execution of this Agreement, the Company will file with the Commission pursuant to Rules 415 and 424(b)(2) or (5) a final supplement to the form of prospectus included in such Registration Statement relating to the Notes and the offering thereof, with such information as is required or permitted by the Securities Act and as has been provided to and approved by the Representatives prior to the date hereof or, to the extent not completed at the date hereof, containing only such specific additional information and other changes (beyond that contained in the Basic Prospectus and any Preliminary Prospectus) as the Company has advised you, prior to the date hereof, will be included or made therein. The Company may also file a Rule 462(b) Registration Statement with the Commission for the purpose of registering certain additional Notes, which registration shall be effective upon filing with the Commission. (y) The Company meets the requirements for the use of Form S-3 under the Securities Act and has filed with the Commission the Original Registration Statement (the file number of which is set forth in Schedule I hereto) on such Form, including a Basic Prospectus, for registration under the Securities Act of the offering and sale of the Notes, and one or more amendments to such Registration Statement, including a Preliminary Prospectus, may have been so filed. After the execution of this Agreement, -8- 10 the Company will file with the Commission either (I) if such Registration Statement, as it may have been amended, has been declared by the Commission to be effective under the Securities Act, either (A) if the Company relies on Rule 434 under the Securities Act, a Term Sheet relating to the Notes that shall identify the Preliminary Prospectus that it supplements containing such information as is required or permitted by Rules 434, 430A and 424(b) under the Securities Act or (B) if the Company does not rely on Rule 434 under the Securities Act, a prospectus in the form most recently included in an amendment to such Registration Statement (or, if no such amendment shall have been filed, in such Registration Statement), with such changes or insertions as are required by Rule 430A under the Securities Act or permitted by Rule 424(b) under the Securities Act, and in the case of either clause (A) or (B) of this sentence, as have been provided to and approved by the Representatives prior to the execution of this Agreement, or (II) if such Registration Statement, as it may have been amended, has not been declared by the Commission to be effective under the Securities Act, an amendment to such Registration Statement, including the form of final prospectus supplement to the Basic Prospectus, a copy of which amendment has been furnished to and approved by the Representatives prior to the execution of this Agreement or, to the extent not completed at the date hereof, containing only such specific additional information and other changes (beyond that contained in the Basic Prospectus and any Preliminary Prospectus) as the Company has advised you, prior to the date hereof, will be included or made therein. The Company may also file a Rule 462(b) Registration Statement with the Commission for the purpose of registering certain additional Notes, which registration shall be effective upon filing with the Commission. (ii) The Commission has not issued any order preventing or suspending the use of any Preliminary Prospectus. When any Preliminary Prospectus was filed with the Commission, it (x) contained all statements required to be stated therein in accordance with, and complied in all material respects with the requirements of, the Securities Act and the rules and regulations of the Commission thereunder and (y) did not include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. When the Registration Statement or any amendment thereto was or is declared effective, it (I) contained or will contain all statements required to be stated therein in accordance with, and complied or will comply in all material respects with the requirements of, the Securities Act and the rules and regulations of the Commission thereunder and (II) did not or will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein in the light of the circumstances under which they were made not misleading. When the Prospectus or any Term Sheet or any amendment or supplement to the Prospectus is filed with the Commission pursuant to Rule 424(b) (or, if the Prospectus or such amendment or supplement is not required to be so filed, when the Registration Statement or the amendment thereto containing the Prospectus or such amendment or supplement to the Prospectus was or is declared effective) and on the Closing Date, the Prospectus, as amended or supplemented at any such time, (A) contained or will contain all statements required to be stated therein in accordance with, and complied or will comply in all material respects with the requirements of, the Securities Act and the rules and regulations of the Commission thereunder and (B) did not or will not include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. The foregoing provisions of this paragraph (ii) do not apply to statements or omissions made in any Preliminary Prospectus, the Registration Statement or any amendment thereto or the Prospectus or any amendment or supplement thereto in reliance upon and in conformity with written information furnished to the Company by any Underwriter through the Representatives specifically for use therein. (iii) If the Company has elected to rely on Rule 462(b) and the Rule 462(b) Registration Statement is not effective, (x) the Company will file a Rule 462(b) Registration Statement in compliance with, -9- 11 and that is effective upon filing pursuant to, Rule 462(b) and (y) the Company has given irrevocable instructions for transmission of the applicable filing fee in connection with the filing of the Rule 462(b) Registration Statement, in compliance with Rule 111 under the Securities Act, or the Commission has received payment of such filing fee. (iv) The Company has not distributed and, prior to the later of (x) any Closing Date and (y) the completion of the distribution of the Notes, will not distribute any offering material in connection with the Offering other than the Registration Statement or any amendment thereto, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto. (v) Subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus (x) the Company and its Subsidiaries, taken as a whole, have not incurred any material liability or obligation, direct or contingent, nor entered into any material transaction not in the ordinary course of business; (y) the Company has not purchased any of its outstanding capital stock, nor declared, paid or otherwise made any dividend or distribution of any kind on its capital stock; and (z) there has not been any material change in the capital stock, short-term or long-term debt of the Company and its Subsidiaries, taken as a whole, except in each case as described in or contemplated by the Prospectus. THE COMMON STOCK (vi) The Company has an authorized, issued and outstanding capitalization as set forth in the Prospectus as of the date set forth therein. All of the issued shares of capital stock of the Company, have been duly authorized and validly issued and are fully paid and nonassessable, have been issued in compliance with all applicable federal and state securities laws and were not issued in violation of or subject to any preemptive rights or other rights to subscribe for or purchase such securities. No holders of outstanding shares of capital stock of the Company are entitled as such to any preemptive or other rights to subscribe for any of the capital stock, and no holder of securities of the Company has any right which has not been fully exercised or waived to require the Company to register the offer or sale of any securities owned by such holder under the Securities Act in the Offering contemplated by this Agreement. The shares of Common Stock issuable upon conversion of the Notes have been duly authorized and reserved for issuance upon conversion of the Notes and, when issued and delivered by the Company upon such conversion, will be duly and validly issued and fully paid and nonassessable, and no preemptive or other rights to subscribe for any of such shares of Common Stock exist with respect thereto. The issuance of the shares of Common Stock issuable upon conversion of the Notes will be exempt from the registration requirements under the Securities Act pursuant to Section 3(a)(9) of the Securities Act. (vii) Except as disclosed in the Prospectus and except for options granted pursuant to qualified option plans and disclosed to the Representatives, there are no outstanding (x) securities or obligations of the Company or any of its Subsidiaries convertible into or exchangeable for any capital stock of the Company or any such Subsidiary, (y) warrants, rights or options to subscribe for or purchase from the Company or any such Subsidiary any such capital stock or any such convertible or exchangeable securities or obligations, or (z) obligations of the Company or any such Subsidiary to issue any shares of capital stock, any such convertible or exchangeable securities or obligations, or any such warrants, rights or options. (viii) Except for the shares of capital stock of each of the Subsidiaries owned by the Company and such Subsidiaries, neither the Company nor any such Subsidiary owns any shares of stock or any other equity securities of any corporation or has any equity interest in any firm, partnership, association or other entity, except as described in or contemplated by the Prospectus. -10- 12 LISTING (ix) The Common Stock is listed for quotation on the Nasdaq National Market, and the Company has taken no action designed to, or likely to, have the effect of, delisting the Common Stock for quotation on the Nasdaq National Market. MARKET MANIPULATION (x) Neither the Company nor any of its affiliates, nor any person acting on behalf of any of them has, directly or indirectly, (A) taken any action designed to cause or to result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Notes, or (B) since the filing of the Original Registration Statement (I) sold, bid for, purchased, or paid anyone any compensation for soliciting purchases of, the Notes or (II) paid or agreed to pay to any person any compensation for soliciting another to purchase any other securities of the Company. CORPORATE POWER AND AUTHORITY; THE INDENTURE AND NOTES (xi) The Company has been duly incorporated and is validly existing as a corporation in good standing under the law of its jurisdiction of incorporation with full power and authority to own, lease and operate its properties and assets and conduct its business as described in the Prospectus, is duly qualified to transact business and is in good standing in each jurisdiction in which its ownership, leasing or operation of its properties or assets or the conduct of its business requires such qualification, except where the failure to be so qualified does not amount to a material liability or disability to the Company and its Subsidiaries, taken as a whole, and has full power and authority to execute and perform its obligations under this Agreement; each Subsidiary of the Company is a corporation duly incorporated and validly existing as a corporation in good standing under the laws of its jurisdiction of incorporation and is duly qualified to transact business and is in good standing in each jurisdiction in which its ownership, leasing or operation of its properties or assets or the conduct of its business requires such qualification, except where the failure to be so qualified does not amount to a material liability or disability to the Company and its Subsidiaries, taken as a whole, and each has full power and authority to own, lease and operate its properties and assets and conduct its business as described in the Registration Statement and the Prospectus; none of the Company's subsidiaries is a "significant subsidiary" as defined in Section 1-02(w) of Regulation S-X; all of the issued and outstanding shares of capital stock (other than statutory nominal stockholdings) of each of the Company's Subsidiaries have been duly authorized and are fully paid and nonassessable and except as otherwise set forth in the Prospectus (and except Aptex Software Inc., which is __% owned by the Company), are owned beneficially by the Company or one of its Subsidiaries free and clear of any security interests, liens, encumbrances, equities or claims. (xii) The execution and delivery of this Agreement and the Indenture and the issuance and sale of the Notes and the Common Stock issuable upon conversion of the Notes have been duly authorized by all necessary corporate action of the Company, and this Agreement, the Indenture and the Notes have been duly executed and delivered by the Company). This Agreement is the valid and binding agreement of the Company, enforceable against the Company in accordance with its terms, except (x) as the enforceability thereof may be limited by bankruptcy, insolvency, federal or state fraudulent conveyance or transfer laws, and reorganization, moratorium or other similar laws affecting the enforcement of creditors' rights generally and by general equitable principles and (y) except to the extent that rights to indemnity or contribution under this Agreement may be limited by federal and state securities laws or the public policy underlying such laws. -11- 13 The Indenture, when executed and delivered by the Company in accordance with its terms (assuming due authorization, execution and delivery thereof by the Trustee) will be the valid and binding agreement of the Company, enforceable against the Company in accordance with its terms, except to the extent the Indenture is subject to, or effected by, applicable bankruptcy, insolvency, federal or state fraudulent conveyance or transfer laws, reorganization, moratorium or similar laws. The Notes conform in all material respect to the descriptions thereof in the Prospectus. When the Notes are issued, executed and authenticated in accordance with the Indenture and paid for in accordance with the terms of this Agreement, the Notes will be the valid and binding obligations of the Company, enforceable against the Company in accordance with their terms, except to the extent the Notes are subject to, or effected by, applicable bankruptcy, insolvency, federal or state fraudulent conveyance or transfer laws, reorganization moratorium or similar laws. (xiii) The execution and delivery by the Company of, and compliance by the Company with the provisions of, and performance of its obligations under this Agreement, the Indenture and the Notes and the consummation of the other transactions herein and therein contemplated do not (x) require the consent, approval, authorization, registration or qualification of or with any governmental authority, except (I) if the Company has elected to rely on Rule 462(b) and the Rule 462(b) Registration Statement is not effective, the registration of certain Shares pursuant to the Rule 462(b) Registration Statement that will be effective upon filing in compliance with Rule 462 (b) and (II) such as have been obtained or made or such as may be required by the state securities or Blue Sky laws of the various states of the United States of America or other U.S. jurisdictions in connection with the offer and sale of the Notes by the Underwriters, or (y) conflict with or result in a breach or violation of any of the terms and provisions of, or constitute a default under, (I) any indenture, mortgage, deed of trust, lease or other agreement or instrument to which the Company or any of its Subsidiaries is a party or by which the Company or any of its Subsidiaries or any of their respective properties are bound, except as would not individually or in the aggregate have a materially adverse effect on or constitute a materially adverse change in the condition (financial or otherwise), earnings, properties, business affairs or business prospects, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, or the ability of the Company to perform its obligations under this Agreement or the Indenture, or (II) the charter documents or by-laws of the Company or any of its Subsidiaries, or (III) any statute or any judgment, decree, order, rule or regulation of any court or other governmental authority or any arbitrator applicable to the Company or any of its Subsidiaries. (xiv) The Company is not, and will conduct its operations in a manner so that it continues not to be, an "investment company" and, after giving effect to the Offering and the application of the proceeds therefrom, will not be an "investment company", as such term is defined in the Investment Company Act of 1940, as amended (the "1940 Act"). TITLE, LICENSES AND CONSENTS (xv) The Company and each of its Subsidiaries have good and marketable title in fee simple to all items of real property and marketable title to all personal property owned by each of them, in each case free and clear of any security interests, liens, encumbrances, equities, claims and other defects, except such as do not materially and adversely affect the use of such property and do not interfere with the use made or proposed to be made of such property by the Company or such Subsidiary, and any real property and buildings held under lease by the Company or any such Subsidiary are held under valid, subsisting and enforceable leases, with such exceptions as are not material and do not interfere with the use made or proposed to be made of such property and buildings by the Company or such Subsidiary, in each case except as described in or contemplated by the Prospectus. -12- 14 (xvi) Except as disclosed in the Prospectus, the Company and each of its Subsidiaries have the right to use or can acquire on reasonable terms all trademarks, trade names, trade secrets, service marks, inventions, patent rights, mask works, copyrights, licenses, software code, audiovisual works, formats, algorithms and underlying data, approvals and governmental authorizations now used in, or which are necessary for fulfillment of their respective obligations or the conduct of, their respective businesses as now conducted or proposed to be conducted as described in the Prospectus; except as discussed in the Prospectus, the expiration of any trademarks, trade names, trade secrets, service marks, inventions, patent rights, mask works, copyrights or licenses would not have a material adverse effect on the condition (financial or otherwise), earnings, properties, business affairs or business prospects, stockholders' equity, net worth or results of operations of the Company; and neither the Company nor any of its Subsidiaries is infringing any trademark, trade name rights, patent rights relating to patents that have issued, mask works, copyrights, licenses, trade secret, service marks or other similar rights of others, and there is no claim being made against the Company or any of its Subsidiaries regarding trademark, trade name, patent, mask work, copyright, license, trade secret or other infringement or assertion of intellectual property rights which could have a material adverse effect on the earnings, properties, business affairs or business prospects, stockholders' equity, net worth or results of operations of the Company. The Company has agreements in place with such employees, consultants or other persons or parties engaged by the Company or any Subsidiary sufficient to enable the Company and any subsidiary to fulfill their contractual obligations and to conduct their respective businesses as now conducted as described in the Prospectus and providing for the assignment to the Company of all intellectual property rights in the work performed and the protection of the trade secrets and confidential information of the Company, each of its Subsidiaries and of third parties. (xvii) The Company and its Subsidiaries possess all consents, licenses, certificates, authorizations and permits issued by the appropriate federal, state or foreign regulatory authorities necessary to conduct their respective businesses, and neither the Company nor any such Subsidiary has received any notice of proceedings relating to the revocation or modification of any such certificate, authorization or permit which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, would have a materially adverse effect on or constitute a materially adverse change in, or constitute a development involving a prospective materially adverse effect on or change in, the condition (financial or otherwise), earnings, properties, business affairs or business prospects, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, except as described in or contemplated by the Prospectus. FINANCIAL STATEMENTS (xviii) Price Waterhouse LLP, who have certified certain financial statements of the Company and its consolidated Subsidiaries and delivered their report with respect to the audited consolidated financial statements and schedules included or incorporated by reference in the Registration Statement and the Prospectus, are independent public accountants as required by the Securities Act and the applicable rules and regulations thereunder. (xix) The consolidated financial statements and schedules of the Company and its consolidated Subsidiaries included or incorporated in the Registration Statement and the Prospectus were prepared in accordance with generally accepted accounting principles ("GAAP") consistently applied throughout the periods involved (except as otherwise noted therein) and they present fairly the consolidated financial condition of the Company as at the dates at which they were prepared and the consolidated results of operations of the Company in respect of the periods for which they were prepared. -13- 15 INTERNAL ACCOUNTING CONTROLS (xx) The Company and each of its Subsidiaries maintain a system of internal accounting controls sufficient to provide reasonable assurance that (w) transactions are executed in accordance with management's general or specific authorizations; (x) transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP and to maintain asset accountability; (y) access to assets is permitted only in accordance with management's general or specific authorization; and (z) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. LITIGATION (xxi) No legal or governmental proceedings are pending or to the Company's knowledge threatened to which the Company or any of its Subsidiaries is a party or to which the property of the Company or any of its Subsidiaries is subject that are required to be described in the Registration Statement or the Prospectus and are not described therein; and no statutes, regulations, contracts or other documents that are required to be described or incorporated in the Registration Statement or the Prospectus or to be filed as exhibits to the Registration Statement are not described or incorporated therein or filed as required. DIVIDENDS AND DISTRIBUTIONS (xxii) Except as disclosed in the Prospectus under the caption "Dividend Policy" or restricted by applicable law, no Subsidiary of the Company is currently prohibited, directly or indirectly, from paying any dividends to the Company, making any other distribution on such Subsidiary's capital stock, repaying to the Company any loans or advances to such Subsidiary from the Company or transferring any of such Subsidiary's property or assets to the Company or any other Subsidiary of the Company, and the Company is not currently prohibited, directly or indirectly, from paying any dividends or making any other distribution on its capital stock, in each case except as described in or contemplated by the Prospectus or prohibited by applicable law. TAXES (xxiii) The Company has filed all foreign, federal, state and local tax returns that are required to be filed or has requested extensions thereof (except in any case in which the failure so to file would not have a materially adverse effect on the Company and its Subsidiaries, taken as a whole) and has paid all taxes required to be paid by it and any other assessment, fine or penalty levied against it, to the extent that any of the foregoing is due and payable, except for any such assessment, fine or penalty that is currently being contested in good faith or as described in or contemplated by the Prospectus. INSURANCE (xxiv) The Company and each of its Subsidiaries are insured by insurers of recognized financial responsibility against such losses and risks and in such amounts as are prudent and customary in the businesses in which they are engaged; neither the Company nor any such Subsidiary has been refused any insurance coverage sought or applied for; and neither the Company nor any such Subsidiary has any reason to believe that it will not be able to renew its existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business at a cost that would not materially and adversely affect the condition (financial or otherwise), earnings, properties, business affairs -14- 16 or business prospects, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, except as described in or contemplated by the Prospectus. PENSION AND LABOR (xxv) The Company is in compliance in all material respects with all presently applicable provisions of the Employee Retirement Income Security Act of 1974, as amended, including the regulations and published interpretations thereunder ("ERISA"); no "reportable event" (as defined in ERISA) has occurred with respect to any "pension plan" (as defined in ERISA) for which the Company would have any liability; the Company has not incurred and does not expect to incur liability under (x) Title IV of ERISA with respect to termination of, or withdrawal from, any "pension plan" or (y) Sections 412 or 4971 of the Internal Revenue Code of 1986, as amended, including the regulations and published interpretations thereunder (the "Code"); and each "pension plan" for which the Company would have any liability that is intended to be qualified under Section 401(a) of the Code is so qualified in all material respects and nothing has occurred, whether by action or by failure to act, which would cause the loss of such qualification. (xxvi) No labor dispute with the employees of the Company or any of its Subsidiaries exists or is threatened or imminent that could have a materially adverse effect on or constitute a materially adverse change in, or constitute a development involving a prospective materially adverse effect on or change in, the condition (financial or otherwise), properties, management, earnings, business affairs or business prospects, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, except as described in or contemplated by the Prospectus. ENVIRONMENTAL (xxvii) Neither the Company nor any of its Subsidiaries is in violation of any federal or state law or regulation relating to occupational safety and health or to the storage, handling or transportation of hazardous or toxic materials and the Company and its Subsidiaries have received all permits, licenses or other approvals required of them under applicable federal and state occupational safety and health and environmental laws and regulations to conduct their respective businesses, and the Company and each such Subsidiary is in compliance with all terms and conditions of any such permit, license or approval, except any such violation of law or regulation, failure to receive required permits, licenses or other approvals or failure to comply with the terms and conditions of such permits, licenses or approvals which would not, singly or in the aggregate, have a materially adverse effect on or constitute a materially adverse change in, or constitute a development involving a prospective materially adverse effect on or change in, the condition (financial or otherwise), earnings, properties, business affairs or business prospects, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, except as described in or contemplated by the Prospectus. OTHER AGREEMENTS (xxviii) No default by the Company or any of its Subsidiaries exists, and no event has occurred which, with notice or lapse of time or both, would constitute a default in the due performance and observance of any term, covenant or condition of any indenture, mortgage, deed of trust, lease or other agreement or instrument to which the Company or any of its Subsidiaries is a party or by which the Company or any of its Subsidiaries or any of their respective properties is bound, where such default could have a material adverse effect on the condition (financial or otherwise), properties, management, earnings, business affairs or business prospects, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, or the ability of the Company to perform its obligations under this Agreement or the Indenture. -15- 17 ABSENCE OF MATERIALLY ADVERSE CHANGE (xxix) Subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, neither the Company nor any of its Subsidiaries has sustained any material loss or interference with their respective businesses or properties from fire, flood, hurricane, accident or other calamity, whether or not covered by insurance, or from any labor dispute or any legal or governmental proceeding, and there has been no materially adverse change (including, without limitation, a change in management or control), or development involving a prospective materially adverse change, in the condition (financial or otherwise), management, earnings, property, business affairs or business prospects, stockholders' equity, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, other than as described in or contemplated by the Prospectus (exclusive of any amendments or supplements thereto). (xxx) No receiver or liquidator (or similar person) has been appointed in respect of the Company or any Subsidiary of the Company or in respect of any part of the assets of the Company or any Subsidiary of the Company; no resolution, order of any court, regulatory body, governmental body or otherwise, or petition or application for an order, has been passed, made or to the Company's knowledge presented for the winding up of the Company or any Subsidiary of the Company or for the protection of the Company or any such Subsidiary from its creditors; and the Company has not, and no Subsidiary of the Company has, stopped or suspended payments of its debts, become unable to pay its debts or otherwise become insolvent. (b) The above representations and warranties with respect to the Company shall be deemed to be repeated at each Closing and all references therein to the Notes and the Closing Date shall be deemed to refer to the Firm Notes or the Option Notes and the First Closing Date or the applicable Option Closing Date, each as applicable. Section 6. Indemnity. (a) The Company agrees to indemnify and hold harmless each Underwriter and each person, if any, who controls any Underwriter within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act, against any and all losses, claims, damages or liabilities, joint or several, to which such Underwriter or such controlling person may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon: (i) any untrue statement or alleged untrue statement made by the Company in Section 5 hereof, (ii) any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement or any amendment thereto, the Basic Prospectus, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto, or (iii) the omission or alleged omission to state in the Registration Statement or any amendment thereto, the Basic Prospectus, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto a material fact required to be stated therein, or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, -16- 18 and will reimburse, as incurred, each Underwriter and each such controlling person for any legal or other costs or expenses reasonably incurred by such Underwriter or such controlling person in connection with investigating, defending against or appearing as a third-party witness in connection with any such loss, claim, damage, liability or action; provided, however, that the Company will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission made in the Registration Statement or any amendment thereto, the Basic Prospectus, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto in reliance upon and in conformity with written information furnished to the Company by such Underwriter through the Representatives specifically for use therein; and provided further, that the Company will not be liable to any Underwriter or any person controlling such Underwriter with respect to any such untrue statement, alleged untrue statement, omission or alleged omission made in any Preliminary Prospectus that is corrected in the Prospectus (or any amendment or supplement thereto) if the person asserting any such loss, claim, damage or liability purchased Notes from such Underwriter but was not sent or given a copy of the Prospectus (as amended or supplemented) in any case where such delivery of the Prospectus (as amended or supplemented) was required by the Securities Act, unless such failure to deliver the Prospectus (as amended or supplemented) was a result of noncompliance by the Company with Section 3 hereof. The indemnity provided for in this Section 6 shall be in addition to any liability which the Company may otherwise have. The Company will not, without the prior written consent of the Representatives, settle or compromise or consent to the entry of any judgment in any pending or threatened claim, action, suit or proceeding in respect of which indemnification may be sought hereunder (whether or not any such Representatives or any person who controls any such Representatives is a party to such claim, action, suit or proceeding), unless such settlement, compromise or consent includes an unconditional release of all of the Underwriters and such controlling persons from all liability arising out of such claim, action, suit or proceeding. (b) Each Underwriter, severally and not jointly, will indemnify and hold harmless the Company, each of its directors, each of its officers who signed the Registration Statement and each person, if any, who controls the Company within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act against any losses, claims, damages or liabilities to which the Company or any such director, officer or controlling person may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement or any amendment thereto, the Basic Prospectus, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto or (ii) the omission or the alleged omission to state in the Registration Statement or any amendment thereto, the Basic Prospectus any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to the Company by such Underwriter through the Representatives specifically for use therein, and, subject to the limitation set forth immediately preceding this clause, will reimburse, as incurred, any legal or other expenses reasonably incurred by the Company or any such director, officer, or controlling person in connection with investigating, defending against or appearing as a third-party witness in connection with any such loss, claim, damage, liability or any action in respect thereof. The remedies provided for in this Section 6 are not exclusive and shall not limit any rights or remedies which may otherwise be available to any indemnified party at law or in equity. No Underwriter will, without the prior written consent of the Company, settle or compromise or consent to the entry of any judgment in any pending or threatened claim, action, suit or proceeding in respect of which indemnification may be sought hereunder (whether or not the Company, any of its officers and directors, or any controlling person is a party to such claim, action, suit or proceeding), unless -17- 19 such settlement, compromise or consent includes an unconditional release of the Company and such directors, officers and controlling persons from all liability arising out of such claim, action, suit or proceeding. (c) In case any proceeding (including any governmental investigation) shall be instituted involving any person in respect of which indemnity may be sought pursuant to paragraph (a) or (b) of this Section 6, such person (for purposes of paragraphs (c) and (d) of this Section 6, the "indemnified party") shall, promptly after receipt by such party of notice of the commencement of such action, notify the person against whom such indemnity may be sought (for purposes of paragraphs (c) and (d) of this Section 6, the "indemnifying party"), but the omission so to notify the indemnifying party will not relieve it from any liability which it may have to any indemnified party otherwise than under this Section 6. In case any such action is brought against any indemnified party, and it notifies the indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel reasonably satisfactory to such indemnified party; provided, however, that if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded (based upon the advice of its counsel) that there may be one or more legal defenses available to it and/or other indemnified parties which are different from or additional to those available to the indemnifying party, the indemnifying party shall not have the right to direct the defense of such action on behalf of such indemnified party or parties and such indemnified party or parties shall have the right to select separate counsel to defend such action on behalf of such indemnified party or parties. After notice from the indemnifying party to such indemnified party of its election so to assume the defense of any such action and approval by such indemnified party of counsel appointed to defend such action, the indemnifying party will not be liable to such indemnified party under this Section 6 for any legal or other expenses, other than reasonable costs of investigation, subsequently incurred by such indemnified party in connection with the defense thereof, unless (i) the indemnified party shall have employed separate counsel in accordance with the proviso to the next preceding sentence (it being understood, however, that in connection with such action the indemnifying party shall not be liable for the expenses of more than one separate counsel (in addition to local counsel) in any one action or separate but substantially similar actions in the same jurisdiction arising out of the same general allegations or circumstances), or (ii) the indemnifying party does not promptly retain counsel satisfactory to the indemnified party, or (iii) the indemnifying party has authorized in writing the employment of counsel for the indemnified party at the expense of the indemnifying party. All fees and expenses to be reimbursed pursuant to this paragraph (d) shall be reimbursed as they are incurred. After such notice from the indemnifying party to such indemnified party, the indemnifying party will not be liable for the costs and expenses of any settlement of such action effected by such indemnified party without the consent of the indemnifying party. (d) In circumstances in which the indemnity agreement provided for in the preceding paragraphs of this Section 6 is unavailable or insufficient, for any reason, to hold harmless an indemnified party in respect of any losses, claims, damages or liabilities (or actions in respect thereof) purporting to be covered thereby, each indemnifying party, in order to provide for just and equitable contribution, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions in respect thereof) in such proportion as is appropriate to reflect (i) the relative benefits received by the indemnifying party or parties on the one hand and the indemnified party on the other from the Offering or (ii) if the allocation provided by the foregoing clause (i) is not permitted by applicable law, not only such relative benefits but also the relative fault of the indemnifying party or parties on the one hand and the indemnified party on the other in connection with the statements or omissions or alleged statements or omissions that resulted in such losses, claims, damages or liabilities (or actions in respect thereof), as well as any other relevant equitable considerations. The relative benefits received by the Company on the one hand and the Underwriters on the other shall be deemed to be in the same proportion as the total proceeds from the Offering -18- 20 (before deducting expenses) received by the Company bear to the total underwriting discounts and commissions received by the Underwriters. The relative fault of the parties shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company or the Underwriters, the parties' relative intents, knowledge, access to information and opportunity to correct or prevent such statement or omission, and any other equitable considerations appropriate in the circumstances. The Company and the Underwriters agree that it would not be equitable if the amount of such contribution were determined by pro rata or per capita allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation that does not take into account the equitable considerations referred to above in this paragraph (e). Notwithstanding any other provision of this paragraph (e), no Underwriter shall be obligated to make contributions hereunder that in the aggregate exceed the total public offering price of the Notes purchased by such Underwriter under this Agreement, less the aggregate amount of any damages that such Underwriter has otherwise been required to pay in respect of the same or any substantially similar claim, and no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations to contribute hereunder are several in proportion to their respective underwriting obligations and not joint, and contributions among Underwriters shall be governed by the provisions of the Deutsche Morgan Grenfell Inc. Master Agreement Among Underwriters. For purposes of this paragraph (d), each person, if any, who controls an Underwriter within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act shall have the same rights to contribution as such Underwriter, and each director of the Company, each officer of the Company who signed the Registration Statement and each person, if any, who controls the Company within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act, shall have the same rights to contribution as the Company. Section 7. Conditions Precedent. The obligations of the several Underwriters to purchase and pay for the Notes shall be subject, in the Representatives' reasonable discretion, to (i) the accuracy of the representations and warranties of the Company contained herein as of the date hereof and as of each Closing Date on which the Company proposes to sell Notes to the Underwriter, in each case, as if made on and as of each Closing Date, (ii) the performance by the Company of its covenants and agreements hereunder required to be performed or satisfied at or prior to the Closing Date, and (iii) the following additional conditions: (a) (i)If the Original Registration Statement or any amendment thereto filed prior to the First Closing Date has not been declared effective as of the time of execution hereof, the Original Registration Statement or such amendment shall have been declared effective not later than 6:00 P.M. New York City time on the date of determination of the public offering price, if such determination occurred at or prior to 4:30 P.M. New York City time on such date, or 12:00 Noon New York City time on the business day following the day on which the public offering price was determined, if such determination occurred after 4:30 P.M. New York City time on such date, and (ii) if the Company has elected to rely upon Rule 462(b), the Rule 462(b) Registration Statement shall have been declared effective not later than the time confirmations are sent or given as specified by Rule 462(b)(2), or such later time and date as shall have been consented to by the Representatives; if required, the Prospectus or any Term Sheet that constitutes a part thereof and any amendment or supplement thereto shall have been filed with the Commission in the manner and within the time period required by Rule 424(b) under the Securities Act; no stop order suspending the effectiveness of the Registration Statement or any amendment thereto shall have been issued, and no proceedings for that purpose shall have been instituted or threatened or, to the knowledge of the Company or the Representatives, shall be contemplated by -19- 21 the Commission; and the Company shall have complied with any request of the Commission for additional information (to be included in the Registration Statement or the Prospectus or otherwise). (b) The Representatives shall have received a legal opinion dated the Closing Date from (i) Fenwick & West LLP, counsel for the Company, with respect to the matters set forth below execpt the first and third sentences of clause (x), and (ii) Winthrop, Stimson, Putram & Roberts, with respect to the matters set forth in the first and third sentences of clause (x): (i) the Registration Statement is effective under the Securities Act; any required filing of the Prospectus, or any Term Sheet that constitutes a part thereof, pursuant to Rules 434 and 424(b) has been made in the manner and within the time period required by Rules 434 and 424(b); and to its knowledge no stop order suspending the effectiveness of the Registration Statement or any amendment thereto has been issued and, to its knowledge, no proceedings for that purpose are pending or threatened by the Commission; (ii) the Original Registration Statement and each amendment thereto, any Rule 462(b) Registration Statement and the Prospectus (in each case, other than the financial statements and other financial and statistical information contained therein, as to which such counsel need express no opinion), excluding in each case the documents incorporated by reference therein, comply as to form in all material respects with the applicable requirements of the Securities Act and the rules and regulations of the Commission thereunder; (iii) the documents incorporated by reference in the Prospectus (in each case other than the financial statements and other financial and statistical information contained therein, as to which such counsel need express no opinion), when they became effective or were filed with the Commission, as the case may be, complied as to form in all material respects with the applicable requirements of the Securities Act or the Exchange Act, as applicable, and the rules and regulations of the Commission thereunder; (iv) at December 31, 1997, the Company has an authorized, issued and outstanding capitalization as set forth in the "Capitalization" section of the Prospectus; all of the shares of capital stock issued and outstanding prior to the Closing Date have been duly authorized and validly issued and, assuming payment therefor in accordance with the resolutions authorizing such issuances or in accordance with the terms of the applicable option or warrant, as the case may be, are fully paid and nonassessable; and none of such shares of capital stock was issued in violation of any statutory preemptive or, to such counsel's knowledge, other similar rights; to such counsel's knowledge, no holders of outstanding shares of capital stock of the Company are entitled as such to any preemptive or other rights to subscribe for any shares of capital stock; and to such counsel's knowledge no holder of securities of the Company has any right which has not been fully exercised or waived to require the Company to register the offer or sale of any securities owned by such holder under the Securities Act in the Offering contemplated by this Agreement; the shares of Common Stock issuable upon conversion of the Notes have been duly authorized and reserved for issuance upon conversion of the Notes and, when issued and delivered by the Company upon such conversion, will be duly and validly issued and fully paid and nonassessable, and no preemptive or other rights to subscribe for any of such shares of Common Stock exists with respect thereto. The issuance of the shares of Common Stock issuable upon conversion of the Notes will be exempt from the registration requirements under the Securities Act pursuant to Section 3(a)(9) of the Securities Act. (v) the Common Stock issuable upon conversion of the Notes is listed for quotation on the Nasdaq National Market; -20- 22 (vi) the Company and each of its domestic Subsidiaries have been duly organized and are validly existing as corporations in good standing under the laws of their respective jurisdictions of incorporation, based solely on certificates from public officials, such counsel confirms that the Company and each of its domestic Subsidiaries and duly qualified to transact business in [the list jurisdictions set forth under their respective names in the list attached as Schedule IV]; to such counsel's knowledge the Company and each of its domestic Subsidiaries have full corporate power and corporate authority to own, lease and operate their respective properties and assets and conduct their respective businesses as described in the Registration Statement and the Prospectus, and the Company has corporate power to enter into this Agreement and to carry out all the terms and provisions hereof to be carried out by it; all of the issued and outstanding shares of capital stock of each of the Company's domestic Subsidiaries have been duly authorized and validly issued, are fully paid and nonassessable and, except as otherwise set forth in the Registration Statement, are owned beneficially by the Company or one of its Subsidiaries free and clear of any perfected security interests or, to the knowledge of such counsel, any other security interests, liens, encumbrances, equities or claims; (vii) the statements set forth under the headings "Description of Capital Stock"; and "Underwriting" in the Prospectus, and under Item 15 in the Registration Statement, insofar as such statements constitute a summary of the legal matters, documents or proceedings referred to therein, have been reviewed by such counsel and fairly present the information called for with respect to such legal matters, documents and proceedings in all material respects as required by the Securities Act and the Exchange Act and the respective rules and regulations thereunder; (viii) the execution and delivery of this Agreement have been duly authorized by all necessary corporate action of the Company and this Agreement, the Indenture and the Notes have been duly executed and delivered by the Company; (ix) the execution and delivery by the Company of, and compliance by the Company with, the provisions of, and performance of its obligations under, this Agreement, the Indenture and the Notes and the consummation of the other transactions contemplated in this Agreement, the Indenture, the Notes and the Registration Statement do not (x) require the consent, approval, authorization, registration or qualification of or with any governmental authority, except such as have been obtained or made (and specified in such opinion) or such as may be required by the securities or Blue Sky laws of the United States of America or any state thereof, or any foreign jurisdiction or under the bylaws or rules of the NASD in connection with the offer and sale of the Notes by the Underwriters, or (y) to such counsel's knowledge, conflict with or result in a breach or violation of any of the terms and provisions of, or constitute a default under, any indenture, mortgage, deed of trust, lease or other agreement or instrument, to which the Company or any of its domestic Subsidiaries is a party or by which the Company or any of its domestic Subsidiaries or any of their respective properties are bound, which indenture, mortgage, deed of trust, lease or other agreement or instrument is (or is required to be, in accordance with applicable laws) included (or incorporated by reference) in the Registration Statement, or any foreign jurisdiction or under the bylaws or rules of the NASD or the charter documents or by-laws of the Company or any of its domestic Subsidiaries, or any statute or any judgment, decree, order, rule or regulation of any court or other governmental authority or any arbitrator known to such counsel and applicable to the Company or its domestic Subsidiaries; (x) The Indenture, when executed and delivered by the Company in accordance with its terms (assuming due authorization, execution and delivery thereof by the Trustee) will be the valid and binding Agreement of the Company, enforceable against the Company in accordance with its terms, except to the extent the Indenture is subject to, or effected by, applicable bankruptcy, insolvency, federal or state fraudulent conveyance or transfer laws, reorganization, moratorium or similar laws. The Notes conform in all material -21- 23 respect to the descriptions thereof in the Prospectus. When the Notes are issued, executed and authenticated in accordance with the Indenture and paid for in accordance with the terms of this Agreement, the Notes will be the valid and binding obligations of the Company, enforceable against the Company in accordance with their terms, except to the extent the Notes are subject to, or effected by, applicable bankruptcy, insolvency, federal or state fraudulent conveyance or transfer laws, reorganization moratorium or similar laws. (xi) the Company is not an "investment company" and, after giving effect to the Offering and the application of the proceeds therefrom, will not be an "investment company", as such term is defined in the 1940 Act; and (xii) such counsel does not know of any legal or governmental proceedings pending or threatened to which the Company or any of its Subsidiaries is a party or to which the property of the Company or any of its Subsidiaries is subject that are required to be described or incorporated in the Registration Statement or the Prospectus and are not described or incorporated therein or any statutes, regulations, contracts or other documents that are Required to be described or incorporated in the Registration Statement or the Prospectus or to be filed as exhibits to the Registration Statement that are not described or incorporated therein or filed as required. Such opinion shall also state such counsel has participated in certain conferences with officers and other representatives of the Company, representatives of the independent certified public accountants for the Company and representatives of the Underwriters, at which conferences the contents of the Registration Statement and the Prospectus and related matters were discussed and, although such counsel is not passing upon and does not assume any responsibility for, nor has such counsel independently verified, the accuracy, completeness or fairness of the statements contained in the Registration Statement and Prospectus, on the basis of the foregoing, no facts have come to such counsel's attention that have caused such counsel to believe that either the Registration Statement, at the time such Registration Statement became effective, or the Prospectus as of the date hereof, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading (except, in the case of both the Registration Statement and the Prospectus, for the financial statements, notes thereto and other schedules, financial and accounting information and statistical data contained therein, as to which such counsel expresses no view). In rendering any such opinion, such counsel may rely, as to matters of fact, to the extent such counsel deems proper, on certificates of responsible officers of the Company or certificates of government officials. References to the Registration Statement and the Prospectus in this paragraph (b) shall include any amendment or supplement thereto at the date of such opinion. The opinions of issuer's counsel described herein shall be rendered to the Underwriters at the request of the Company and shall so state therein. (c) The Representatives shall have received a legal opinion from Wilson Sonsini Goodrich & Rosati, P.C., counsel for the Underwriters, dated the Closing Date, covering the issuance and sale of the Notes, the Registration Statement and the Prospectus, and such other related matters as the Representatives may reasonably require, and the Company shall have furnished to such counsel such documents as they may reasonably request for the purpose of enabling them to pass upon such matters. (d) The Representatives shall have received from Price Waterhouse LLP letters dated, respectively, the date hereof and the Closing Date, in form and substance satisfactory to the Representatives, together with signed or reproduced copies of such letters for each of the other Underwriters containing -22- 24 statements and information of the type ordinarily included in accountants' "comfort letters" to underwriters with respect to the financial statements and certain financial information contained in the Registration Statement and the Prospectus. In the event that the letters referred to above set forth any such changes, decreases or increases, it shall be a further condition to the obligations of the Underwriters that (I) such letters shall be accompanied by a written explanation of the Company as to the significance thereof, unless the Representatives deem such explanation unnecessary, and (II) such changes, decreases or increases do not, in the sole judgment of the Representatives, make it impractical or inadvisable to proceed with the purchase and delivery of the Notes as contemplated by the Registration Statement, as amended as of the date hereof. References to the Registration Statement and the Prospectus in this paragraph (f) with respect to either letter referred to above shall include any amendment or supplement thereto at the date of such letter. (e) The Company shall have furnished or caused to be furnished to the Underwriters at the Closing a certificate of its President and Chief Executive Officer and its Chief Financial Officer satisfactory to the Underwriters to the effect that: (i) the representations and warranties of the Company in this Agreement are true and correct as if made on and as of the Closing Date; the Registration Statement, as amended as of the Closing Date, does not include any untrue statement of a material fact or omit to state any material fact necessary to make the statements therein not misleading, and the Prospectus, as amended or supplemented as of the Closing Date, does not include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; and the Company has performed all covenants and agreements and satisfied all conditions on its part to be performed or satisfied at or prior to the Closing Date; (ii) no stop order suspending the effectiveness of the Registration Statement or any amendment thereto has been issued, and no proceedings for that purpose have been instituted or threatened or, to the best of the Company's knowledge, are contemplated by the Commission; and (iii) subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus (exclusive of any amendment or supplement thereto), neither the Company nor any of its Subsidiaries has sustained any material loss or interference with their respective businesses or properties from fire, flood, hurricane, accident or other calamity, whether or not covered by insurance, or from any labor dispute or any legal or governmental proceeding, and there has not been any materially adverse change (including, without limitation, a change in management or control), or development involving a prospective materially adverse change, in the condition (financial or otherwise), management, earnings, properties, business affairs or business prospects, stockholders' equity, net worth or results of operations of the Company or any of its Subsidiaries, except in each case as described in or contemplated by the Prospectus (exclusive of any amendment or supplement thereto). (f) The Representatives shall have received from the Company and each person who is a director or executive officer of the Company an agreement dated on or before the date of this Agreement to the effect that such person will not, without the prior written consent of the Representatives during a period from the date of this Agreement and continuing and including the date which is the number of days after the date hereof as specified in Schedule I hereto, without the prior written consent of the Underwriters, (i) offer, pledge, sell, offer to sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase or otherwise transfer or dispose of, directly or indirectly, any -23- 25 shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock, or (ii) enter into any swap or any other agreement or any transaction that transfers, in whole or in part, directly or indirectly, the economic consequence of ownership of the Common Stock, whether any such swap or transaction described in clause (i) or (ii) above is to be settled by delivery of Common Stock or such securities, in cash or otherwise; provided, however, that such person may, without the prior written consent of the Representatives on behalf of the Underwriters, transfer shares of Common Stock or such other securities to members of such person's immediate family or to trusts for the benefit of members of such person's immediate family or in connection with bona fide gifts, provided that any transferee agrees to the transfer restrictions described above. (g) On or before the Closing Date, the Representatives and counsel for the Underwriters shall have received such further certificates, documents or other information as they may have reasonably requested from the Company. All opinions, certificates, letters and documents delivered pursuant to this Agreement will comply with the provisions hereof only if they are reasonably satisfactory in all material respects to the Representatives and counsel for the Underwriters. The Company shall furnish to the Representatives such conformed copies of such opinions, certificates, letters and documents in such quantities as the Representatives and counsel for the Underwriters shall reasonably request. The respective obligations of the several Underwriters to purchase and pay for any Notes shall be subject, in their discretion, to each of the foregoing conditions to purchase the Notes, except that all references therein to the Notes and the Closing Date shall be deemed to refer to the Firm Notes or the Option Notes and the First Closing Date or the related Option Closing Date, each as applicable. The Underwriters and the Company further acknowledge and agree that it shall be a condition precedent to the purchase and sale of the Notes contemplated by this Agreement that on the First Closing Date the sale of 1,500,000 shares of Common Stock by the Company and certain selling stockholders shall have been consummated, as provided in an Underwriting Agreement of even date herewith among the Underwriters, the Company and such selling stockholders. Section 8. Default of Underwriters. If, at the First Closing, any one or more of the Underwriters shall fail or refuse to purchase Notes that it has or they have agreed to purchase hereunder on such date, and the aggregate number of Notes which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase is ten percent or less of the aggregate number of the Notes to be purchased on such date, the other Underwriters may make arrangements satisfactory to the Representatives for the purchase of such Notes by other persons (who may include one or more of the non-defaulting Underwriters, including the Representatives), but if no such arrangements are made by the First Closing Date, the other Underwriters shall be obligated severally in the proportions that the number of Firm Notes set forth opposite their respective names in Schedule II hereto bears to the aggregate number of Firm Notes set forth opposite the names of all such non-defaulting Underwriters, or in such other proportions as the Representatives may specify, to purchase the Notes which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase on such date. If, at the First Closing, any Underwriter or Underwriters shall fail or refuse to purchase Firm Notes and the aggregate number of Firm Notes with respect to which such default occurs is more than ten per cent of the aggregate number of Firm Notes to be purchased, and arrangements satisfactory to the Representatives and the Company for the purchase of such Firm Notes are not made within 36 hours after such default, this Agreement shall terminate without liability on the part of any -24- 26 non-defaulting Underwriter or the Company. In any such case either the Representatives or the Company shall have the right to postpone the Closing, but in no event for longer than seven days, in order that the required changes, if any, in the Registration Statement and in the Prospectus or in any other documents or arrangements may be effected. If, at any Option Closing, any Underwriter or Underwriters shall fail or refuse to purchase Option Notes, the non-defaulting Underwriters shall have the option to (i) terminate their obligation hereunder to purchase Option Notes or (ii) purchase not less than the number of Option Notes that such non-defaulting Underwriters would have been obligated to purchase in the absence of such default. As used in this Agreement, the term "Underwriter" includes any person substituted for an Underwriter under this Section 8. Any action taken under this Section 8 shall not relieve any defaulting Underwriter from liability in respect of any default of such Underwriter under this Agreement. Section 9. Termination. This Agreement shall be subject to termination in the sole discretion of the Representatives by notice to the Company given prior to any Closing Date in the event that the Company shall have failed, refused or been unable to perform all obligations and satisfy all conditions on its part to be performed or satisfied hereunder at the Closing or prior thereto or, if at or prior to any Closing Date, (a) trading in securities generally on the New York Stock Exchange or the Nasdaq National Market shall have been suspended or materially limited or minimum or maximum prices shall have been established by or on, as the case may be, the Commission or the New York Stock Exchange or the Nasdaq National Market; (b) trading of any securities of the Company shall have been suspended on any exchange or in any over-the-counter market; (c) a general moratorium on commercial banking activities shall have been declared by either Federal or New York State authorities; (d) there shall have occurred (i) an outbreak or escalation of hostilities between the United States and any foreign power, (ii) an outbreak or escalation of any other insurrection or armed conflict involving the United States, or (iii) any other calamity or crisis or materially adverse change in general economic, political or financial conditions having an effect on the U.S. financial markets that, in the reasonable judgment of the Representatives, in the case of clauses (d)(i), (d)(ii) and (d)(iii), makes it impractical or inadvisable to proceed with the public offering or the delivery of the Notes as contemplated by the Registration Statement, as amended as of the date hereof; or (e) the Company or any of its Subsidiaries shall have, in the reasonable judgment of the Representatives, sustained any material loss or interference with their respective businesses or properties from fire, flood, hurricane, accident or other calamity, whether or not covered by insurance, or from any labor dispute or any legal or governmental proceeding, or there shall have been any materially adverse change (including, without limitation, a change in management or control), or constitute a development involving a prospective materially adverse change, in the condition (financial or otherwise), management, earnings, properties, business affairs or business prospects, stockholders' equity, net worth or results of operations of the Company or any of its Subsidiaries, except in each case as described in or contemplated by the Prospectus (exclusive of any amendment or supplement thereto). Termination of this Agreement pursuant to this Section 9 shall be without liability of any party to any other party except for the liability of the Company in relation to expenses as provided in Sections 4 and 10 hereof, the indemnity provided in Section 6 hereof and any liability arising before or in relation to such termination. Section 10. Reimbursement of Expenses. If the sale of the Notes provided for herein is not consummated because any condition to the obligations of the Underwriters set forth in Section 7 hereof is not satisfied or because of any termination pursuant to Section 9 hereof (other than by reason of a default by any of the Underwriters), the Company shall reimburse the Underwriters, severally upon demand, for all out-of-pocket expenses (including fees and -25- 27 disbursements of counsel) that shall have been incurred by them in connection with the proposed purchase and sale of the Notes. Section 11. Information Supplied by Underwriters. The statements set forth in the last paragraph on the front cover page and in the third and last three paragraphs under the heading "Underwriting" in any Preliminary Prospectus or the Prospectus (to the extent such statements relate to the Underwriters) constitute the only information furnished by any Underwriter through the Representatives to the Company for the purposes of Section 5(a)(ii) and Section 6 hereof. The Underwriters confirm that such statements (to such extent) are correct. Section 12. Notices. In all dealings hereunder, you shall act on behalf of each of the Underwriters, and the parties hereto shall be entitled to act and rely upon any statement, request, notice or agreement on behalf of any Underwriter made or given by the Representatives. Any notice or notification in any form to be given under this Agreement may be delivered in person or sent by telex, facsimile or telephone (subject in the case of a communication by telephone to confirmation by telex or facsimile) addressed to: in the case of the Company: HNC Software Inc. 5930 Cornerstone Court West San Diego, California 92121-3728 Telephone: 619-546-8877 Facsimile: 619-452-3220 Attention: President in the case of the Underwriters: Deutsche Morgan Grenfell Inc. 31 West 52nd Street New York, New York 10019 Telephone: 212-469-5600 Facsimile: 212-469-5995 Attention: Equity Syndicate Desk Section 13. Miscellaneous. (a) Time shall be of the essence of this Agreement. (b) The headings herein are inserted for convenience of reference only and are not intended to be part of, or to affect, the meaning or interpretation of this Agreement. -26- 28 (c) For purposes of this Agreement, (a) "business day" means any day on which the New York Stock Exchange is open for trading, and (b) "subsidiary" has the meaning set forth in Rule 405 under the Securities Act. (d) This Agreement may be executed in any number of counterparts, all of which, taken together, shall constitute one and the same Agreement and any party may enter into this Agreement by executing a counterpart. (e) This Agreement shall inure to the benefit of and shall be binding upon the several Underwriters, the Company and their respective successors and legal representatives, and nothing expressed or mentioned in this Agreement is intended or shall be construed to give any other person any legal or equitable right, remedy or claim under or in respect of this Agreement, or any provisions herein contained, this Agreement and all conditions and provisions hereof being intended to be and being for the sole and exclusive benefit of such persons and for the benefit of no other person, except that (i) the indemnities of the Company contained in Section 6 hereof shall also be for the benefit of any person or persons who control any Underwriter within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act and (ii) the indemnities of the Underwriters contained in Section 6 hereof shall also be for the benefit of the directors of the Company, the officers of the Company who have signed the Registration Statement and any person or persons who control the Company within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act. No purchaser of Notes from any Underwriter shall be deemed a successor because of such purchase. (f) The respective representations, warranties, agreements, covenants, indemnities and other statements of the Company, its officers and the several Underwriters set forth in this Agreement or made by or on behalf of them, respectively, pursuant to this Agreement shall remain in full force and effect, regardless of (i) any investigation made by or on behalf of the Company, any of its officers or directors, any Underwriter or any controlling person referred to in Section 6 hereof and (ii) delivery of and payment for the Notes. The respective agreements, covenants, indemnities and other statements set forth in Sections 4, 6 and 10 hereof shall remain in full force and effect, regardless of any termination or cancellation of this Agreement. Section 14. Severability. It is the desire and intent of the parties that the provisions of this Agreement be enforced to the fullest extent permissible under the law and public policies applied in each jurisdiction in which enforcement is sought. Accordingly, in the event that any provision of this Agreement would be held in any jurisdiction to be invalid, prohibited or unenforceable for any reason, such provision, as to such jurisdiction, shall be ineffective, without invalidating the remaining provisions of this Agreement or affecting the validity or enforceability of such provision in any other jurisdiction. Section 15. Governing Law. The validity and interpretation of this Agreement, and the terms and conditions set forth herein, shall be governed by and construed in accordance with the laws of the State of New York, without giving effect to any provisions relating to conflicts of laws. -27- 29 If the foregoing is in accordance with your understanding, please sign and return to us ten (10) counterparts hereof, and upon the acceptance hereof by you, on behalf of each of the Underwriters, this letter and such acceptance hereof shall constitute a binding agreement among each of the Underwriters and the Company. It is understood that your acceptance of this letter on behalf of each of the Underwriters is pursuant to the authority set forth in the Deutsche Morgan Grenfell Inc. Master Agreement Among Underwriters, the form of which shall be submitted to the Company for examination upon request, but without warranty on your part as to the authority of the signers thereof. Very truly yours, HNC SOFTWARE INC. By:______________________________________ President and Chief Executive Officer The foregoing Agreement is hereby confirmed and accepted as of the date specified in Schedule I hereto. DEUTSCHE MORGAN GRENFELL INC. BANCAMERICA ROBERTSON STEPHENS SMITH BARNEY INC. By: DEUTSCHE MORGAN GRENFELL INC. By: ____________________________ Name: __________________________ Title: _________________________ By: ____________________________ Name: __________________________ Title: _________________________ For themselves and on behalf of the other several Underwriters, if any, named in Schedule II to the foregoing Agreement. -28- 30 SCHEDULE I Underwriting Agreement dated: ___________ __, 1998 Other Representatives: BancAmerica Robertson Stephens Smith Barney Inc. Type of Offering: ___% Convertible Subordinated Notes due 2003 Purchase Price of Notes: Purchase price per Note: ___% of principal amount plus accrued interest, if any, from ___________, 1998. Closing Date, Time and Location: _____________ __, 1998, at the offices of Fenwick & West LLP, Two Palo Alto Square, Palo Alto, California, 94306. Registration Statement No. 333-____ Number of days referred to in Section 3(a)(v): 90 Number of days referred to in Section 7(f): 90 Modification of items to be covered by the letter from Price Waterhouse LLP delivered pursuant to Section 7(d) at the Closing Date: 31 SCHEDULE II The Underwriters
UNDERWRITER UNDERWRITING COMMITMENT ----------- ----------------------- Deutsche Morgan Grenfell Inc. __________________ BancAmerica Robertson Stephens __________________ Smith Barney Inc. __________________
32 SCHEDULE III Listing of all States in which HNC and Subsidiaries do Business HNC Software Inc. Arizona California Connecticut Delaware Florida Georgia Illinois Minnesota Maryland Nebraska New York North Carolina Ohio Pennsylvania Texas Utah Virginia Washington CompReview, Inc. California Texas Retek Information Systems, Inc. Minnesota Texas Illinois Georgia Indiana Massachusetts Pennsylvania California 33 Risk Data Corporation California Arizona Colorado Minnesota New York Virginia Aptex Software Inc. California Texas Massachusetts EX-1.02 3 FORM OF UNDERWRITING AGMT. - COMMON STOCK OFFERING 1 EXHIBIT 1.02 Dated ____________, 1998 HNC SOFTWARE INC. UNDERWRITING AGREEMENT 2 HNC SOFTWARE INC. 2,100,000 Shares Plus an Option to Purchase up to 315,000 Additional Shares to Cover Over-allotments Common Stock UNDERWRITING AGREEMENT ___________, 1998 To: DEUTSCHE MORGAN GRENFELL INC. and the other Representatives named in Schedule I hereto of the several Underwriters named in Schedule II hereto c/o Deutsche Morgan Grenfell Inc. 31 West 52nd Street New York, New York 10019 Dear Sirs: HNC Software Inc., a Delaware corporation (the "Company"), and the persons listed in Schedule III hereto (the "Selling Stockholders") hereby confirm their agreement with the several underwriters named in Schedule II hereto (the "Underwriters"), for whom you have been duly authorized to act as representatives (the one or more firms acting in such capacities, the "Representatives"), as set forth below. If you are the only Underwriters, all references herein to the Representatives shall be deemed to be references to the Underwriters. Section 1. Underwriting. Subject to the terms and conditions contained herein: (a) The Company proposes to issue and sell 20,000 shares of common stock, par value $0.001 per share (the "Common Stock"), of the Company and the Selling Shareholders propose to sell 2,080,000 shares of Common Stock (said shares to be issued and sold by the Company and sold by the Selling Stockholders collectively referred to herein as the "Firm Shares") to the several Underwriters. The Selling Stockholders also propose to sell to the several Underwriters not more than 315,000 additional shares (the "Option Shares"), if requested by the Representatives as provided in Section 2(b) hereof. The Firm Shares and the Option Shares are sometimes collectively referred to herein as the "Shares". (b) Upon your authorization of the release of the Firm Shares, the Underwriters propose to make a public offering (the "Offering") of the Firm Shares upon the terms set forth in the Prospectus (as defined below) as soon after the Registration Statement (as defined below) and this Agreement have become effective as in the Representatives' sole judgment is advisable. As used in this Agreement, the term "Effective Date" 3 shall mean each date that the registration statement and any post-effective amendment or amendments thereto became or become effective; the term "Original Registration Statement" means the registration statement referred to in Section 5(a)(i) below, as amended at the time when it was or is declared effective, including incorporated documents, financial schedules and exhibits thereto, including any Rule 430A Information (as defined below) deemed to be included therein at the Effective Date as provided by Rule 430A and, in the event any post-effective amendment thereto becomes effective prior to the Closing Date (as defined below), also means such registration statement as so amended; the term "Rule 430A Information" means information permitted to be omitted from the Original Registration Statement when it becomes effective pursuant to Rule 430A; the term "Rule 462(b) Registration Statement" means any registration statement filed with the Commission pursuant to Rule 462(b) under the Securities Act of 1933, as amended (the "Securities Act") (including the Registration Statement and any Preliminary Prospectus (as defined below) or Prospectus incorporated therein at the time such Registration Statement becomes effective); the term "Registration Statement" includes both the Original Registration Statement and any Rule 462(b) Registration Statement; the term "Basic Prospectus" shall mean the prospectus referred to in Section 5(a)(i) below contained in the Registration Statement at the Effective Date including, in the case of a Rule 430A Offering (as defined below), any Preliminary Prospectus; the term "Preliminary Prospectus" means the preliminary prospectus supplement to the Basic Prospectus used prior to the filing of the Prospectus; the term "Prospectus" means: (i) if the Company relies on Rule 434 under the Securities Act, the Term Sheet (as defined below) relating to the Shares that is first filed pursuant to Rule 424(b) under the Securities Act, together with the Preliminary Prospectus identified therein that such Term Sheet supplements; (ii) the prospectus supplement to the Basic Prospectus first filed with the Commission pursuant to Rule 424(b) under the Securities Act, together with the Basic Prospectus; (iii) if, in the case of a Rule 430A Offering, no prospectus supplement is required to be filed pursuant to Rule 424(b) under the Securities Act, the form of final prospectus supplement to the Basic Prospectus, including the Basic Prospectus, included in the Registration Statement at the Effective Date; or (iv) for purposes of the representations and warranties in Section 5 hereof, if the prospectus is not in existence, the Basic Prospectus and the most recent Preliminary Prospectus, if any. "Rule 415", "Rule 424" and "Rule 430A" refer to such rules or regulations under the Securities Act, and the term "Term Sheet" means any term sheet that satisfies the requirements of Rule 434 under the Securities Act. Any reference herein to the Registration Statement, the Basic Prospectus, any Preliminary Prospectus or the Prospectus shall be deemed to refer to and include the documents incorporated by reference therein pursuant to Item 12 of Form S-3 which were filed under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), on or before the Effective Date of the Registration Statement or the issue date of the Basic Prospectus, any Preliminary Prospectus or the Prospectus, as the case may be; and any reference herein to the terms "amend", "amendment" or "supplement" with respect to the Registration Statement, the Basic Prospectus, any Preliminary Prospectus or the Prospectus shall be deemed to refer to and include the filing of any document under the Exchange Act after the Effective Date of the Registration Statement or the issue date of the Basic Prospectus, any Preliminary Prospectus or the Prospectus, as the case may be, deemed to be incorporated therein by reference. A "Rule 430A Offering" means an offering of securities which is intended to commence promptly after the effective date of a registration statement, with the result that, pursuant to Rules 415 and 430A, all information (other than Rule 430A Information) with respect to the securities so offered must be included in such registration statement at the effective date thereof. A "Rule 415 Offering" means an offering of securities pursuant to Rule 415 which does not commence promptly after the effective -2- 4 date of a registration statement, with the result that only information required pursuant to Rule 415 need be included in such registration statement at the effective date thereof with respect to the securities so offered. Whether the offering of the Shares is a Rule 430A Offering or a Rule 415 Offering shall be set forth in Schedule I hereto. (c) For purposes of this Agreement, all references to the Registration Statement, any Preliminary Prospectus, the Prospectus, the Term Sheet or the Basic Prospectus, or any amendment or supplement to any of the foregoing shall be deemed to include the copy filed with the Commission pursuant to its Electronic Data Gathering, Analysis and Retrieval system ("EDGAR"). Section 2. Purchase and Closing. (a) On the basis of the representations, warranties, agreements and covenants herein contained and subject to the terms and conditions herein set forth, the Company agrees to issue and sell, and the Selling Stockholders agree to sell, to each of the Underwriters, and each of the Underwriters, severally and not jointly, agrees to purchase from the Company and the Selling Stockholders, at the purchase price per Share set forth in Schedule I hereto (the "Purchase Price"), the number of Firm Shares set forth opposite the name of such Underwriter in Schedule II hereto. Firm Shares shall be registered by First National Bank of Boston in the name of the nominee of the Depository Trust Company ("DTC"), Cede & Co. ("Cede & Co."), and credited to the accounts of such of its participants as the Representatives shall request, upon notice to the Company and the Selling Stockholders at least 48 hours prior to the First Closing Date (as defined below), with any transfer taxes payable in connection with the transfer of the Firm Shares to the Underwriters duly paid, against payment by or on behalf of the Underwriters to the respective accounts of the Company and the Selling Stockholders of the aggregate Purchase Price therefor by wire transfer in immediately available funds. Delivery or registry of and payment for the Firm Shares shall be made at the office of, on the date and at the time specified in Schedule I hereto, or at such other place, time or date as the Representatives and the Company may agree upon. Such time and date of delivery against payment are herein referred to as the "First Closing Date", and the implementation of all the actions described in this Section 2(a) is herein referred to as the "First Closing". (b) For the purpose of covering any over-allotments in connection with the distribution and sale of the Firm Shares as contemplated by the Prospectus, the Selling Stockholders hereby grant to the several Underwriters an option to purchase, severally and not jointly, the Option Shares. The purchase price to be paid for any Option Shares shall be the same as the Purchase Price for the Firm Shares set forth above in paragraph (a) of this Section 2. The option granted hereby may be exercised as to all or any part of the Option Shares from time to time within thirty (30) days after the date of the Prospectus (or, if such 30th day shall be a Saturday or Sunday or a holiday, on the next business day thereafter when the New York Stock Exchange and the Nasdaq Stock Market's National Market (the "Nasdaq National Market") are open for trading). The Underwriters shall not be under any obligation to purchase any of the Option Shares prior to the exercise of such option. The Representatives may from time to time exercise the option granted hereby by giving notice in writing or by telephone (confirmed in writing) to the Company and the Selling Stockholders setting forth the aggregate number of Option Shares as to which the several Underwriters are then exercising the option and the date and time for delivery or registry of and payment for such Option Shares. Any such date of delivery or registry shall be determined by the Representatives but shall not be earlier than two business days or later than five business days after such exercise of the option unless otherwise agreed to by the Company and the Representatives and, in any event, shall not be earlier than the First Closing Date. The time and date set forth in such notice, or such other time or date as the Representatives, the Company and the Selling Stockholders may agree upon or as the Representatives may determine pursuant to Section 2(a) hereof, is herein called an "Option Closing Date" with respect to such Option Shares, and the implementation of all the actions described in this Section 2(b) is herein referred to as the "Option Closing". As used in this Agreement, the term "Closing -3- 5 Date" means either the First Closing Date or any Option Closing Date, as applicable, and the term "Closing" means either the First Closing or any Option Closing, as applicable. If the option is exercised as to all or any portion of the Option Shares, then either one or more certificates in definitive form for such Option Shares shall be delivered or, if such Option Shares are to be held through DTC, such Option Shares shall be registered and credited, on the related Option Closing Date in the same manner, and upon the same terms and conditions, set forth in paragraph (a) of this Section 2, except that reference therein to the Firm Shares and the First Closing Date shall be deemed, for purposes of this paragraph (b), to refer to such Option Shares and Option Closing Date, respectively. Upon exercise of the option as provided herein, the Selling Stockholders shall become obligated to sell to each of the several Underwriters, and, on the basis of the representations, warranties, agreements and covenants herein contained and subject to the terms and conditions herein set forth, each of the Underwriters (severally and not jointly) shall become obligated to purchase from each Selling Stockholder, that number of Option Shares being offered by such Selling Stockholder, as the case may be, which is in the same proportion to the number of Option Shares set forth opposite the name of such Selling Stockholder in Schedule III hereto as to which the several Underwriters are then exercising the option, as the number of Firm Shares such Underwriter is obligated to purchase is to the aggregate number of Firm Shares, as adjusted by the Representatives in such manner as they deem advisable to avoid fractional shares. (c) The Company and the Selling Stockholders hereby acknowledge that the payment of monies pursuant to Section 2(a) or 2(b) hereof (a "Payment") by or on behalf of the Underwriters of the aggregate Purchase Price for any Shares does not constitute closing of a purchase and sale of the Shares. Only execution and delivery, by facsimile or otherwise, of a receipt for Shares by the Underwriters indicates completion of the closing of a purchase of the Shares from the Company and the Selling Stockholders. Furthermore, in the event that the Underwriters make a Payment to the Company and the Selling Stockholders prior to the completion of the closing of a purchase of Shares, the Company and the Selling Stockholders hereby acknowledge that until the Underwriters execute and deliver such receipt for the Shares, the Company and the Selling Stockholders will not be entitled to the Payment and shall return the Payment to the Underwriters as soon as practicable (by wire transfer of same-day funds) upon demand. In the event that the closing of a purchase of Shares is not completed and the Payment is not returned by the Company and the Selling Stockholders to the Underwriters on the same day the Payment was received by the Company and the Selling Stockholders, each of the Company and the Selling Stockholders (severally and not jointly) agree to pay to the Underwriters in respect of each day the Payment is not returned to any one of them, in same-day funds, interest on the amount of such Payment not returned by such party in an amount representing the Underwriters' cost of financing as reasonably determined by the Representatives. (d) It is understood that any of you, individually and not as one of the Representatives, may (but shall not be obligated to) make Payment on behalf of any Underwriter or Underwriters for any of the Shares to be purchased by such Underwriter or Underwriters. No such Payment shall relieve such Underwriter or Underwriters from any of its or their obligations hereunder. Section 3. Covenants. (a) The Company covenants and agrees with the several Underwriters that: (i) The Company will: (A) use its best efforts to cause the Registration Statement, if not effective at the time of execution of this Agreement, and any amendments thereto, to become effective as promptly as possible. If required, the Company will file the Prospectus or any Term Sheet that constitutes a part thereof and any -4- 6 amendment or supplement thereto with the Commission in the manner and within the time period required by Rule 424(b) under the Securities Act. During any time when a prospectus relating to the Shares is required to be delivered under the Securities Act, the Company (x) will comply with all requirements imposed upon it by the Securities Act and the rules and regulations of the Commission thereunder to the extent necessary to permit the continuance of sales of or dealings in the Shares in accordance with the provisions hereof and of the Prospectus, as then amended or supplemented, and (y) will not, prior to the earlier of the date upon which the over-allotment option is fully exercised or the date thirty (30) days after the date of Prospectus, file with the Commission the Basic Prospectus, Term Sheet or any amendment or supplement to such Basic Prospectus (including the Prospectus or any Preliminary Prospectus), any amendment or supplement to such Term Sheet, any amendment to the Registration Statement (including the amendment referred to in the second sentence of Section 5(a)(i)) or any Rule 462(b) Registration Statement unless the Representatives previously have been advised of, and furnished with a copy within a reasonable period of time prior to, the proposed filing and the Representatives shall have given their consent to such filing which consent shall not be unreasonably withheld. The Company will prepare and file with the Commission, in accordance with the rules and regulations of the Commission, promptly upon request by the Representatives or counsel for the Underwriters, any amendments to the Registration Statement or amendments or supplements to the Prospectus that may be necessary or advisable in connection with the distribution of the Shares by the several Underwriters. The Company will advise the Representatives, promptly after receiving notice thereof, of the time when the Registration Statement or any amendment thereto has been filed or declared effective or the Prospectus or Term Sheet or any amendment or supplement thereto has been filed and will provide evidence satisfactory to the Representatives of each such filing or effectiveness. (B) without charge, provide (x) to the Representatives and to counsel for the Underwriters, an executed and a conformed copy of the Original Registration Statement and each amendment thereto or any Rule 462(b) Registration Statement (in each case including exhibits thereto), (y) to each other Underwriter, a conformed copy of the Original Registration Statement and each amendment thereto or any Rule 462(b) Registration Statement (in each case without exhibits thereto), and (z) so long as a prospectus relating to the Shares is required to be delivered under the Securities Act, as many copies of each Preliminary Prospectus or the Prospectus or any amendment or supplement thereto as the Representatives may reasonably request. Without limiting the application of clause (z) of the preceding sentence, the Company, not later than (I) 9:00 A.M., New York City time, on the business day following the date of determination of the public offering price, if such determination occurred at or prior to 12:00 noon, New York City time, on such date or (II) 6:00 P.M., New York City time, on the business day following the date of determination of the public offering price, if such determination occurred after 12:00 noon, New York City time, on such date, will deliver to the Underwriters, without charge, as many copies of the Prospectus and any amendment or supplement thereto as the Representatives may reasonably request for purposes of confirming orders that are expected to settle on the First Closing Date. The copies of each Original Registration Statement, 462(b) Registration Statement, Preliminary Prospectus, Term Sheet and Prospectus, and any amendments to the foregoing documents, shall be identical to the electronically transmitted copies thereof filed with the Commission pursuant to EDGAR, except to the extent permitted by Regulation S-T. (C) advise the Representatives, promptly after receiving notice or obtaining knowledge thereof, of (w) the issuance by the Commission of any stop order suspending the effectiveness of the Original Registration Statement or any amendment thereto or any Rule 462(b) Registration Statement or any order preventing or suspending the use of any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto, (x) the suspension of the qualification of the Shares for offering or sale in any jurisdiction, (y) the institution, threatening or contemplation of any proceeding for any purpose identified in the preceding clause (w) or (x), or (z) any request made by the Commission for amending the Original Registration -5- 7 Statement or any Rule 462(b) Registration Statement, for amending or supplementing the Prospectus or for additional information. The Company will use its best efforts to prevent the issuance of any such stop order and, if any such stop order is issued, to obtain the withdrawal thereof as promptly as possible. (ii) The Company will endeavor in good faith, in cooperation with the Representatives, to arrange for the qualification of the Shares for offering and sale in each jurisdiction as the Representatives shall reasonably designate including, but not limited to, pursuant to applicable state securities ("Blue Sky") laws of certain states of the United States of America or other U.S. jurisdictions, and the Company shall use its best reasonable efforts to maintain such qualifications in effect for so long as may be necessary in order to complete the placement of the Shares; provided, however, that the Company shall not be obliged to file any general consent to service of process or to qualify as a foreign corporation or as a securities dealer in any jurisdiction or to subject itself to taxation in respect of doing business in any jurisdiction in which it is not otherwise so subject. (iii) If, at any time prior to the final date when a prospectus relating to the Shares is required to be delivered under the Securities Act, any event occurs as a result of which the Prospectus, as then amended or supplemented, would include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading, or if for any other reason it shall be necessary at any time to amend the Registration Statement or amend or supplement the Prospectus to comply with the Securities Act or the rules or regulations of the Commission thereunder or applicable law, the Company will promptly notify the Representatives thereof and will promptly, at its own expense: (x) prepare and file with the Commission an amendment to the Registration Statement or amendment or supplement to the Prospectus which will correct such statement or omission or effect such compliance; and (y) supply any amended Registration Statement or amended or supplemented Prospectus to the Underwriters in such quantities as the Underwriters may reasonably request. (iv) The Company will make generally available to the Company's security holders and to the Representatives as soon as practicable an earnings statement that satisfies the provisions of Section 11(a) of the Securities Act, including Rule 158 thereunder. (v) The Company will not, and will not allow any majority-owned subsidiary (each a "Subsidiary" and collectively, the "Subsidiaries") to publicly announce any intention to, and will not itself, and will not allow any Subsidiary to, without the prior written consent of Deutsche Morgan Grenfell Inc., on behalf of the Underwriters, (i) offer, pledge, sell, offer to sell, contract to sell, sell any option or contract to purchase, purchase any option to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into, or exercisable or exchangeable for, Common Stock, or (ii) enter into any swap or other agreement that transfers, in whole or in part, any of the economic consequences of ownership of the shares of Common Stock or securities convertible into, or exercisable or exchangeable for, shares of Common Stock (whether any such transaction described in clause (i) or (ii) above is to be settled by delivery of shares of Common Stock or such other securities, in cash or otherwise), for a period beginning from the date hereof and continuing to and including the date which is the number of days after the date hereof specified in Schedule I hereto, except pursuant to this Agreement and other than with respect to (v) the shares of Common Stock issued and sold by the Company hereunder, (w) shares issued upon the conversion of the Notes, (x) shares of Common Stock (or any securities exercisable for, convertible into or exchangeable for shares of Common Stock) issued or issuable pursuant to any employee benefit plans, qualified and non qualified stock option plans or other employee compensation plans which are disclosed in the Prospectus, (y) shares of Common Stock that may be issued to shareholders of Practical Control Systems Technologies, Inc. or Financial Technologies, Inc. and (z) shares of Common Stock (or any -6- 8 securities convertible into or exchangeable for shares of Common Stock) issued by the Company in connection with any other acquisition, joint venture, strategic partnership or similar strategic arrangement, provided that the recipient of such shares or convertible securities, at or prior to such issuance, agrees to be bound by the transfer restrictions described above with respect to such shares of Common Stock or convertible securities. (vi) Neither the Company nor any of its affiliates, nor any person acting on behalf of any of them will, directly or indirectly, (i) take any action designed to cause or to result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Shares or (ii) (x) sell, bid for, purchase, or pay anyone any compensation for soliciting purchases of, the Shares or (y) pay or agree to pay to any person any compensation for soliciting another to purchase any other securities of the Company. (vii) The Company will obtain the agreements described in Section 7(g) hereof prior to the First Closing Date. (viii) If at any time during the period prior to the First Closing Date, any rumor, publication or event relating to or affecting the Company shall occur as a result of which in the Representatives' reasonable judgment the market price of the Shares has been or is likely to be materially affected (regardless of whether such rumor, publication or event necessitates a supplement to or amendment of the Prospectus), the Company will, after notice from the Representatives advising the Company to the effect set forth above, forthwith prepare, consult with the Representatives concerning the substance of, and disseminate a press release responding to or commenting on such rumor, publication or event or other public statement, that is reasonably satisfactory to the Representatives. (ix) If the Company elects to rely on Rule 462(b), the Company shall both file the Rule 462(b) Registration Statement with the Commission in compliance with Rule 462(b) and pay the applicable fees in accordance with Rule 111 promulgated under the Securities Act by the earlier of (i) 10:00 p.m. New York City time on the date of this Agreement and (ii) the time confirmations are sent or given, as specified by Rule 462(b)(2) under the Securities Act. (x) The Company will use its best efforts to cause the Shares to be duly included for quotation on the Nasdaq National Market prior to the First Closing Date. The Company will use all reasonable efforts to ensure that the Shares remain included for quotation on the Nasdaq National Market, or are included for quotation on the New York Stock Exchange or the American Stock Exchange, for a period of five years following the First Closing Date. (b) Each Selling Stockholder covenants and agrees with the several Underwriters that: (i) Such Selling Stockholder will not, and no person acting on behalf of such Selling Stockholder will, directly or indirectly, (x) take any action designed to cause or to result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Shares or (y) sell, bid for, purchase, or pay anyone any compensation for soliciting purchase of, the Shares or (z) pay or agree to pay to any person any compensation for soliciting another to purchase any other securities of the Company (except for the sale of Shares by the Selling Stockholders under this Agreement). (ii) Such Selling Stockholder will not, and will not cause any affiliate to, publicly announce any intention to, and will not itself, and will not allow any affiliate to, without the prior written -7- 9 consent of the Representatives on behalf of the Underwriters, (x) offer, pledge, sell, offer to sell, contract to sell, sell any option or contract to purchase, purchase any option to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any of the shares of Common Stock or any securities convertible into, or exercisable or exchangeable for, Common Stock, or (y) enter into any swap or other agreement that transfers, in whole or in part, any of the economic consequences of ownership of the shares of Common Stock or any securities convertible into, or exercisable or exchangeable for, shares of Common Stock (whether any such transaction described in clause (x) or (y) above is to be settled by delivery of shares of Common Stock or such other securities, in cash or otherwise), in each case, beneficially owned (within the meaning of Rule 13d-3 under the Exchange Act) or otherwise controlled by such person on the date hereof or hereafter acquired, for a period beginning from the date hereof and continuing to and including the date 90 days after the date hereof; provided, however, that such Selling Stockholder may, without the prior written consent of the Representatives on behalf of the Underwriters, transfer shares of Common Stock or such other securities to members of such Selling Stockholder's immediate family or to trusts for the benefit of members of such Selling Stockholder's immediate family or in connection with bona fide gifts; provided that any transferee agrees to the transfer restrictions described above. Section 4. Expenses. (a) The Company shall bear and pay all costs and expenses incurred incident to the performance of its obligations under this Agreement, whether or not the transactions contemplated herein are consummated or this Agreement is terminated pursuant to Section 9 hereof, including: (i) the fees and expenses of its counsel, accountants and any other experts or advisors retained by the Company; (ii) fees and expenses incurred in connection with the registration of the Shares under the Securities Act and the preparation and filing of the Registration Statement, the Prospectus and all amendments and supplements thereto; (iii) the printing and distribution of the Prospectus and any Preliminary Prospectus and the printing and production of all other documents connected with the Offering (including this Agreement and any other related agreements); (iv) expenses related to the qualification of the Shares under the state securities or Blue Sky laws, including filing fees and the fees and disbursements of counsel for the Underwriters in connection therewith and in connection with the preparation of any Blue Sky memoranda; (v) the filing fees and expenses, if any, incurred with respect to any filing with the National Association of Securities Dealers, Inc. (the "NASD"), including the fees and disbursements of counsel for the Underwriters in connection therewith; (vi) all expenses arising from the quoting of the Shares on the Nasdaq National Market; (vii) all arrangements relating to the preparation, issuance and delivery to the Underwriters of any certificates evidencing the Shares, including transfer agent's and registrar's fees; and (viii) the costs and expenses of travel, lodging and meals of the Company's employees in connection with associated with the "roadshow" and any other meetings with prospective investors in the Shares (other than as shall have been specifically approved by the Representatives to be paid for by the Underwriters). Subject to the provisions of Section 10, the Underwriters agree to pay, whether or not the transactions contemplated hereby are consummated or this Agreement is terminated, all costs and expenses incident to the performance of obligations under this Agreement not payable by the Company pursuant to the preceding sentence, including, without limitation, all costs associated with the "roadshow" (other than as set forth in clause (viii) above) and the fees and disbursements of counsel to the Underwriters. (b) The Selling Stockholders shall bear and pay all costs and expenses incurred incident to the performance of their respective obligations under this Agreement, whether or not the transactions contemplated herein are consummated or this Agreement is terminated pursuant to Section 9 hereof, including: (i) any stamp duties, capital duties and stock transfer taxes, if any, payable upon the sale of the Shares of such Selling Stockholders to the Underwriters and (ii) the fees and disbursements of their respective counsel, accountants and other advisors. -8- 10 Section 5. Representations And Warranties. (a) As a condition of the obligation of the Underwriters to underwrite and pay for the Shares, the Company represents and warrants to, and agrees with, each of the several Underwriters as follows: REGISTRATION STATEMENT AND PROSPECTUS (i) If the Offering is a Rule 415 Offering (as specified in Schedule I hereto), paragraph (x) below is applicable and, if the Offering is a Rule 430A Offering (as so specified), paragraph (y) below is applicable. (x) The Company meets the requirements for use of Form S-3 under the Securities Act and has filed with the Commission the Original Registration Statement (the file number of which is set forth in Schedule I hereto) on such Form, including a Basic Prospectus, for registration under the Act of the offering and sale of the Shares, one or more amendments to such Registration Statement may have been so filed, and the Company may have used a Preliminary Prospectus. Such Registration Statement, as so amended, has become effective. The Offering is a Rule 415 Offering and, although the Basic Prospectus may not include all the information with respect to the Shares and the offering thereof required by the Securities Act and the rules thereunder to be included in the Prospectus, the Basic Prospectus includes all such information required by the Securities Act and the rules thereunder to be included therein as of the Effective Date. After the execution of this Agreement, the Company will file with the Commission pursuant to Rules 415 and 424(b)(2) or (5) a final supplement to the form of prospectus included in such Registration Statement relating to the Shares and the offering thereof, with such information as is required or permitted by the Securities Act and as has been provided to and approved by the Representatives prior to the date hereof or, to the extent not completed at the date hereof, containing only such specific additional information and other changes (beyond that contained in the Basic Prospectus and any Preliminary Prospectus) as the Company has advised you, prior to the date hereof, will be included or made therein. The Company may also file a Rule 462(b) Registration Statement with the Commission for the purpose of registering certain additional Shares, which registration shall be effective upon filing with the Commission. (y) The Company meets the requirements for the use of Form S-3 under the Securities Act and has filed with the Commission the Original Registration Statement (the file number of which is set forth in Schedule I hereto) on such Form, including a Basic Prospectus, for registration under the Securities Act of the offering and sale of the Shares, and one or more amendments to such Registration Statement, including a Preliminary Prospectus, may have been so filed. After the execution of this Agreement, the Company will file with the Commission either (I) if such Registration Statement, as it may have been amended, has been declared by the Commission to be effective under the Securities Act, either (A) if the Company relies on Rule 434 under the Securities Act, a Term Sheet relating to the Shares that shall identify the Preliminary Prospectus that it supplements containing such information as is required or permitted by Rules 434, 430A and 424(b) under the Securities Act or (B) if the Company does not rely on Rule 434 under the Securities Act, a prospectus in the form most recently included in an amendment to such Registration Statement (or, if no such amendment shall have been filed, in such Registration Statement), with such changes or insertions as are required by Rule 430A under the Securities Act or permitted by Rule 424(b) under the Securities Act, and in the case of either clause (A) or (B) of this sentence, as have been provided to and approved by the Representatives prior to the execution of this Agreement, or (II) if such Registration Statement, as it may have been amended, has not been declared by the Commission to be effective under the Securities Act, an amendment to such Registration Statement, including the form of final prospectus supplement to the Basic Prospectus, a copy of which amendment has been furnished to and approved by the -9- 11 Representatives prior to the execution of this Agreement or, to the extent not completed at the date hereof, containing only such specific additional information and other changes (beyond that contained in the Basic Prospectus and any Preliminary Prospectus) as the Company has advised you, prior to the date hereof, will be included or made therein. The Company may also file a Rule 462(b) Registration Statement with the Commission for the purpose of registering certain additional Shares, which registration shall be effective upon filing with the Commission. (ii) The Commission has not issued any order preventing or suspending the use of any Preliminary Prospectus. When any Preliminary Prospectus was filed with the Commission, it (x) contained all statements required to be stated therein in accordance with, and complied in all material respects with the requirements of, the Securities Act and the rules and regulations of the Commission thereunder and (y) did not include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. When the Registration Statement or any amendment thereto was or is declared effective, it (I) contained or will contain all statements required to be stated therein in accordance with, and complied or will comply in all material respects with the requirements of, the Securities Act and the rules and regulations of the Commission thereunder and (II) did not or will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein in the light of the circumstances under which they were made not misleading. When the Prospectus or any Term Sheet or any amendment or supplement to the Prospectus is filed with the Commission pursuant to Rule 424(b) (or, if the Prospectus or such amendment or supplement is not required to be so filed, when the Registration Statement or the amendment thereto containing the Prospectus or such amendment or supplement to the Prospectus was or is declared effective) and on the Closing Date, the Prospectus, as amended or supplemented at any such time, (A) contained or will contain all statements required to be stated therein in accordance with, and complied or will comply in all material respects with the requirements of, the Securities Act and the rules and regulations of the Commission thereunder and (B) did not or will not include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. The foregoing provisions of this paragraph (ii) do not apply to statements or omissions made in any Preliminary Prospectus, the Registration Statement or any amendment thereto or the Prospectus or any amendment or supplement thereto in reliance upon and in conformity with written information furnished to the Company by any Underwriter through the Representatives specifically for use therein. (iii) If the Company has elected to rely on Rule 462(b) and the Rule 462(b) Registration Statement is not effective, (x) the Company will file a Rule 462(b) Registration Statement in compliance with, and that is effective upon filing pursuant to, Rule 462(b) and (y) the Company has given irrevocable instructions for transmission of the applicable filing fee in connection with the filing of the Rule 462(b) Registration Statement, in compliance with Rule 111 under the Securities Act, or the Commission has received payment of such filing fee. (iv) The Company has not distributed and, prior to the later of (x) any Closing Date and (y) the completion of the distribution of the Shares, will not distribute any offering material in connection with the Offering other than the Registration Statement or any amendment thereto, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto. (v) Subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus (x) the Company and its Subsidiaries, taken as a whole, have not incurred any material liability or obligation, direct or contingent, nor entered into any material transaction not in the ordinary -10- 12 course of business; (y) the Company has not purchased any of its outstanding capital stock, nor declared, paid or otherwise made any dividend or distribution of any kind on its capital stock; and (z) there has not been any material change in the capital stock, short-term or long-term debt of the Company and its Subsidiaries, taken as a whole, except in each case as described in or contemplated by the Prospectus. THE SHARES (vi) The Company has an authorized, issued and outstanding capitalization as set forth in the Prospectus as of the date set forth therein. All of the issued shares of capital stock of the Company (including the Option Shares being offered by the Selling Stockholders) have been duly authorized and validly issued and are fully paid and nonassessable, have been issued in compliance with all applicable federal and state securities laws and were not issued in violation of or subject to any preemptive rights or other rights to subscribe for or purchase such securities. No holders of outstanding shares of capital stock of the Company are entitled as such to any preemptive or other rights to subscribe for any of the Shares, and no holder of securities of the Company has any right which has not been fully exercised or waived to require the Company to register the offer or sale of any securities owned by such holder under the Securities Act in the Offering contemplated by this Agreement. (vii) Except as disclosed in the Prospectus and except for options granted pursuant to qualified option plans and disclosed to the Representatives, there are no outstanding (x) securities or obligations of the Company or any of its Subsidiaries convertible into or exchangeable for any capital stock of the Company or any such Subsidiary, (y) warrants, rights or options to subscribe for or purchase from the Company or any such Subsidiary any such capital stock or any such convertible or exchangeable securities or obligations, or (z) obligations of the Company or any such Subsidiary to issue any shares of capital stock, any such convertible or exchangeable securities or obligations, or any such warrants, rights or options. (viii) Except for the shares of capital stock of each of the Subsidiaries owned by the Company and such Subsidiaries, neither the Company nor any such Subsidiary owns any shares of stock or any other equity securities of any corporation or has any equity interest in any firm, partnership, association or other entity, except as described in or contemplated by the Prospectus. LISTING (ix) All of the Shares have been duly authorized and accepted for quotation on the Nasdaq National Market, subject to official notice of issuance. MARKET MANIPULATION (x) Neither the Company nor any of its affiliates, nor any person acting on behalf of any of them has, directly or indirectly, (A) taken any action designed to cause or to result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Shares, or (B) since the filing of the Original Registration Statement (I) sold, bid for, purchased, or paid anyone any compensation for soliciting purchases of, the Shares or (II) paid or agreed to pay to any person any compensation for soliciting another to purchase any other securities of the Company. -11- 13 CORPORATE POWER AND AUTHORITY (xi) The Company has been duly incorporated and is validly existing as a corporation in good standing under the law of its jurisdiction of incorporation with full power and authority to own, lease and operate its properties and assets and conduct its business as described in the Prospectus, is duly qualified to transact business and is in good standing in each jurisdiction in which its ownership, leasing or operation of its properties or assets or the conduct of its business requires such qualification, except where the failure to be so qualified does not amount to a material liability or disability to the Company and its Subsidiaries, taken as a whole, and has full power and authority to execute and perform its obligations under this Agreement; each Subsidiary of the Company is a corporation duly incorporated and validly existing as a corporation in good standing under the laws of its jurisdiction of incorporation and is duly qualified to transact business and is in good standing in each jurisdiction in which its ownership, leasing or operation of its properties or assets or the conduct of its business requires such qualification, except where the failure to be so qualified does not amount to a material liability or disability to the Company and its Subsidiaries, taken as a whole, and each has full power and authority to own, lease and operate its properties and assets and conduct its business as described in the Registration Statement and the Prospectus; none of the Company's subsidiaries is a "significant subsidiary" as defined in Section 1-02 (w) of Regulation S-X; all of the issued and outstanding shares of capital stock (other than statutory nominal stockholdings) of each of the Company's Subsidiaries have been duly authorized and are fully paid and nonassessable and except as otherwise set forth in the Prospectus (and except Aptex Software Inc., which is __% owned by the Company), are owned beneficially by the Company or one of its Subsidiaries free and clear of any security interests, liens, encumbrances, equities or claims. (xii) The execution and delivery of this Agreement and the issuance and sale of the Shares have been duly authorized by all necessary corporate action of the Company, and this Agreement has been duly executed and delivered by the Company and is the valid and binding agreement of the Company, enforceable against the Company in accordance with its terms, except (x) as the enforceability thereof may be limited by bankruptcy, insolvency, federal or state fraudulent conveyance or transfer laws, and reorganization, moratorium or other similar laws affecting the enforcement of creditors' rights generally and by general equitable principles and (y) except to the extent that rights to indemnity or contribution under this Agreement may be limited by federal and state securities laws or the public policy underlying such laws. (xiii) The execution and delivery by the Company of, and compliance by the Company with the provisions of, and performance of its obligations under, this Agreement and the consummation of the other transactions herein contemplated do not (x) require the consent, approval, authorization, registration or qualification of or with any governmental authority, except (I) if the Company has elected to rely on Rule 462(b) and the Rule 462(b) Registration Statement is not effective, the registration of certain Shares pursuant to the Rule 462(b) Registration Statement that will be effective upon filing in compliance with Rule 462 (b) and (II) such as have been obtained or made or such as may be required by the state securities or Blue Sky laws of the various states of the United States of America or other U.S. jurisdictions in connection with the offer and sale of the Shares by the Underwriters, or (y) conflict with or result in a breach or violation of any of the terms and provisions of, or constitute a default under, (I) any indenture, mortgage, deed of trust, lease or other agreement or instrument to which the Company or any of its Subsidiaries is a party or by which the Company or any of its Subsidiaries or any of their respective properties are bound, except as would not individually or in the aggregate have a materially adverse effect on or constitute a materially adverse change in the condition (financial or otherwise), earnings, properties, business affairs or business prospects, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, or the ability of the Company to perform its obligations under this Agreement, or (II) the charter documents or by-laws of the Company or any -12- 14 of its Subsidiaries, or (III) any statute or any judgment, decree, order, rule or regulation of any court or other governmental authority or any arbitrator applicable to the Company or any of its Subsidiaries. (xiv) The Company is not, and will conduct its operations in a manner so that it continues not to be, an "investment company" and, after giving effect to the Offering and the application of the proceeds therefrom, will not be an "investment company", as such term is defined in the Investment Company Act of 1940, as amended (the "1940 Act"). TITLE, LICENSES AND CONSENTS (xv) The Company and each of its Subsidiaries have good and marketable title in fee simple to all items of real property and marketable title to all personal property owned by each of them, in each case free and clear of any security interests, liens, encumbrances, equities, claims and other defects, except such as do not materially and adversely affect the use of such property and do not interfere with the use made or proposed to be made of such property by the Company or such Subsidiary, and any real property and buildings held under lease by the Company or any such Subsidiary are held under valid, subsisting and enforceable leases, with such exceptions as are not material and do not interfere with the use made or proposed to be made of such property and buildings by the Company or such Subsidiary, in each case except as described in or contemplated by the Prospectus. (xvi) Except as disclosed in the Prospectus, the Company and each of its Subsidiaries have the right to use or can acquire on reasonable terms all trademarks, trade names, trade secrets, service marks, inventions, patent rights, mask works, copyrights, licenses, software code, audiovisual works, formats, algorithms and underlying data, approvals and governmental authorizations now used in, or which are necessary for fulfillment of their respective obligations or the conduct of, their respective businesses as now conducted or proposed to be conducted as described in the Prospectus; except as discussed in the Prospectus, the expiration of any trademarks, trade names, trade secrets, service marks, inventions, patent rights, mask works, copyrights or licenses would not have a material adverse effect on the condition (financial or otherwise), earnings, properties, business affairs or business prospects, stockholders' equity, net worth or results of operations of the Company; and neither the Company nor any of its Subsidiaries is infringing any trademark, trade name rights, patent rights relating to patents that have issued, mask works, copyrights, licenses, trade secret, service marks or other similar rights of others, and there is no claim being made against the Company or any of its Subsidiaries regarding trademark, trade name, patent, mask work, copyright, license, trade secret or other infringement or assertion of intellectual property rights which could have a material adverse effect on the earnings, properties, business affairs or business prospects, stockholders' equity, net worth or results of operations of the Company. The Company has agreements in place with such employees, consultants or other persons or parties engaged by the Company or any Subsidiary sufficient to enable the Company and any subsidiary to fulfill their contractual obligations and to conduct their respective businesses as now conducted as described in the Prospectus and providing for the assignment to the Company of all intellectual property rights in the work performed and the protection of the trade secrets and confidential information of the Company, each of its Subsidiaries and of third parties. (xvii) The Company and its Subsidiaries possess all consents, licenses, certificates, authorizations and permits issued by the appropriate federal, state or foreign regulatory authorities necessary to conduct their respective businesses, and neither the Company nor any such Subsidiary has received any notice of proceedings relating to the revocation or modification of any such certificate, authorization or permit which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, would have a materially adverse effect on or constitute a materially adverse change in, or constitute a development involving a -13- 15 prospective materially adverse effect on or change in, the condition (financial or otherwise), earnings, properties, business affairs or business prospects, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, except as described in or contemplated by the Prospectus. FINANCIAL STATEMENTS (xviii) Price Waterhouse LLP, who have certified certain financial statements of the Company and its consolidated Subsidiaries and delivered their report with respect to the audited consolidated financial statements and schedules included or incorporated by reference in the Registration Statement and the Prospectus, are independent public accountants as required by the Securities Act and the applicable rules and regulations thereunder. (xix) The consolidated financial statements and schedules of the Company and its consolidated Subsidiaries included or incorporated in the Registration Statement and the Prospectus were prepared in accordance with generally accepted accounting principles ("GAAP") consistently applied throughout the periods involved (except as otherwise noted therein) and they present fairly the consolidated financial condition of the Company as at the dates at which they were prepared and the consolidated results of operations of the Company in respect of the periods for which they were prepared. INTERNAL ACCOUNTING CONTROLS (xx) The Company and each of its Subsidiaries maintain a system of internal accounting controls sufficient to provide reasonable assurance that (w) transactions are executed in accordance with management's general or specific authorizations; (x) transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP and to maintain asset accountability; (y) access to assets is permitted only in accordance with management's general or specific authorization; and (z) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. LITIGATION (xxi) No legal or governmental proceedings are pending or to the Company's knowledge threatened to which the Company or any of its Subsidiaries is a party or to which the property of the Company or any of its Subsidiaries is subject that are required to be described in the Registration Statement or the Prospectus and are not described therein; and no statutes, regulations, contracts or other documents that are required to be described or incorporated in the Registration Statement or the Prospectus or to be filed as exhibits to the Registration Statement are not described or incorporated therein or filed as required. DIVIDENDS AND DISTRIBUTIONS (xxii) Except as disclosed in the Prospectus under the caption "Dividend Policy" or restricted by applicable law, no Subsidiary of the Company is currently prohibited, directly or indirectly, from paying any dividends to the Company, making any other distribution on such Subsidiary's capital stock, repaying to the Company any loans or advances to such Subsidiary from the Company or transferring any of such Subsidiary's property or assets to the Company or any other Subsidiary of the Company, and the Company is not currently prohibited, directly or indirectly, from paying any dividends or making any other distribution on its capital stock, in each case except as described in or contemplated by the Prospectus or prohibited by applicable law. -14- 16 TAXES (xxiii) The Company has filed all foreign, federal, state and local tax returns that are required to be filed or has requested extensions thereof (except in any case in which the failure so to file would not have a materially adverse effect on the Company and its Subsidiaries, taken as a whole) and has paid all taxes required to be paid by it and any other assessment, fine or penalty levied against it, to the extent that any of the foregoing is due and payable, except for any such assessment, fine or penalty that is currently being contested in good faith or as described in or contemplated by the Prospectus. INSURANCE (xxiv) The Company and each of its Subsidiaries are insured by insurers of recognized financial responsibility against such losses and risks and in such amounts as are prudent and customary in the businesses in which they are engaged; neither the Company nor any such Subsidiary has been refused any insurance coverage sought or applied for; and neither the Company nor any such Subsidiary has any reason to believe that it will not be able to renew its existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business at a cost that would not materially and adversely affect the condition (financial or otherwise), earnings, properties, business affairs or business prospects, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, except as described in or contemplated by the Prospectus. PENSION AND LABOR (xxv) The Company is in compliance in all material respects with all presently applicable provisions of the Employee Retirement Income Security Act of 1974, as amended, including the regulations and published interpretations thereunder ("ERISA"); no "reportable event" (as defined in ERISA) has occurred with respect to any "pension plan" (as defined in ERISA) for which the Company would have any liability; the Company has not incurred and does not expect to incur liability under (x) Title IV of ERISA with respect to termination of, or withdrawal from, any "pension plan" or (y) Sections 412 or 4971 of the Internal Revenue Code of 1986, as amended, including the regulations and published interpretations thereunder (the "Code"); and each "pension plan" for which the Company would have any liability that is intended to be qualified under Section 401(a) of the Code is so qualified in all material respects and nothing has occurred, whether by action or by failure to act, which would cause the loss of such qualification. (xxvi) No labor dispute with the employees of the Company or any of its Subsidiaries exists or is threatened or imminent that could have a materially adverse effect on or constitute a materially adverse change in, or constitute a development involving a prospective materially adverse effect on or change in, the condition (financial or otherwise), properties, management, earnings, business affairs or business prospects, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, except as described in or contemplated by the Prospectus. ENVIRONMENTAL (xxvii)Neither the Company nor any of its Subsidiaries is in violation of any federal or state law or regulation relating to occupational safety and health or to the storage, handling or transportation of hazardous or toxic materials and the Company and its Subsidiaries have received all permits, licenses or other approvals required of them under applicable federal and state occupational safety and health and environmental laws and regulations to conduct their respective businesses, and the Company and each such Subsidiary is in -15- 17 compliance with all terms and conditions of any such permit, license or approval, except any such violation of law or regulation, failure to receive required permits, licenses or other approvals or failure to comply with the terms and conditions of such permits, licenses or approvals which would not, singly or in the aggregate, have a materially adverse effect on or constitute a materially adverse change in, or constitute a development involving a prospective materially adverse effect on or change in, the condition (financial or otherwise), earnings, properties, business affairs or business prospects, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, except as described in or contemplated by the Prospectus. OTHER AGREEMENTS (xxviii) No default by the Company or any of its Subsidiaries exists, and no event has occurred which, with notice or lapse of time or both, would constitute a default in the due performance and observance of any term, covenant or condition of any indenture, mortgage, deed of trust, lease or other agreement or instrument to which the Company or any of its Subsidiaries is a party or by which the Company or any of its Subsidiaries or any of their respective properties is bound, where such default could have a material adverse effect on the condition (financial or otherwise), properties, management, earnings, business affairs or business prospects, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, or the ability of the Company to perform its obligations under this Agreement . ABSENCE OF MATERIALLY ADVERSE CHANGE (xxix) Subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, neither the Company nor any of its Subsidiaries has sustained any material loss or interference with their respective businesses or properties from fire, flood, hurricane, accident or other calamity, whether or not covered by insurance, or from any labor dispute or any legal or governmental proceeding, and there has been no materially adverse change (including, without limitation, a change in management or control), or development involving a prospective materially adverse change, in the condition (financial or otherwise), management, earnings, property, business affairs or business prospects, stockholders' equity, net worth or results of operations of the Company or any of its Subsidiaries, taken as a whole, other than as described in or contemplated by the Prospectus (exclusive of any amendments or supplements thereto). (xxx) No receiver or liquidator (or similar person) has been appointed in respect of the Company or any Subsidiary of the Company or in respect of any part of the assets of the Company or any Subsidiary of the Company; no resolution, order of any court, regulatory body, governmental body or otherwise, or petition or application for an order, has been passed, made or to the Company's knowledge presented for the winding up of the Company or any Subsidiary of the Company or for the protection of the Company or any such Subsidiary from its creditors; and the Company has not, and no Subsidiary of the Company has, stopped or suspended payments of its debts, become unable to pay its debts or otherwise become insolvent. (b) As a further condition of the obligation of the Underwriters to underwrite and pay for the Shares, each Selling Stockholder severally represents and warrants to, and agrees with, each of the several Underwriters that: (i) Such Selling Stockholder has full power to enter into this Agreement and to sell, assign, transfer and deliver to the Underwriters the Shares to be sold by such Selling Stockholder hereunder in accordance with the terms of this Agreement; and this Agreement has been duly executed and delivered by such Selling Stockholder. -16- 18 (ii) Such Selling Stockholder has duly executed and delivered a power of attorney and custody agreement (with respect to such Selling Stockholder, the "Power-of-Attorney" and the "Custody Agreement", respectively) each in the form heretofore delivered to the Representatives, appointing Robert L. North and Raymond V. Thomas as such Selling Stockholder's attorney-in-fact (the "Attorney-in-Fact") with authority to execute, deliver and perform this Agreement on behalf of such Selling Stockholder and appointing the BancBoston, N.A. as custodian thereunder (the "Custodian"). Certificates in negotiable form, endorsed in blank or accompanied by blank stock powers duly executed, with signatures appropriately guaranteed, representing the Shares to be sold by such Selling Stockholder hereunder (other than Shares issuable upon exercise of vested stock options) have been deposited with the Custodian pursuant to the Custody Agreement for the purpose of delivery pursuant to this Agreement. Such Selling Stockholder has full power to enter into the Custody Agreement and the Power-of-Attorney and to perform its obligations under the Custody Agreement. The execution and delivery of the Custody Agreement and the Power-of-Attorney have been duly authorized by all necessary action of such Selling Stockholder; the Custody Agreement and the Power-of-Attorney have been duly executed and delivered by such Selling Stockholder and, assuming due authorization, execution and delivery by the Custodian, are the legal, valid, binding and enforceable instruments of such Selling Stockholder. Such Selling Stockholder agrees that each of the Shares represented by the certificates on deposit with the Custodian is subject to the interests of the Underwriters hereunder, that the arrangements made for such custody, the appointment of the Attorney-in-Fact and the right, power and authority of the Attorney-in-Fact to execute and deliver this Agreement, to agree on the price at which the Shares (including such Selling Stockholder's Shares) are to be sold to the Underwriters, and to carry out the terms of this Agreement, are to that extent irrevocable and that the obligations of such Selling Stockholder hereunder shall not be terminated, except as provided in this Agreement or the Custody Agreement, by any act of such Selling Stockholder, by operation of law or otherwise, whether by the death or incapacity of such Selling Stockholder or by the occurrence of any other event. If any Selling Stockholder should die or if any other event should occur before the delivery of such Shares hereunder, the certificates for such Shares deposited with the Custodian shall be delivered by the Custodian in accordance with the respective terms and conditions of this Agreement as if such death or other event had not occurred, regardless of whether or not the Custodian or the Attorney-in-Fact shall have received notice thereof. (iii) Such Selling Stockholder has good and valid title to the Shares to be sold by the Selling Stockholder hereunder and upon sale and delivery of, and payment for, such Shares, as provided herein, each Selling Stockholder will convey good and valid title to such Shares, free and clear of any security interests, liens, encumbrances, equities, claims or other defects. (iv) Neither such Selling Stockholder nor any person acting on behalf of it has, directly or indirectly, (x) taken any action designed to cause or to result in, or that has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Shares or (y) since the filing of the Original Registration Statement (I) sold, bid for, purchased, or paid anyone any compensation for soliciting purchases of, the Shares or (II) paid or agreed to pay to any person any compensation for soliciting another to purchase any other securities of the Company (except for the sale of Shares by the Selling Stockholders under this Agreement). (v) Such Selling Stockholder has reviewed the Prospectus and the Registration Statement, and the information regarding such Selling Stockholder set forth therein under the caption "Selling Stockholders" is complete and accurate. All information furnished in writing by or on behalf of such Selling Stockholder for use in the Registration Statement is, and on each Closing Date will be, true, correct and complete, and does not, and on such Closing Date will not, contain any untrue statement of a material fact or omit to state any material fact necessary to make such information not misleading, and all information -17- 19 furnished in writing by or on behalf of such Selling Stockholder for use in the Prospectus is, and on such Closing Date will be, true, correct and complete, and does not, and on such Closing Date will not, contain any untrue statement of a material fact or omit to state any material fact necessary to make such information not misleading in the light of the circumstances under which they were made. (vi) The sale by such Selling Stockholder of Shares pursuant hereto is not prompted by any adverse information concerning the Company that is not set forth in the Registration Statement or Prospectus. (vii) Neither such Selling Stockholder nor any of its affiliates directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, or has any other association with (within the meaning of Article I, Section 1(m) of the By-laws of the NASD), any member firm of the NASD. (viii) The sale of the Shares to the Underwriters by such Selling Stockholder pursuant to this Agreement, the compliance by such Selling Stockholder with the other provisions of this Agreement, the Custody Agreement and the consummation of the other transactions herein contemplated do not (i) require the consent, approval, authorization, registration or qualification of or with any governmental authority, except such as have been obtained, such as may be required under foreign or state securities or blue sky laws, such as may be requested under the Securities Exchange Act of 1934, as amended, and, if the registration statement filed with respect to the Shares (as amended) is not effective under the Securities Act as of the time of execution hereof, such as may be required (and shall be obtained as provided in this Agreement) under the Securities Act, or (ii) conflict with or result in a breach or violation of any of the terms and provisions of, or constitute a default under any indenture, mortgage, deed of trust, lease or other agreement or instrument to which such Selling Stockholder or is a party or by which such Selling Stockholder or any of its properties are bound, or any statute or any judgment, decree, order, rule or regulation of any court or other governmental authority or any arbitrator applicable to such Selling Stockholder. (ix) Such Selling Stockholder has not distributed and, prior to the later of (x) any Closing Date and (y) the completion of the distribution of the Shares, will not distribute any offering material in connection with the offering other than the Registration Statement or any amendment thereto, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto. (c) The above representations and warranties with respect to the Company shall be deemed to be repeated at each Closing and with respect to each Selling Stockholder at each Closing where such Selling Stockholder is selling Shares to the Underwriters, and all references therein to the Shares and the Closing Date shall be deemed to refer to the Firm Shares or the Option Shares and the First Closing Date or the applicable Option Closing Date, each as applicable. Section 6. Indemnity. (a) The Company agrees to indemnify and hold harmless each Underwriter and each person, if any, who controls any Underwriter within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act, against any and all losses, claims, damages or liabilities, joint or several, to which such Underwriter or such controlling person may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon: -18- 20 (i) any untrue statement or alleged untrue statement made by the Company in Section 5 hereof, (ii) any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement or any amendment thereto, the Basic Prospectus, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto, or (iii) the omission or alleged omission to state in the Registration Statement or any amendment thereto, the Basic Prospectus, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto a material fact required to be stated therein, or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, and will reimburse, as incurred, each Underwriter and each such controlling person for any legal or other costs or expenses reasonably incurred by such Underwriter or such controlling person in connection with investigating, defending against or appearing as a third-party witness in connection with any such loss, claim, damage, liability or action; provided, however, that the Company will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission made in the Registration Statement or any amendment thereto, the Basic Prospectus, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto in reliance upon and in conformity with written information furnished to the Company by such Underwriter through the Representatives specifically for use therein; and provided further, that the Company will not be liable to any Underwriter or any person controlling such Underwriter with respect to any such untrue statement, alleged untrue statement, omission or alleged omission made in any Preliminary Prospectus that is corrected in the Prospectus (or any amendment or supplement thereto) if the person asserting any such loss, claim, damage or liability purchased Shares from such Underwriter but was not sent or given a copy of the Prospectus (as amended or supplemented) in any case where such delivery of the Prospectus (as amended or supplemented) was required by the Securities Act, unless such failure to deliver the Prospectus (as amended or supplemented) was a result of noncompliance by the Company with Section 3 hereof. The indemnity provided for in this Section 6 shall be in addition to any liability which the Company may otherwise have. The Company will not, without the prior written consent of the Representatives, settle or compromise or consent to the entry of any judgment in any pending or threatened claim, action, suit or proceeding in respect of which indemnification may be sought hereunder (whether or not any such Representatives or any person who controls any such Representatives is a party to such claim, action, suit or proceeding), unless such settlement, compromise or consent includes an unconditional release of all of the Underwriters and such controlling persons from all liability arising out of such claim, action, suit or proceeding. (b) Each of the Selling Stockholders agrees, severally and not jointly, to indemnify and hold harmless each Underwriter and each person, if any, who controls any Underwriter within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act, against any and all losses, claims, damages or liabilities, joint or several, to which such Underwriter or such controlling person may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement made by any of the Selling Stockholders in Section 5 hereof, and will reimburse, as incurred, each Underwriter and each such controlling person for any legal or other costs or expenses reasonably incurred by such Underwriter or such controlling person in connection with investigating, defending against or appearing as a third-party witness in connection with any such loss, claim, damage, liability or action; provided, however, that the Selling Stockholders will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon any untrue statement or alleged untrue statement or omission or alleged omission -19- 21 made in the Registration Statement or any amendment thereto, the Basic Prospectus, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto in reliance upon and in conformity with written information furnished to the Company by such Underwriter through the Representatives specifically for use therein; and provided further, that such Selling Stockholder will not be liable to any Underwriter or any person controlling such Underwriter with respect to any such untrue statement or omission made in any Preliminary Prospectus that is corrected in the Prospectus (or any amendment or supplement thereto) if the person asserting any such loss, claim, damage or liability purchased Shares from such Underwriter but was not sent or given a copy of the Prospectus (as amended or supplemented) in any case where such delivery of the Prospectus (as amended or supplemented) was required by the Securities Act, unless such failure to deliver the Prospectus (as amended or supplemented) was a result of noncompliance by the Company with Section 3 hereof. The indemnity provided for in this Section 6 shall be in addition to any liability which the Selling Stockholders may otherwise have. None of the Selling Stockholders will, without the prior written consent of the Representatives, settle or compromise or consent to the entry of any judgment in any pending or threatened claim, action, suit or proceeding in respect of which indemnification may be sought hereunder (whether or not any such Representatives or any person who controls any such Representatives is a party to such claim, action, suit or proceeding), unless such settlement, compromise or consent includes an unconditional release of all of the Underwriters and such controlling persons from all liability arising out of such claim, action, suit or proceeding. The liability of each Selling Stockholder under this Section 6 shall not exceed the net proceeds from the Offering received by such Selling Stockholder. (c) Each Underwriter, severally and not jointly, will indemnify and hold harmless the Company, each of its directors, each of its officers who signed the Registration Statement, each Selling Stockholder and each person, if any, who controls the Company or Selling Stockholder within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act against any losses, claims, damages or liabilities to which the Company or any such director, officer, Selling Stockholder or controlling person may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement or any amendment thereto, the Basic Prospectus, any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto or (ii) the omission or the alleged omission to state in the Registration Statement or any amendment thereto, the Basic Prospectus any Preliminary Prospectus or the Prospectus or any amendment or supplement thereto a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to the Company by such Underwriter through the Representatives specifically for use therein, and, subject to the limitation set forth immediately preceding this clause, will reimburse, as incurred, any legal or other expenses reasonably incurred by the Company or any such director, officer, Selling Stockholder or controlling person in connection with investigating, defending against or appearing as a third-party witness in connection with any such loss, claim, damage, liability or any action in respect thereof. The remedies provided for in this Section 6 are not exclusive and shall not limit any rights or remedies which may otherwise be available to any indemnified party at law or in equity. No Underwriter will, without the prior written consent of the Company, settle or compromise or consent to the entry of any judgment in any pending or threatened claim, action, suit or proceeding in respect of which indemnification may be sought hereunder (whether or not the Company, any of its officers and directors, or any controlling person, Selling Stockholder or controlling person of such Selling Stockholder, is a party to such claim, action, suit or proceeding), unless such settlement, compromise or consent includes an unconditional release of the Company and such directors, officers and controlling persons, the Selling Stockholder or controlling person of such Selling Stockholder from all liability arising out of such claim, action, suit or proceeding. -20- 22 (d) In case any proceeding (including any governmental investigation) shall be instituted involving any person in respect of which indemnity may be sought pursuant to paragraph (a), (b) or (c) of this Section 6, such person (for purposes of paragraphs (d) and (e) of this Section 6, the "indemnified party") shall, promptly after receipt by such party of notice of the commencement of such action, notify the person against whom such indemnity may be sought (for purposes of paragraphs (d) and (e) of this Section 6, the "indemnifying party"), but the omission so to notify the indemnifying party will not relieve it from any liability which it may have to any indemnified party otherwise than under this Section 6. In case any such action is brought against any indemnified party, and it notifies the indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel reasonably satisfactory to such indemnified party; provided, however, that if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded (based upon the advice of its counsel) that there may be one or more legal defenses available to it and/or other indemnified parties which are different from or additional to those available to the indemnifying party, the indemnifying party shall not have the right to direct the defense of such action on behalf of such indemnified party or parties and such indemnified party or parties shall have the right to select separate counsel to defend such action on behalf of such indemnified party or parties. After notice from the indemnifying party to such indemnified party of its election so to assume the defense of any such action and approval by such indemnified party of counsel appointed to defend such action, the indemnifying party will not be liable to such indemnified party under this Section 6 for any legal or other expenses, other than reasonable costs of investigation, subsequently incurred by such indemnified party in connection with the defense thereof, unless (i) the indemnified party shall have employed separate counsel in accordance with the proviso to the next preceding sentence (it being understood, however, that in connection with such action the indemnifying party shall not be liable for the expenses of more than one separate counsel (in addition to local counsel) in any one action or separate but substantially similar actions in the same jurisdiction arising out of the same general allegations or circumstances), or (ii) the indemnifying party does not promptly retain counsel satisfactory to the indemnified party, or (iii) the indemnifying party has authorized in writing the employment of counsel for the indemnified party at the expense of the indemnifying party. All fees and expenses to be reimbursed pursuant to this paragraph (d) shall be reimbursed as they are incurred. After such notice from the indemnifying party to such indemnified party, the indemnifying party will not be liable for the costs and expenses of any settlement of such action effected by such indemnified party without the consent of the indemnifying party. (e) In circumstances in which the indemnity agreement provided for in the preceding paragraphs of this Section 6 is unavailable or insufficient, for any reason, to hold harmless an indemnified party in respect of any losses, claims, damages or liabilities (or actions in respect thereof) purporting to be covered thereby, each indemnifying party, in order to provide for just and equitable contribution, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions in respect thereof) in such proportion as is appropriate to reflect (i) the relative benefits received by the indemnifying party or parties on the one hand and the indemnified party on the other from the Offering or (ii) if the allocation provided by the foregoing clause (i) is not permitted by applicable law, not only such relative benefits but also the relative fault of the indemnifying party or parties on the one hand and the indemnified party on the other in connection with the statements or omissions or alleged statements or omissions that resulted in such losses, claims, damages or liabilities (or actions in respect thereof), as well as any other relevant equitable considerations. The relative benefits received by the Company and the Selling Stockholders on the one hand and the Underwriters on the other shall be deemed to be in the same proportion as the total proceeds from the Offering (before deducting expenses) received by the Company and the Selling Stockholders bear to the total underwriting discounts and commissions received by the Underwriters. The relative fault of the parties shall be determined by reference to, among other things, whether the untrue or alleged untrue -21- 23 statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company, the Selling Stockholders or the Underwriters, the parties' relative intents, knowledge, access to information and opportunity to correct or prevent such statement or omission, and any other equitable considerations appropriate in the circumstances. The Company, the Selling Stockholders and the Underwriters agree that it would not be equitable if the amount of such contribution were determined by pro rata or per capita allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation that does not take into account the equitable considerations referred to above in this paragraph (e). Notwithstanding any other provision of this paragraph (e), no Underwriter shall be obligated to make contributions hereunder that in the aggregate exceed the total public offering price of the Shares purchased by such Underwriter under this Agreement, less the aggregate amount of any damages that such Underwriter has otherwise been required to pay in respect of the same or any substantially similar claim, and no Selling Stockholder shall be required to contribute any amount in excess of the lesser of (x) the amount by which the proceeds (after deducting underwriting discounts or commission) received by such Selling Stockholder or (y) such Selling Stockholder's pro rata liability based on the number of shares of Common Stock sold by such Selling Stockholder relative to the overall size of the offering, exceeds the amount of any damages which such Selling Stockholder has otherwise been required to pay in respect of the same or any substantially similar claim, and no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations to contribute hereunder are several in proportion to their respective underwriting obligations and not joint, and contributions among Underwriters shall be governed by the provisions of the Deutsche Morgan Grenfell Inc. Master Agreement Among Underwriters. For purposes of this paragraph (e), each person, if any, who controls an Underwriter within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act shall have the same rights to contribution as such Underwriter, and each director of the Company, each officer of the Company who signed the Registration Statement, each Selling Stockholder and each person, if any, who controls the Company within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act, shall have the same rights to contribution as the Company or such Selling Stockholder, as the case may be. Section 7. Conditions Precedent. The obligations of the several Underwriters to purchase and pay for the Shares shall be subject, in the Representatives' reasonable discretion, to (i) the accuracy of the representations and warranties of the Company and the Selling Stockholders contained herein as of the date hereof and as of each Closing Date on which the Company and the Selling Stockholders propose to sell Shares to the Underwriter, in each case, as if made on and as of each Closing Date, (ii) the performance by the Company and the Selling Stockholders of their respective covenants and agreements hereunder required to be performed or satisfied at or prior to the Closing Date, and (iii) the following additional conditions: (a) (i)If the Original Registration Statement or any amendment thereto filed prior to the First Closing Date has not been declared effective as of the time of execution hereof, the Original Registration Statement or such amendment shall have been declared effective not later than 6:00 P.M. New York City time on the date of determination of the public offering price, if such determination occurred at or prior to 4:30 P.M. New York City time on such date, or 12:00 Noon New York City time on the business day following the day on which the public offering price was determined, if such determination occurred after 4:30 P.M. New York City time on such date, and (ii) if the Company has elected to rely upon Rule 462(b), the Rule 462(b) Registration Statement shall have been declared effective not later than the time confirmations are sent or given as specified by Rule 462(b)(2), or such later time and date as shall have been consented to by the Representatives; if required, the Prospectus or any Term Sheet that constitutes a part thereof and any amendment or supplement -22- 24 thereto shall have been filed with the Commission in the manner and within the time period required by Rule 424(b) under the Securities Act; no stop order suspending the effectiveness of the Registration Statement or any amendment thereto shall have been issued, and no proceedings for that purpose shall have been instituted or threatened or, to the knowledge of the Company or the Representatives, shall be contemplated by the Commission; and the Company shall have complied with any request of the Commission for additional information (to be included in the Registration Statement or the Prospectus or otherwise). (b) The Representatives shall have received a legal opinion from Fenwick & West LLP, counsel for the Company, dated the Closing Date, to the effect that: (i) the Registration Statement is effective under the Securities Act; any required filing of the Prospectus, or any Term Sheet that constitutes a part thereof, pursuant to Rules 434 and 424(b) has been made in the manner and within the time period required by Rules 434 and 424(b); and to its knowledge, no stop order suspending the effectiveness of the Registration Statement or any amendment thereto has been issued and, to its knowledge, no proceedings for that purpose are pending or threatened by the Commission; (ii) the Original Registration Statement and each amendment thereto, any Rule 462(b) Registration Statement and the Prospectus (in each case, other than the financial statements and other financial and statistical information contained therein, as to which such counsel need express no opinion), excluding in each case the documents incorporated by reference therein, comply as to form in all material respects with the applicable requirements of the Securities Act and the rules and regulations of the Commission thereunder; (iii) the documents incorporated by reference in the Prospectus (in each case other than the financial statements and other financial and statistical information contained therein, as to which such counsel need express no opinion), when they became effective or were filed with the Commission, as the case may be, complied as to form in all material respects with the applicable requirements of the Securities Act or the Exchange Act, as applicable, and the rules and regulations of the Commission thereunder; (iv) at December 31, 1997, the Company had an authorized, issued and outstanding capitalization as set forth in the "Capitalization" section of the Prospectus; all of the shares of capital stock issued and outstanding prior to the sale of the Shares have been duly authorized and validly issued and, assuming payment therefor in accordance with the resolutions authorizing such issuances or in accordance with the terms of the applicable option or warrant, as the case may be, are fully paid and nonassessable; and none of such shares of capital stock was issued in violation of any statutory preemptive or, to such counsel's knowledge, other similar rights; to such counsel's knowledge, no holders of outstanding shares of capital stock of the Company are entitled as such to any preemptive or other rights to subscribe for any of the Shares; and to such counsel's knowledge no holder of securities of the Company has any right which has not been fully exercised or waived to require the Company to register the offer or sale of any securities owned by such holder under the Securities Act in the Offering contemplated by this Agreement; (v) all of the Shares have been duly authorized and accepted for quotation on the Nasdaq National Market, subject to official notice of issuance; (vi) the Company and each of its domestic Subsidiaries have been duly organized and are validly existing as corporations in good standing under the laws of their respective jurisdictions of incorporation; based solely on certificates from public officials, such counsel confirms that the Company and each of its domestic Subsidiaries are duly qualified to transact business in the jurisdictions set forth under their respective names in the list attached as Schedule IV; to such counsel's knowledge the Company and each of its -23- 25 domestic Subsidiaries have the corporate power and corporate authority to own, lease and operate their respective properties and assets and conduct their respective businesses as described in the Registration Statement and the Prospectus, and the Company has corporate power to enter into this Agreement and to carry out all the terms and provisions hereof to be carried out by it; all of the issued and outstanding shares of capital stock of each of the Company's domestic Subsidiaries have been duly authorized and validly issued, are, to its knowledge, fully paid and nonassessable and, except as otherwise set forth in the Registration Statement, are owned beneficially by the Company or one if its Subsidiaries free and clear of any perfected security interests or, to the knowledge of such counsel, any other security interests, liens, encumbrances, equities or claims; (vii) the statements set forth under the headings "Description of Capital Stock"; and "Underwriting" in the Prospectus, and under Item 15 in the Registration Statement, insofar as such statements constitute a summary of the legal matters, documents or proceedings referred to therein, have been reviewed by such counsel and fairly present the information called for with respect to such legal matters, documents and proceedings in all material respects as required by the Securities Act and the Exchange Act and the respective rules and regulations thereunder; (viii) the execution and delivery of this Agreement have been duly authorized by all necessary corporate action of the Company and this Agreement has been duly executed and delivered by the Company; (ix) the execution and delivery by the Company of, and compliance by the Company with, the provisions of, and performance of its obligations under, this Agreement, and the consummation of the other transactions contemplated in this Agreement and the Registration Statement do not (x) require the consent, approval, authorization, registration or qualification of or with any governmental authority, except such as have been obtained or made (and specified in such opinion) or such as may be required by the securities or Blue Sky laws of the United States of America, or any state thereof, or any foreign jurisdiction or under the bylaws or rules of the NASD in connection with the offer and sale of the Shares by the Underwriters, or (y) to such counsel's knowledge, conflict with or result in a breach or violation of any of the terms and provisions of, or constitute a default under, any indenture, mortgage, deed of trust, lease or other agreement or instrument, to which the Company or any of its Subsidiaries is a party or by which the Company or any of its domestic Subsidiaries or any of their respective properties are bound, which indenture, mortgage, deed of trust, lease or other agreement or instrument is (or is required to be, in accordance with applicable laws) included (or incorporated by reference) in the Registration Statement, or any foreign jurisdiction or under the bylaws or rules of the NASD, or the charter documents or by-laws of the Company or any of its domestic Subsidiaries, or any statute or any judgment, decree, order, rule or regulation of any court or other governmental authority or any arbitrator known to such counsel and applicable to the Company or its domestic Subsidiaries; (x) the Company is not an "investment company" and, after giving effect to the Offering and the application of the proceeds therefrom, will not be an "investment company", as such term is defined in the 1940 Act; and (xi) such counsel does not know of any legal or governmental proceedings pending or threatened to which the Company or any of its domestic Subsidiaries is a party or to which the property of the Company or any of its domestic Subsidiaries is subject that are required to be described or incorporated in the Registration Statement or the Prospectus and are not described or incorporated therein or any statutes, regulations, contracts or other documents that are required to be described or incorporated in the Registration Statement or the Prospectus or to be filed as exhibits to the Registration Statement that are not described or incorporated therein or filed as required. -24- 26 Such opinion shall also state such counsel has participated in certain conferences with officers and other representatives of the Company, representatives of the independent certified public accountants for the Company and representatives of the Underwriters, at which conferences the contents of the Registration Statement and the Prospectus and related matters were discussed and, although such counsel is not passing upon and does not assume any responsibility for, nor has such counsel independently verified, the accuracy, completeness or fairness of the statements contained in the Registration Statement and Prospectus, on the basis of the foregoing, no facts have come to such counsel's attention that have caused such counsel to believe that either the Registration Statement, at the time such Registration Statement became effective, or the Prospectus as of the date hereof, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading (except, in the case of both the Registration Statement and the Prospectus, for the financial statements, notes thereto and other schedules, financial and accounting information and statistical data contained therein, as to which such counsel expresses no view). In rendering any such opinion, such counsel may rely, as to matters of fact, to the extent such counsel deems proper, on certificates of responsible officers of the Company or certificates of government officials. References to the Registration Statement and the Prospectus in this paragraph (b) shall include any amendment or supplement thereto at the date of such opinion. The opinions of issuer's counsel described herein shall be rendered to the Underwriters at the request of the Company and shall so state therein. (c) The Representatives shall have received a legal opinion from counsel for the Selling Stockholders, acceptable to the Representatives, dated the Closing Date, with respect to each of the Selling Stockholders, to the effect that: (i) To such counsel's knowledge, such Selling Stockholder has full power to enter into this Agreement, the Custody Agreement and the Power-of-Attorney and to sell, assign, transfer and deliver the Shares being sold by such Selling Stockholder hereunder in the manner provided in this Agreement and to perform its obligations under the Custody Agreement; this Agreement, the Custody Agreement and the Power-of-Attorney have been duly executed and delivered by or on behalf of such Selling Stockholder; assuming due authorization, execution and delivery by the Custodian, the Custody Agreement and the Power-of-Attorney are the legal, valid, binding and enforceable instruments of such Selling Stockholder, subject to applicable bankruptcy, insolvency and similar laws affecting creditors' rights generally and subject, as to enforceability, to general principles of equity (regardless of whether enforcement is sought in a proceeding in equity or at law); (ii) Upon delivery of and payment for the Shares to be sold by the Company as provided in the Underwriting Agreement and upon registration of such Shares in the names of the Underwriters (or their nominees) in the stock records of the Company, the Underwriters will be the owners of such Shares, free and clear of any adverse claim, provided that the Underwriters are purchasing such Shares in good faith and without notice of any adverse claim. (iii) the sale of the Shares to the Underwriters by such Selling Stockholder pursuant to this Agreement, the compliance by such Selling Stockholder with the other provisions of this Agreement and the Custody Agreement and the consummation of the other transactions herein contemplated do not (x) require the consent, approval, authorization, registration or qualification of or with any governmental authority, except such as have been obtained and such as may be required under state securities or blue sky laws or the bylaws or -25- 27 rules of the NASD, or (y) conflict with or result in a breach or violation of any of the terms and provisions of, or constitute a default under, any material indenture, mortgage, deed of trust, lease or other material agreement or instrument to which such Selling Stockholder is a party or by which such Selling Stockholder or any of its properties are bound, or any statute or any judgment, decree, order, rule or regulation of any court or other governmental authority or any arbitrator applicable to such Selling Stockholder. In rendering such opinion, such counsel may rely, to the extent such counsel deems proper, upon the representations and warranties of the Selling Stockholders contained herein or in the Powers of Attorney and Custody Agreement. References to the Registration Statement and the Prospectus in this paragraph (d) shall include any amendment or supplement thereto at the date of such opinion. (d) The Representatives shall have received a legal opinion from Wilson Sonsini Goodrich & Rosati, P.C., counsel for the Underwriters, dated the Closing Date, covering the issuance and sale of the Shares, the Registration Statement and the Prospectus, and such other related matters as the Representatives may reasonably require, and the Company shall have furnished to such counsel such documents as they may reasonably request for the purpose of enabling them to pass upon such matters. (e) The Representatives shall have received from Price Waterhouse LLP letters dated the date hereof and the Closing Date, in form and substance satisfactory to the Representatives, together with signed or reproduced copies of such letters for each of the other Underwriters containing statements and information of the type ordinarily included in accountants' "comfort letters" to underwriters with respect to the financial statements and certain financial information contained in the Registration Statement and the Prospectus. In the event that the letters referred to above set forth any such changes, decreases or increases, it shall be a further condition to the obligations of the Underwriters that (I) such letters shall be accompanied by a written explanation of the Company as to the significance thereof, unless the Representatives deem such explanation unnecessary, and (II) such changes, decreases or increases do not, in the sole judgment of the Representatives, make it impractical or inadvisable to proceed with the purchase and delivery of the Shares as contemplated by the Registration Statement, as amended as of the date hereof. References to the Registration Statement and the Prospectus in this paragraph (f) with respect to either letter referred to above shall include any amendment or supplement thereto at the date of such letter. (f) The Company shall have furnished or caused to be furnished to the Underwriters at the Closing a certificate of its President and Chief Executive Officer and its Chief Financial Officer satisfactory to the Underwriters to the effect that: (i) the representations and warranties of the Company in this Agreement are true and correct as if made on and as of the Closing Date; the Registration Statement, as amended as of the Closing Date, does not include any untrue statement of a material fact or omit to state any material fact necessary to make the statements therein not misleading, and the Prospectus, as amended or supplemented as of the Closing Date, does not include any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; and the Company has performed all covenants and agreements and satisfied all conditions on its part to be performed or satisfied at or prior to the Closing Date; -26- 28 (ii) no stop order suspending the effectiveness of the Registration Statement or any amendment thereto has been issued, and no proceedings for that purpose have been instituted or threatened or, to the best of the Company's knowledge, are contemplated by the Commission; and (iii) subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus (exclusive of any amendment or supplement thereto), neither the Company nor any of its Subsidiaries has sustained any material loss or interference with their respective businesses or properties from fire, flood, hurricane, accident or other calamity, whether or not covered by insurance, or from any labor dispute or any legal or governmental proceeding, and there has not been any materially adverse change (including, without limitation, a change in management or control), or development involving a prospective materially adverse change, in the condition (financial or otherwise), management, earnings, properties, business affairs or business prospects, stockholders' equity, net worth or results of operations of the Company or any of its Subsidiaries, except in each case as described in or contemplated by the Prospectus (exclusive of any amendment or supplement thereto). (g) The Representatives shall have received from the Company and each person who is a director or executive officer of the Company an agreement dated on or before the date of this Agreement to the effect that such person will not, without the prior written consent of the Representatives during a period from the date of this Agreement and continuing and including the date which is the number of days, after the date hereof as specified in Schedule I hereto, without the prior written consent of the Underwriters, (i) offer, pledge, sell, offer to sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase or otherwise transfer or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock, or (ii) enter into any swap or any other agreement or any transaction that transfers, in whole or in part, directly or indirectly, the economic consequence of ownership of the Common Stock, whether any such swap or transaction described in clause (i) or (ii) above is to be settled by delivery of Common Stock or such securities, in cash or otherwise; provided, however, that such person may, without the prior written consent of the Representatives on behalf of the Underwriters, transfer shares of Common Stock or such other securities to members of such person's immediate family or to trusts for the benefit of members of such person's immediate family or in connection with bona fide gifts, provided that any transferee agrees to the transfer restrictions described above. (h) The Representatives shall have received a certificate from each Selling Stockholder dated each Option Closing Date, signed by an Attorney-in-Fact on behalf of such Selling Stockholder, to the effect that: (i) the representations and warranties of such Selling Stockholder in this Agreement are true and correct as if made on and as of such Closing Date; (ii) To the knowledge of such Selling Stockholder, but without independent verification of information not relating to such Selling Stockholder, (i) each part of the Registration Statement, when such part became effective, did not contain and each such part, as amended or supplemented, if applicable, will not contain any untrue statement of a material fact or omit to a state a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, and (ii) the Prospectus does not contain and, as amended or supplemented, if applicable, will not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading, except that the representations and warranties set forth in this subsection (i) do not apply to statements or omissions in the -27- 29 Registration Statement or the Prospectus based upon information relating to any Underwriter furnished to the Company in writing by such Underwriter through you expressly for use therein. (iii) such Selling Stockholder has performed all covenants and agreements on its part to be performed or satisfied at or prior to such Closing Date. (i) Prior to the commencement of the Offering, the Company shall have made an application for the quotation of the Shares on the Nasdaq National Market and the Shares shall have been included for trading on the Nasdaq National Market, subject to official notice of issuance. (j) On or before the Closing Date, the Representatives and counsel for the Underwriters shall have received such further certificates, documents or other information as they may have reasonably requested from the Company and the Selling Stockholders. All opinions, certificates, letters and documents delivered pursuant to this Agreement will comply with the provisions hereof only if they are reasonably satisfactory in all material respects to the Representatives and counsel for the Underwriters. The Company and the Selling Stockholders shall furnish to the Representatives such conformed copies of such opinions, certificates, letters and documents in such quantities as the Representatives and counsel for the Underwriters shall reasonably request. The respective obligations of the several Underwriters to purchase and pay for any Shares shall be subject, in their discretion, to each of the foregoing conditions to purchase the Shares, except that all references therein to the Shares and the Closing Date shall be deemed to refer to the Firm Shares or the Option Shares and the First Closing Date or the related Option Closing Date, each as applicable. Section 8. Default of Underwriters. If, at the First Closing, any one or more of the Underwriters shall fail or refuse to purchase Shares that it has or they have agreed to purchase hereunder on such date, and the aggregate number of Shares which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase is ten percent or less of the aggregate number of the Shares to be purchased on such date, the other Underwriters may make arrangements satisfactory to the Representatives for the purchase of such Shares by other persons (who may include one or more of the non-defaulting Underwriters, including the Representatives), but if no such arrangements are made by the First Closing Date, the other Underwriters shall be obligated severally in the proportions that the number of Firm Shares set forth opposite their respective names in Schedule II hereto bears to the aggregate number of Firm Shares set forth opposite the names of all such non-defaulting Underwriters, or in such other proportions as the Representatives may specify, to purchase the Shares which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase on such date. If, at the First Closing, any Underwriter or Underwriters shall fail or refuse to purchase Firm Shares and the aggregate number of Firm Shares with respect to which such default occurs is more than ten per cent of the aggregate number of Firm Shares to be purchased, and arrangements satisfactory to the Representatives and the Company and the Selling Stockholders for the purchase of such Firm Shares are not made within 36 hours after such default, this Agreement shall terminate without liability on the part of any non-defaulting Underwriter, the Company or the Selling Stockholders. In any such case either the Representatives or the Company shall have the right to postpone the Closing, but in no event for longer than seven days, in order that the required changes, if any, in the Registration Statement and in the Prospectus or in any other documents or arrangements may be effected. If, at any Option Closing, any Underwriter or Underwriters shall fail or refuse to purchase Option Shares, the non-defaulting Underwriters shall have the option to (i) terminate their obligation hereunder to purchase Option Shares or (ii) purchase not -28- 30 less than the number of Option Shares that such non-defaulting Underwriters would have been obligated to purchase in the absence of such default. As used in this Agreement, the term "Underwriter" includes any person substituted for an Underwriter under this Section 8. Any action taken under this Section 8 shall not relieve any defaulting Underwriter from liability in respect of any default of such Underwriter under this Agreement. Section 9. Termination. This Agreement shall be subject to termination in the sole discretion of the Representatives by notice to the Company and the Selling Stockholders given prior to any Closing Date in the event that the Company shall have failed, refused or been unable to perform all obligations and satisfy all conditions on its part to be performed or satisfied hereunder at the Closing or prior thereto or, if at or prior to any Closing Date, (a) trading in securities generally on the New York Stock Exchange or the Nasdaq National Market shall have been suspended or materially limited or minimum or maximum prices shall have been established by or on, as the case may be, the Commission or the New York Stock Exchange or the Nasdaq National Market; (b) trading of any securities of the Company shall have been suspended on any exchange or in any over-the-counter market; (c) a general moratorium on commercial banking activities shall have been declared by either Federal or New York State authorities; (d) there shall have occurred (i) an outbreak or escalation of hostilities between the United States and any foreign power, (ii) an outbreak or escalation of any other insurrection or armed conflict involving the United States, or (iii) any other calamity or crisis or materially adverse change in general economic, political or financial conditions having an effect on the U.S. financial markets that, in the reasonable judgment of the Representatives, in the case of clauses (d)(i), (d)(ii) and (d)(iii), makes it impractical or inadvisable to proceed with the public offering or the delivery of the Shares as contemplated by the Registration Statement, as amended as of the date hereof; or (e) the Company or any of its Subsidiaries shall have, in the reasonable judgment of the Representatives, sustained any material loss or interference with their respective businesses or properties from fire, flood, hurricane, accident or other calamity, whether or not covered by insurance, or from any labor dispute or any legal or governmental proceeding, or there shall have been any materially adverse change (including, without limitation, a change in management or control), or constitute a development involving a prospective materially adverse change, in the condition (financial or otherwise), management, earnings, properties, business affairs or business prospects, stockholders' equity, net worth or results of operations of the Company or any of its Subsidiaries, except in each case as described in or contemplated by the Prospectus (exclusive of any amendment or supplement thereto). Termination of this Agreement pursuant to this Section 9 shall be without liability of any party to any other party except for the liability of the Company in relation to expenses as provided in Sections 4 and 10 hereof, the liability of the Selling Stockholders in relation to expenses as provided in Sections 4 and 10 hereof, the indemnity provided in Section 6 hereof and any liability arising before or in relation to such termination. Section 10. Reimbursement of Expenses. If the sale of the Shares provided for herein is not consummated because any condition to the obligations of the Underwriters set forth in Section 7 hereof is not satisfied or because of any termination pursuant to Section 9 hereof (other than by reason of a default by any of the Underwriters), the Company shall reimburse the Underwriters, severally upon demand, for all out-of-pocket expenses (including fees and disbursements of counsel) that shall have been incurred by them in connection with the proposed purchase and sale of the Shares. If the Company is required to make any payments to the Underwriters under this Section 10 because of any Selling Stockholder's refusal, inability or failure to satisfy any condition to the obligations of the Underwriters set forth in Section 7 hereof, such defaulting Selling Stockholder, pro rata in proportion to the percentage of Shares to be sold by it, shall reimburse the Company on demand for amounts so paid. -29- 31 Section 11. Information Supplied by Underwriters. The statements set forth in the last paragraph on the front cover page and in the third and last three paragraphs under the heading "Underwriting" in any Preliminary Prospectus or the Prospectus (to the extent such statements relate to the Underwriters) constitute the only information furnished by any Underwriter through the Representatives to the Company for the purposes of Section 5(a)(ii) and Section 6 hereof. The Underwriters confirm that such statements (to such extent) are correct. -30- 32 Section 12. Notices. In all dealings hereunder, you shall act on behalf of each of the Underwriters, and the parties hereto shall be entitled to act and rely upon any statement, request, notice or agreement on behalf of any Underwriter made or given by the Representatives. Any notice or notification in any form to be given under this Agreement may be delivered in person or sent by telex, facsimile or telephone (subject in the case of a communication by telephone to confirmation by telex or facsimile) addressed to: in the case of the Company: HNC Software Inc. 5930 Cornerstone Court West San Diego, California 92121-3728 Telephone: 619-546-8877 Facsimile: 619-452-3220 Attention: President in the case of the Underwriters: Deutsche Morgan Grenfell Inc. 31 West 52nd Street New York, New York 10019 Telephone: 212-469-5600 Facsimile: 212-469-5995 Attention: Equity Syndicate Desk In the case of the Selling Stockholders, any such notice shall be addressed to the Selling Stockholders at the addresses set forth in Schedule III hereto. Any such notice shall take effect, in the case of delivery, at the time of delivery and, in the case of telex or facsimile, at the time of dispatch. Section 13. Miscellaneous. (a) Time shall be of the essence of this Agreement. (b) The headings herein are inserted for convenience of reference only and are not intended to be part of, or to affect, the meaning or interpretation of this Agreement. (c) For purposes of this Agreement, (a) "business day" means any day on which the New York Stock Exchange is open for trading, and (b) "subsidiary" has the meaning set forth in Rule 405 under the Securities Act. (d) This Agreement may be executed in any number of counterparts, all of which, taken together, shall constitute one and the same Agreement and any party may enter into this Agreement by executing a counterpart. -31- 33 (e) This Agreement shall inure to the benefit of and shall be binding upon the several Underwriters, the Company, the Selling Stockholders and their respective successors and legal representatives, and nothing expressed or mentioned in this Agreement is intended or shall be construed to give any other person any legal or equitable right, remedy or claim under or in respect of this Agreement, or any provisions herein contained, this Agreement and all conditions and provisions hereof being intended to be and being for the sole and exclusive benefit of such persons and for the benefit of no other person, except that (i) the indemnities of the Company and the Selling Stockholders contained in Section 6 hereof shall also be for the benefit of any person or persons who control any Underwriter within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act and (ii) the indemnities of the Underwriters contained in Section 6 hereof shall also be for the benefit of the directors of the Company, the officers of the Company who have signed the Registration Statement, each Selling Stockholder and any person or persons who control the Company or such Selling Stockholder within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act. No purchaser of Shares from any Underwriter shall be deemed a successor because of such purchase. (f) The respective representations, warranties, agreements, covenants, indemnities and other statements of the Company, its officers, the Selling Stockholders and the several Underwriters set forth in this Agreement or made by or on behalf of them, respectively, pursuant to this Agreement shall remain in full force and effect, regardless of (i) any investigation made by or on behalf of the Company, any of its officers or directors, the Selling Stockholders, any Underwriter or any controlling person referred to in Section 6 hereof and (ii) delivery of and payment for the Shares. The respective agreements, covenants, indemnities and other statements set forth in Sections 4, 6 and 10 hereof shall remain in full force and effect, regardless of any termination or cancellation of this Agreement. Section 14. Severability. It is the desire and intent of the parties that the provisions of this Agreement be enforced to the fullest extent permissible under the law and public policies applied in each jurisdiction in which enforcement is sought. Accordingly, in the event that any provision of this Agreement would be held in any jurisdiction to be invalid, prohibited or unenforceable for any reason, such provision, as to such jurisdiction, shall be ineffective, without invalidating the remaining provisions of this Agreement or affecting the validity or enforceability of such provision in any other jurisdiction. Section 15. Governing Law. The validity and interpretation of this Agreement, and the terms and conditions set forth herein, shall be governed by and construed in accordance with the laws of the State of New York, without giving effect to any provisions relating to conflicts of laws. -32- 34 If the foregoing is in accordance with your understanding, please sign and return to us ten (10) counterparts hereof, and upon the acceptance hereof by you, on behalf of each of the Underwriters, this letter and such acceptance hereof shall constitute a binding agreement among each of the Underwriters, the Company and each of the Selling Stockholders. It is understood that your acceptance of this letter on behalf of each of the Underwriters is pursuant to the authority set forth in the Deutsche Morgan Grenfell Inc. Master Agreement Among Underwriters, the form of which shall be submitted to the Company and the Selling Stockholders for examination upon request, but without warranty on your part as to the authority of the signers thereof. Very truly yours, HNC SOFTWARE INC. By:_________________________________________ President and Chief Executive Officer ROBERT L. KAAREN By: _________________________________________ Attorney-in-Fact MICHAEL E. MUNAYYER, TRUSTEE OF THE MICHAEL MUNAYYER TRUST DATED AUGUST 11,1995 By:___________________________________________ Attorney-in-Fact OLIVER D. CURME By:___________________________________________ Attorney-in-Fact -33- 35 The foregoing Agreement is hereby confirmed and accepted as of the date specified in Schedule I hereto. DEUTSCHE MORGAN GRENFELL INC. BANCAMERICA ROBERTSON STEPHENS SMITH BARNEY INC. By: DEUTSCHE MORGAN GRENFELL INC. By: ____________________________ Name: __________________________ Title: _________________________ By: ____________________________ Name: __________________________ Title: _________________________ For themselves and on behalf of the other several Underwriters, if any, named in Schedule II to the foregoing Agreement. -34- 36 SCHEDULE I Underwriting Agreement dated: ___________ __, 1998 Other Representatives: BancAmerica Robertson Stephens Smith Barney Inc. Type of Offering: Purchase Price of Securities: Purchase price per share: Closing Date, Time and Location: _____________ __, 1998, at the offices of Fenwick & West LLP, Two Palo Alto Square, Palo Alto, CA 94306. Registration Statement No. 333-____ Number of days referred to in Section 3(a)(v): 90 Number of days referred to in Section 7(g): 90 Modification of items to be covered by the letter from Price Waterhouse LLP delivered pursuant to Section 7(e) at the Closing Date: 37 SCHEDULE II The Underwriters
UNDERWRITER UNDERWRITING COMMITMENT ----------- ----------------------- Deutsche Morgan Grenfell Inc. __________________ BancAmerica Robertson Stephens __________________ Smith Barney Inc. __________________
38 SCHEDULE III The Selling Stockholders
NUMBER OF SHARES NUMBER OF OPTION SELLING STOCKHOLDERS TO BE SOLD SHARES TO BE SOLD -------------------- ---------------- ----------------- Robert K. Kaaren......................... 1,035,000 157,500 c/o CompReview, Inc. 3200 Park Center Drive, 5th floor Costa Mesa, California 92626 Michael E. Munayyer,..................... 1,035.000 157,500 Trustee of the Michael Munayyer Trust dated August 11, 1995 c/o CompReview, Inc. 3200 Park Center Drive, 5th floor Costa Mesa, California 92626 Oliver D. Curme ......................... 10,000 --- Battery Ventures 20 William Street, Suite 200 Wellesley, Massachusetts 02181 --------- ------- Total................................ 2,080,000 315,000 ========= =======
39 SCHEDULE IV Listing of all States in which HNC and Subsidiaries do Business HNC Software Inc. Arizona California Connecticut Delaware Florida Georgia Illinois Minnesota Maryland Nebraska New York North Carolina Ohio Pennsylvania Texas Utah Virginia Washington CompReview, Inc. California Texas Retek Information Systems, Inc. Minnesota Texas Illinois Georgia Indiana Massachusetts Pennsylvania California 40 Risk Data Corporation California Arizona Colorado Minnesota New York Virginia Aptex Software Inc. California Texas Massachusetts EX-4.08 4 INDENTURE BETWEEN REGISRANT & STATE STREET BANK 1 EXHIBIT 4.8 ================================================================================ HNC SOFTWARE INC. AND STATE STREET BANK AND TRUST COMPANY OF CALIFORNIA, N.A. TRUSTEE INDENTURE DATED AS OF MARCH 1, 1998 __% CONVERTIBLE SUBORDINATED NOTES DUE 2003 ================================================================================ 2 TABLE OF CONTENTS
PAGE ---- ARTICLE I DEFINITIONS..........................................................................1 Section 1.1 Definitions...............................................................1 ARTICLE II ISSUE, DESCRIPTION, EXECUTION, REGISTRATION AND EXCHANGE OF NOTES...................8 Section 2.1 Designation, Amount and Issue of Notes....................................8 Section 2.2 Form of Notes.............................................................9 Section 2.3 Date and Denomination of Notes; Payments of Interest......................9 Section 2.4 Execution of Notes.......................................................11 Section 2.5 Exchange and Registration of Transfer of Notes...........................11 Section 2.6 Mutilated, Destroyed, Lost or Stolen Notes...............................12 Section 2.7 Temporary Notes..........................................................13 Section 2.8 Cancellation of Notes Paid, Etc..........................................14 ARTICLE III REDEMPTION OF NOTES...............................................................14 Section 3.1 Right of Redemption......................................................14 Section 3.2 Applicability of Article.................................................14 Section 3.3 Election to Redeem; Notice to Trustee....................................14 Section 3.4 Selection by Trustee of Notes to Be Redeemed.............................15 Section 3.5 Notice of Redemption.....................................................15 Section 3.6 Deposit of Redemption Price..............................................16 Section 3.7 Notes Payable on Redemption Date.........................................16 Section 3.8 Notes Redeemed in Part...................................................17 Section 3.9 Conversion Arrangement on Call for Redemption............................17 ARTICLE IV SUBORDINATION OF NOTES.............................................................18 Section 4.1 Agreement of Subordination...............................................18 Section 4.2 Payments to Holders......................................................18 Section 4.3 Subrogation of Notes.....................................................21 Section 4.4 Authorization to Effect Subordination....................................22 Section 4.5 Notice to Trustee........................................................22 Section 4.6 Trustee's Relation to Senior Indebtedness of the Company.................23 Section 4.7 No Impairment of Subordination...........................................24 Section 4.8 Article Applicable to Paying Agents......................................24 Section 4.9 Senior Indebtedness of the Company Entitled to Rely......................24
-i- 3 TABLE OF CONTENTS (CONTINUED)
PAGE ---- Section 4.10 Certain Conversions Deemed Payment.......................................24 ARTICLE V PARTICULAR COVENANTS OF THE COMPANY.................................................25 Section 5.1 Payment of Principal, Premium and Interest...............................25 Section 5.2 Maintenance of Office or Agency..........................................25 Section 5.3 Appointments to Fill Vacancies in Trustee's Office.......................26 Section 5.4 Provisions as to Paying Agent............................................26 Section 5.5 Existence................................................................27 Section 5.6 Stay, Extension and Usury Laws...........................................27 Section 5.7 Statement by Officers as to Default......................................27 Section 5.8 Further Instruments and Acts.............................................28 ARTICLE VI HOLDERS' LISTS AND REPORTS BY THE COMPANY AND THE TRUSTEE..........................28 Section 6.1 Holders' Lists...........................................................28 Section 6.2 Preservation and Disclosure of Lists.....................................28 Section 6.3 Reports by Trustee.......................................................29 Section 6.4 Reports by Company.......................................................29 ARTICLE VII DEFAULTS AND REMEDIES.............................................................29 Section 7.1 Events of Default........................................................29 Section 7.2 Payments of Notes on Default; Suit Therefor..............................31 Section 7.3 Application of Monies Collected by Trustee...............................33 Section 7.4 Proceedings by Holder....................................................34 Section 7.5 Proceedings by Trustee...................................................35 Section 7.6 Remedies Cumulative and Continuing.......................................35 Section 7.7 Direction of Proceedings and Waiver of Defaults by Majority of Holders ..35 Section 7.8 Notice of Defaults.......................................................36 Section 7.9 Undertaking to Pay Costs.................................................36 Section 7.10 Delay or Omission Not Waiver.............................................36 ARTICLE VIII CONCERNING THE TRUSTEE...........................................................36 Section 8.1 Duties and Responsibilities of Trustee...................................36 Section 8.2 Reliance on Documents, Opinions, Etc.....................................38
-ii- 4 TABLE OF CONTENTS (CONTINUED)
PAGE ---- Section 8.3 No Responsibility for Recitals, Etc......................................39 Section 8.4 Trustee, Paying Agents, Conversion Agents or Registrar May Own Notes ....39 Section 8.5 Monies to Be Held in Trust...............................................39 Section 8.6 Compensation and Expenses of Trustee.....................................39 Section 8.7 Officers' Certificate as Evidence........................................40 Section 8.8 Conflicting Interests of Trustee.........................................40 Section 8.9 Eligibility of Trustee...................................................40 Section 8.10 Resignation or Removal of Trustee........................................40 Section 8.11 Acceptance by Successor Trustee..........................................42 Section 8.12 Succession by Merger, Etc................................................42 Section 8.13 Limitation on Rights of Trustee as Creditor..............................43 ARTICLE IX CONCERNING THE HOLDERS.............................................................43 Section 9.1 Action by Holders........................................................43 Section 9.2 Proof of Execution by Holders............................................43 Section 9.3 Who Are Deemed Absolute Owners...........................................44 Section 9.4 Company-Owned Notes Disregarded..........................................44 Section 9.5 Revocation of Consents; Future Holders Bound.............................44 ARTICLE X HOLDERS' MEETINGS...................................................................45 Section 10.1 Purpose of Meetings......................................................45 Section 10.2 Call of Meetings by Trustee..............................................45 Section 10.3 Call of Meetings by Company or Holders...................................46 Section 10.4 Qualifications for Voting................................................46 Section 10.5 Regulations..............................................................46 Section 10.6 Voting...................................................................47 Section 10.7 No Delay of Rights by Meeting............................................47 ARTICLE XI SUPPLEMENTAL INDENTURES............................................................47 Section 11.1 Supplemental Indentures Without Consent of Holders.......................47 Section 11.2 Supplemental Indentures With Consent of Holders..........................49 Section 11.3 Effect of Supplemental Indentures........................................49 Section 11.4 Notation on Notes........................................................50 Section 11.5 Evidence of Compliance of Supplemental Indenture to Be Furnished Trustee.......................................................50
-iii- 5 TABLE OF CONTENTS (CONTINUED)
PAGE ---- ARTICLE XII MERGER, SALE OR CONSOLIDATION.....................................................50 Section 12.1 Limitation on Merger, Sale or Consolidation..............................50 Section 12.2 Successor Corporation to Be Substituted..................................51 ARTICLE XIII SATISFACTION AND DISCHARGE OF INDENTURE..........................................52 Section 13.1 Discharge of Indenture...................................................52 Section 13.2 Deposited Monies to Be Held in Trust by Trustee..........................52 Section 13.3 Paying Agent to Repay Monies Held........................................52 Section 13.4 Return of Unclaimed Monies...............................................53 Section 13.5 Reinstatement............................................................53 ARTICLE XIV IMMUNITY OF INCORPORATORS, STOCKHOLDERS, OFFICERS AND DIRECTORS...................53 Section 14.1 Indenture and Notes Solely Corporate Obligations.........................53 ARTICLE XV CONVERSION OF NOTES................................................................54 Section 15.1 Conversion Privilege and Conversion Price................................54 Section 15.2 Exercise of Conversion Privilege.........................................54 Section 15.3 Fractions of Shares......................................................55 Section 15.4 Adjustment of Conversion Price...........................................55 Section 15.5 Notice of Adjustments of Conversion Price................................64 Section 15.6 Notice of Certain Corporate Action.......................................64 Section 15.7 Company to Provide Common Stock..........................................66 Section 15.8 Taxes on Conversions.....................................................66 Section 15.9 Company Covenants as to Common Stock.....................................66 Section 15.10 Cancellation of Converted Notes..........................................67 Section 15.11 Effect of Reclassification, Consolidation, Merger or Sale................67 Section 15.12 Responsibility of Trustee for Conversion Provisions......................68 ARTICLE XVI REPURCHASE UPON A FUNDAMENTAL CHANGE..............................................68 Section 16.1 Right to Require Repurchase..............................................68 Section 16.2 Notices; Method of Exercising Repurchase Right, Etc......................69
-iv- 6 TABLE OF CONTENTS (CONTINUED)
PAGE ---- Section 16.3 Merger, Consolidation, etc............................................71 ARTICLE XVII MISCELLANEOUS PROVISIONS......................................................72 Section 17.1 Provisions Binding on Company's Successors............................72 Section 17.2 Official Acts by Successor Corporation................................72 Section 17.3 Addresses for Notices, Etc............................................72 Section 17.4 Governing Law.........................................................73 Section 17.5 Evidence of Compliance with Conditions Precedent; Certificates to Trustee ...........................................................73 Section 17.6 Legal Holidays........................................................73 Section 17.7 No Note Interest Created..............................................73 Section 17.8 Trust Indenture Act...................................................73 Section 17.9 Benefits of Indenture.................................................74 Section 17.10 Table of Contents, Headings, Etc......................................74 Section 17.11 Authenticating Agent..................................................74 Section 17.12 Execution in Counterparts.............................................75
-v- 7 INDENTURE dated as of March 1, 1998 between HNC Software Inc., a Delaware corporation (hereinafter sometimes called the "Company", as more fully set forth in Section 1.1), and State Street Bank and Trust Company of California, N.A., a national banking association organized under the laws of the United States (hereinafter sometimes called the "Trustee", as more fully set forth in Section 1.1). W I T N E S S E T H: WHEREAS, for its lawful corporate purposes, the Company has duly authorized the issue of its __% Convertible Subordinated Notes due 2003 (hereinafter sometimes called the "Notes"), in an aggregate principal amount not to exceed $100,000,000 and, to provide the terms and conditions upon which the Notes are to be authenticated, issued and delivered, the Company has duly authorized the execution and delivery of this Indenture; and WHEREAS, all acts and things necessary to make the Notes, when executed by the Company and authenticated and delivered by the Trustee or a duly authorized authenticating agent, as in this Indenture provided, the valid, binding and legal obligations of the Company, and to constitute these presents a valid agreement according to its terms, have been done and performed, and the execution of this Indenture and the issue hereunder of the Notes have in all respects been duly authorized. NOW, THEREFORE, THIS INDENTURE WITNESSETH: That in order to declare the terms and conditions upon which the Notes are, and are to be, authenticated, issued and delivered, and in consideration of the premises and of the purchase and acceptance of the Notes by the holders thereof, the Company covenants and agrees with the Trustee for the equal and proportionate benefit of the respective holders from time to time of the Notes (except as otherwise provided below), as follows: ARTICLE I DEFINITIONS Section 1.1 Definitions. The terms defined in this Section 1.1 (except as herein otherwise expressly provided or unless the context otherwise requires) for all purposes of this Indenture and of any indenture supplemental hereto shall have the respective meanings specified in this Section 1.1. All other terms used in this Indenture, which are defined in the Trust Indenture Act or which are by reference therein defined in the Securities Act (except as herein otherwise expressly provided or unless the context otherwise requires) shall have the meanings assigned to such terms in said Trust Indenture Act and in said Securities Act as in force at the date of the execution of this Indenture. The words "herein," "hereof," "hereunder," and words of similar import refer to this Indenture as a whole and not to any particular Article, Section or other Subdivision. The terms defined in this Indenture include the plural as well as the singular. -1- 8 Affiliate: The term "Affiliate" of any specified Person means any other Person directly or indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, "control," when used with respect to any specified Person means the power to direct or cause the direction of the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms "controlling" and "controlled" have meanings correlative to the foregoing. Applicable Price: The term "Applicable Price" means (i) in the event of a Fundamental Change in which the holders of Common Stock receive only cash, the amount of cash received by the holders of one share of Common Stock and (ii) in the event of any other Fundamental Change, the arithmetic average of the Closing Price for the Common Stock during the ten Trading Days prior to the record date for the determination of the holders of Common Stock entitled to receive cash, securities, property or other assets in connection with such Fundamental Change, or, if no such record date exists, the date upon which the holders of the Common Stock shall have the right to receive such cash, securities, property or other assets in connection with the Fundamental Change. Board of Directors: The term "Board of Directors" means the Board of Directors of the Company or a committee of such Board duly authorized to act for it hereunder. Board Resolution: The term "Board Resolution" means a copy of a resolution certified by the Secretary or an Assistant Secretary of the Company to have been duly adopted by the Board of Directors, or duly authorized committee thereof (to the extent permitted by applicable law), and to be in full force and effect on the date of such certification. Business Day: The term "Business Day" means each Monday, Tuesday, Wednesday, Thursday and Friday which is not a day on which the banking institutions in The City of New York or San Diego, California or the city in which the Corporate Trust Office is located are authorized or obligated by law or executive order to close or be closed. Commission: The term "Commission" means the Securities and Exchange Commission. Common Stock: The term "Common Stock" means any stock of any class of the Company which has no preference in respect of dividends or of amounts payable in the event of any voluntary or involuntary liquidation, dissolution or winding up of the Company and which is not subject to redemption by the Company. Subject to the provisions of Section 15.11, however, shares issuable on conversion of Notes shall include only shares of the class designated as common stock of the Company at the date of this Indenture or shares of any class or classes resulting from any reclassification or reclassifications thereof and which have no preference in respect of dividends or of amounts payable in the event of any voluntary or involuntary liquidation, dissolution or winding up of the Company and which are not subject to redemption by the Company; provided that if at any time there shall be more than one such resulting class, -2- 9 the shares of each such class then so issuable shall be substantially in the proportion which the total number of shares of such class resulting from all such reclassifications bears to the total number of shares of all such classes resulting from all such reclassifications. Company: The term "Company" means HNC Software Inc., a Delaware corporation, and subject to the provisions of Article XII, shall include its successors and assigns. Corporate Trust Office: The term "Corporate Trust Office," or other similar term, means the office of the Trustee at which at any particular time its corporate trust business shall be principally administered, which office is, at the date as of which this Indenture is dated, located at 633 West 5th Street, 12th Floor, Los Angeles, California 90071, Attention: Corporate Trust Division (HNC Software Inc. __% Convertible Subordinated Notes due 2003). Credit Agreement: The term "Credit Agreement" means that certain Credit Agreement, dated as of July 11, 1997, between the Company and Wells Fargo Bank National Association, as amended through the date hereof, as further amended and restated, supplemented or otherwise modified from time to time. default: The term "default" means any event that is, or after notice or passage of time, or both, would be, an Event of Default. Designated Senior Indebtedness: The term "Designated Senior Indebtedness" means the Credit Agreement and the Company's obligations under any other particular Senior Indebtedness of the Company in which the instrument creating or evidencing the same or the assumption or guarantee thereof (or related agreements or documents to which the Company is a party) expressly provides that such Senior Indebtedness shall be "Designated Senior Indebtedness" for purposes of this Indenture (provided that such instrument, agreement or other document may place limitations and conditions on the right of such Senior Indebtedness to exercise the rights of Designated Senior Indebtedness). Exchange Act: The term "Exchange Act" means the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder. Event of Default: The term "Event of Default" means any event specified in Section 7.1(a), (b), (c), (d) or (e), continued for the period of time, if any, and after the giving of notice, if any, therein designated. Fundamental Change: The term "Fundamental Change" means the occurrence of any transaction or event in connection with which all or substantially all of the Common Stock shall be exchanged for, converted into, acquired for or constitute solely the right to receive, consideration (whether by means of an exchange offer, liquidation, tender offer, consolidation, merger, combination, reclassification, recapitalization or otherwise) which is not all or substantially all common stock or shares which are (or, upon consummation of or immediately -3- 10 following such transaction or event, will be) listed on a United States national securities exchange or approved for quotation on the Nasdaq National Market or any similar United States system of automated dissemination of quotations of securities prices. Holder or holder: The terms "Holder" or "holder" as applied to any Note, or other similar terms (but excluding the term "beneficial holder"), means any Person in whose name at the time a particular Note is registered on the Note register. Indebtedness: The term "Indebtedness" means, with respect to any Person, and without duplication, (a) all indebtedness, obligations and other liabilities (contingent or otherwise) of the Person for borrowed money (including obligations of the Person in respect of overdrafts, foreign exchange contracts, currency exchange agreements, interest rate protection agreements, and any loans or advances from banks, whether or not evidenced by notes or similar instruments) or evidenced by bonds, debentures, notes or similar instruments (whether or not the recourse of the lender is to the whole of the assets of the Person or to only a portion thereof), (b) all reimbursement obligations and other liabilities (contingent or otherwise) of the Person with respect to letters of credit, bank guarantees or bankers' acceptances, (c) all obligations and liabilities (contingent or otherwise) in respect of leases of the Person required, in conformity with generally accepted accounting principles, to be accounted for as capitalized lease obligations on the balance sheet of the Person and all obligations and other liabilities (contingent or otherwise) under any lease or related document (including a purchase agreement) in connection with the lease of real property or improvements thereon which provides that such Person is contractually obligated to purchase or cause a third party to purchase the leased property and thereby guarantee a minimum residual value of the leased property to the lessor and the obligations of such Person under such lease or related document to purchase or to cause a third party to purchase such leased property, (d) all obligations of the Person (contingent or otherwise) with respect to an interest rate or other swap, cap or collar agreement or other similar instrument or agreement or foreign currency hedge, exchange, purchase or similar instrument or agreement, (e) all direct or indirect guaranties or similar agreements by the Person in respect of, and obligations or liabilities (contingent or otherwise) of the Person to purchase or otherwise acquire or otherwise assure a creditor against loss in respect of, indebtedness, obligations or liabilities of another Person of the kind described in clauses (a) through (d), (f) any indebtedness or other obligations described in clauses (a) through (d) secured by any mortgage, pledge, lien or other encumbrance existing on property which is owned or held by the Person, regardless of whether the indebtedness or other obligation secured thereby shall have been assumed by the Person and (g) any and all deferrals, renewals, extensions, refinancings and refundings of, or amendments, modifications or supplements to, any indebtedness, obligation or liability of the kind described in clauses (a) through (f). Notwithstanding the foregoing, the term "Indebtedness" shall not include any account payable or other accrued current liability or obligation incurred in the ordinary course of business in connection with the obtaining of materials or services. Indenture: The term "Indenture" means this instrument as originally executed or, if amended or supplemented as herein provided, as so amended or supplemented. -4- 11 Note or Notes: The terms "Note" or "Notes" means any Note or Notes, as the case may be, authenticated and delivered under this Indenture. Officers' Certificate: The term "Officers' Certificate", when used with respect to the Company, means a certificate signed by the Chief Executive Officer, President, or any Vice President (whether or not designated by a number or numbers or word added before or after the title "Vice President") and by the Treasurer, any Assistant Treasurer, the Secretary or any Assistant Secretary of the Company, which is delivered to the Trustee. Each such certificate shall include the statements provided for in Section 17.5 if and to the extent required by the provisions of such Section. Opinion of Counsel: The term "Opinion of Counsel" means an opinion in writing signed by legal counsel, who may be an employee of or counsel to the Company, or other counsel acceptable to the Trustee, which is delivered to the Trustee. Each such opinion shall include the statements provided for in Section 17.5 if and to the extent required by the provisions of such Section. outstanding: The term "outstanding," when used with reference to Notes, means, subject to the provisions of Section 9.4, as of any particular time, all Notes authenticated and delivered by the Trustee under this Indenture, except (a) Notes theretofore canceled by the Trustee or delivered to the Trustee for cancellation; (b) Notes, or portions thereof, for the payment or redemption of which monies in the necessary amount shall have been deposited in trust with the Trustee or with any paying agent (other than the Company) or shall have been set aside and segregated in trust by the Company (if the Company shall act as its own paying agent); provided that if such Notes are to be redeemed prior to the maturity thereof, notice of such redemption shall have been given as provided in Section 3.2 or provision satisfactory to the Trustee shall have been made for giving such notice; provided further that if any Notes are not redeemed on a redemption date, then such Notes shall be deemed outstanding until all principal of and premium, if any, and accrued interest on such Notes has been paid in full in accordance with the terms of this Indenture; (c) Notes which have been paid pursuant to Section 3.6 or in lieu of which, or in substitution for which, other Notes shall have been authenticated and delivered pursuant to the terms of Section 2.6 unless proof satisfactory to the Trustee is presented that any such Notes are held by bona fide holders in due course; and (d) Notes converted into Common Stock pursuant to Article XV and Notes deemed not outstanding pursuant to Section 3.2. -5- 12 Person: The term "Person" means a corporation, an association, a partnership, a limited liability company, an individual, a joint venture, a joint stock company, a trust, an unincorporated organization or a government or an agency or a political subdivision thereof. Predecessor Note: The term "Predecessor Note" of any particular Note means every previous Note evidencing all or a portion of the same debt as that evidenced by such particular Note; and, for the purposes of this definition, any Note authenticated and delivered under Section 2.6 in lieu of a lost, destroyed or stolen Note shall be deemed to evidence the same debt as the lost, destroyed or stolen Note that it replaces. Record Date: The term "Record Date" means any Regular Record Date or Special Record Date. Redemption Date: The term "Redemption Date," when used with respect to any Note to be redeemed in whole or in part, means the date fixed for such redemption by or pursuant to this Indenture. Redemption Price: The term "Redemption Price", when used with respect to any Note to be redeemed, means the price at which it is to be redeemed pursuant to this Indenture. Reference Market Price: The term "Reference Market Price" will initially mean $_____ and in the event of any adjustment to the Conversion Price pursuant to Section 15.4, the Reference Market Price shall also be adjusted so that the ratio of the Reference Market Price to the Conversion Price after giving effect to any such adjustment shall always be the same as the ratio of $_____ to the initial Conversion Price specified in Section 15.1 (without regard to any adjustment thereto). Regular Record Date: The term "Regular Record Date" for interest payable in respect of any Security on any interest payment date means the February 15 or August 15 (whether or not a Business Day), as the case may be, next preceding such interest payment date. Representative. The term "Representative" means the (a) indenture trustee or other trustee, agent or representative for any Senior Indebtedness or (b) with respect to any Senior Indebtedness that does not have any such trustee, agent or other representative, (i) in the case of such Senior Indebtedness issued pursuant to an agreement providing for voting arrangements as among the holders or owners of such Senior Indebtedness, any holder or owner of such Senior Indebtedness acting with the consent of the required Persons necessary to bind such holders or owners of such Senior Indebtedness and (ii) in the case of all other such Senior Indebtedness, the holder or owner of such Senior Indebtedness. Responsible Officer: The term "Responsible Officer", when used with respect to the Trustee, means an officer of the Trustee assigned to the Corporate Trust Office of the Trustee, -6- 13 and any other officer of the Trustee to whom such matter is referred to because of his knowledge of and familiarity with the particular subject. Securities Act: The term "Securities Act" means the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. Senior Indebtedness: The term "Senior Indebtedness" means the principal of, premium, if any, interest (including all interest accruing subsequent to the commencement of any bankruptcy or similar proceeding, whether or not a claim for post-petition interest is allowable as a claim in any such proceeding) and rent payable on or in connection with, and all fees, costs, expenses and other amounts accrued or due on or in connection with, Indebtedness of the Company, whether outstanding on the date of this Indenture or thereafter created, incurred, assumed, guaranteed or in effect guaranteed by the Company (including all deferrals, renewals, extensions or refundings of, or amendments, modifications or supplements to, the foregoing), unless in the case of any particular Indebtedness the instrument creating or evidencing the same or the assumption or guarantee thereof expressly provides that such Indebtedness shall not be senior in right of payment to the Notes or expressly provides that such Indebtedness is "pari passu" or "junior" to the Notes. Notwithstanding the foregoing, Senior Indebtedness shall not include (i) any Indebtedness of the Company to any Subsidiary of the Company or (ii) the Notes. Special Record Date: The term "Special Record Date" for the payment of any Defaulted Interest means a date fixed by the Trustee pursuant to Section 2.3. Subsidiary: The term "Subsidiary" means a corporation more than 50% of the outstanding voting stock of which is owned, directly or indirectly, by the Company or by one or more other Subsidiaries, or by the Company and one or more other Subsidiaries. For the purposes of this definition, "voting stock" means stock which ordinarily has voting power for the election of directors, whether at all times or only so long as no senior class of stock has such voting power by reason of any contingency. Trust Indenture Act: The term "Trust Indenture Act" means the Trust Indenture Act of 1939, as amended, as it was in force at the date of execution of this Indenture, except as provided in Sections 11.3 and 15.6; provided, however, that in the event the Trust Indenture Act of 1939 is amended after the date hereof, the term "Trust Indenture Act" shall mean, to the extent required by such amendment, the Trust Indenture Act of 1939 as so amended. Trustee: The term "Trustee" means State Street Bank and Trust Company of California, N.A., and its successors and any corporation resulting from or surviving any consolidation or merger to which it or its successors may be a party and any successor trustee at the time serving as successor trustee hereunder. In addition to the foregoing defined terms (except as herein otherwise expressly provided or unless the context otherwise requires), the following terms shall have the respective meanings -7- 14 specified in the following Sections and any other terms defined herein shall have the meanings assigned thereto:
Term Section ---- ------- Closing Price 15.4(8) Company Notice 16.2 Conversion Price 15.1 Conversion Shares 15.4(4) Current Market Price 15.4 Defaulted Interest 2.3 Distribution Record Date 15.4(8) "ex" date 15.5(h) Expiration Time 15.5(f) fair market value 15.4(8) junior securities 4.8 non-electing share 15.6 Note register 2.5 Note registrar 2.5 Offer Expiration Time 15.5(g) Payment Blockage Notice 4.2(ii) Purchased Common Shares 15.5(g) Purchased Shares 15.5(f) Removal Notice 8.10(b) Repurchase Date 16.1 Repurchase Price 16.1 Termination of Trading 16.3 Trading Day 15.4(8) Trigger Event 15.2
ARTICLE II ISSUE, DESCRIPTION, EXECUTION, REGISTRATION AND EXCHANGE OF NOTES Section 2.1 Designation, Amount and Issue of Notes. The Notes shall be designated as "__% Convertible Subordinated Notes due 2003". Notes not to exceed the aggregate principal amount of $90,000,000 (or $100,000,000 if the over-allotment option set forth in Section 2(b) of the Underwriting Agreement for the Notes dated March __, 1998 (as amended from time to time by the parties thereto) by and between the Company and the several underwriters named therein is exercised in full) (except pursuant to Sections 2.5, 2.6, 3.7, 15.2 and 16.2) upon the execution of this Indenture, or from time to time thereafter, may be executed by the Company and delivered -8- 15 to the Trustee for authentication, and the Trustee shall thereupon authenticate and deliver said Notes upon the written order of the Company, signed by its (a) Chief Executive Officer, President or any Vice President (whether or not designated by a number or numbers or word or words added before or after the title "Vice President") and (b) Treasurer or Assistant Treasurer or its Secretary or any Assistant Secretary, without any further action by the Company hereunder. Section 2.2 Form of Notes. The Notes and the Trustee's certificate of authentication to be borne by such Notes shall be substantially in the form set forth in Exhibit A, which is incorporated in and made a part of this Indenture. Any of the Notes may have such letters, numbers or other marks of identification and such notations, legends and endorsements as the officers executing the same may approve (execution thereof to be conclusive evidence of such approval) and as are not inconsistent with the provisions of this Indenture, or as may be required to comply with any law or with any rule or regulation made pursuant thereto or with any rule or regulation of any securities exchange or automated quotation system on which the Notes may be listed or designated for issuance, or to conform to usage. The terms and provisions contained in the form of Note attached as Exhibit A hereto shall constitute, and are hereby expressly made, a part of this Indenture and to the extent applicable, the Company and the Trustee, by their execution and delivery of this Indenture, expressly agree to such terms and provisions and to be bound thereby. Section 2.3 Date and Denomination of Notes; Payments of Interest. The Notes shall be issuable in registered form without coupons in denominations of $1,000 principal amount and integral multiples thereof. Every Note shall be dated the date of its authentication, shall bear interest from the applicable date and accrued interest shall be payable semiannually on each March 1 and September 1, commencing September 1, 1998 as specified on the face of the form of Note, attached as Exhibit A hereto. The Person in whose name any Note (or its Predecessor Note) is registered at the close of business on any Regular Record Date with respect to any interest payment date (including any Note that is converted during the period from the close of business on any Regular Record Date to the close of business on the Business Day prior to the next succeeding interest payment date) shall be entitled to receive the interest payable on such interest payment date notwithstanding the cancellation of such Note upon any transfer, exchange or conversion subsequent to the Regular Record Date and prior to such interest payment date; provided that any Note surrendered for conversion during the period from the close of business on any Regular Record Date to the close of business on the Business Day prior to the next succeeding interest payment date, to the extent provided in Section 15.2, shall be accompanied by a payment equal to the interest otherwise payable on such next succeeding interest payment date; provided further that in the event of any redemption or repurchase of any Note after a Regular Record Date and prior to the next succeeding interest payment date, interest shall not be paid to the Person in whose name the Note -9- 16 is registered on the close of business on such Regular Record Date, but instead shall be payable to the holder of such Note surrendering such Note for redemption or repurchase, as the case may be, as required by Section 3.7 hereof and Article XVI hereof, respectively. Interest may, at the option of the Company, be paid by check mailed to the address of such Person on the registry kept for such purposes; provided that, with respect to any holder of Notes with an aggregate principal amount equal to or in excess of $1,000,000, at the request of such holder in writing to the Company, interest on such holder's Notes shall be paid by wire transfer in immediately available funds in accordance with the wire transfer instruction supplied by such holder to the Trustee and paying agent (if different from Trustee). Interest on the Notes shall be computed on the basis of a 360-day year comprised of twelve 30-day months. Any interest on any Note which is payable, but is not punctually paid or duly provided for, on any said March 1 or September 1 (herein called "Defaulted Interest") shall forthwith cease to be payable to the Holder on the relevant Regular Record Date by virtue of his having been such Holder; and such Defaulted Interest shall be paid by the Company, at its election in each case, as provided in clause (1) or (2) below: (1) The Company may elect to make payment of any Defaulted Interest to the Persons in whose names the Notes (or their respective Predecessor Notes) are registered at the close of business on a Special Record Date for the payment of such Defaulted Interest, which shall be fixed in the following manner. The Company shall notify the Trustee in writing of the amount of Defaulted Interest to be paid on each Note and the date of the payment (which shall be not less than twenty-five (25) days after the receipt by the Trustee of such notice, unless the Trustee shall consent to an earlier date), and at the same time the Company shall deposit with the Trustee an amount of money equal to the aggregate amount to be paid in respect of such Defaulted Interest or shall make arrangements satisfactory to the Trustee for such deposit prior to the date of the proposed payment, such money when deposited to be held in trust for the benefit of the Persons entitled to such Defaulted Interest as in this clause provided. Thereupon the Trustee shall fix a Special Record Date for the payment of such Defaulted Interest which shall be not more than fifteen (15) days and not less than ten (10) days prior to the date of the proposed payment and not less than ten (10) days (or such shorter period to which the Trustee consents) after the receipt by the Trustee of the notice of the proposed payment. The Trustee shall promptly notify the Company of such Special Record Date and, in the name and at the expense of the Company, shall cause notice of the proposed payment of such Defaulted Interest and the Special Record Date therefor to be mailed, first-class postage prepaid, to each Holder at his address as it appears in the Note register, not less than ten (10) days prior to such Special Record Date. Notice of the proposed payment of such Defaulted Interest and the Special Record Date therefor having been so mailed, such Defaulted Interest shall be paid to the Persons in whose names the Notes (or their -10- 17 respective Predecessor Notes) were registered at the close of business on such Special Record Date and shall no longer be payable pursuant to the following clause (2). (2) The Company may make payment of any Defaulted Interest in any other lawful manner not inconsistent with the requirements of any securities exchange or automated quotation system on which the Notes may be listed or designated for issuance, and upon such notice as may be required by such exchange or automated quotation system, if, after notice given by the Company to the Trustee of the proposed payment pursuant to this clause, such manner of payment shall be deemed practicable by the Trustee. Section 2.4 Execution of Notes. The Notes shall be signed in the name and on behalf of the Company by the signature of its Chief Executive Officer, its President, or any of its Vice Presidents (whether or not designated by a number or numbers or word or words added before or after the title "Vice President") and attested by the signature of its Treasurer or any of its Assistant Treasurers or its Secretary or any of its Assistant Secretaries. The signature of any of these officers on the Notes may be manual or facsimile and may be printed, engraved or otherwise reproduced on the Notes. Only such Notes as shall bear thereon a certificate of authentication substantially in the form set forth on the form of Note attached as Exhibit A hereto, manually executed by the Trustee (or an authenticating agent appointed by the Trustee as provided by Section 17.11), shall be entitled to the benefits of this Indenture or be valid or obligatory for any purpose. Such certificate by the Trustee (or such an authenticating agent) upon any Note executed by the Company shall be conclusive evidence that the Note so authenticated has been duly authenticated and delivered hereunder and that the holder is entitled to the benefits of this Indenture. In case any officer of the Company who shall have signed any of the Notes shall cease to be such officer before the Notes so signed shall have been authenticated and delivered by the Trustee, or disposed of by the Company, such Notes nevertheless may be authenticated and delivered or disposed of as though the Person who signed such Notes had not ceased to be such officer of the Company; and any Note may be signed on behalf of the Company by such Persons as, at the actual date of the execution of such Note, shall be the proper officers of the Company, although at the date of the execution of this Indenture any such Person was not such an officer. Section 2.5 Exchange and Registration of Transfer of Notes. The Company shall cause to be kept at the Corporate Trust Office of the Trustee a register (the register maintained in such office and in any other office or agency of the Company designated pursuant to Section 5.2 being herein sometimes collectively referred to as the "Note register") in which, subject to such reasonable regulations as it may prescribe, the Company shall provide for the registration of Notes and of transfers of Notes. Such Note register shall be in written form or in any form capable of being converted into written form within a reasonable period of time. The Trustee is hereby appointed "Note registrar" for the purpose of registering Notes and transfers of Notes as -11- 18 herein provided. The Company may appoint one or more co-registrars in accordance with Section 5.2. Upon surrender for registration of transfer of any Note to the Note registrar or any co-registrar, and satisfaction of the requirements for such transfer set forth in this Section 2.5, the Company shall execute, and the Trustee shall authenticate and deliver, in the name of the designated transferee or transferees, one or more new Notes of any authorized denominations and of a like aggregate principal amount. Notes may be exchanged for other Notes of any authorized denominations and of a like aggregate principal amount, upon surrender of the Notes to be exchanged at any such office or agency. Whenever any Notes are so surrendered for exchange, the Company shall execute, and the Trustee shall authenticate and deliver, the Notes which the Holder making the exchange is entitled to receive, bearing registration numbers not contemporaneously outstanding. All Notes presented or surrendered for registration of transfer or for exchange shall (if so required by the Company, the Trustee, the Note registrar or any co-registrar) be duly endorsed, or be accompanied by a written instrument or instruments of transfer in form satisfactory to the Company and duly executed by the Holder thereof or his attorney duly authorized in writing. No service charge shall be charged to the Holder for any exchange or registration of transfer of Notes, but the Company may require payment of a sum sufficient to cover any tax, assessments or other governmental charges that may be imposed in connection therewith. None of the Company, the Trustee, the Note registrar or any co-registrar shall be required to exchange or register a transfer of (a) any Notes for a period of fifteen (15) days next preceding any selection of Notes to be redeemed or (b) any Notes called for redemption or, if a portion of any Note is selected or called for redemption, such portion thereof selected or called for redemption or (c) any Notes surrendered for conversion or, if a portion of any Note is surrendered for conversion, such portion thereof surrendered for conversion or (d) any Notes surrendered for repurchase (and not withdrawn) pursuant to Article XVI or, if a portion of any Note is surrendered for repurchase pursuant to Article XVI, such portion thereof surrendered for repurchase (and not withdrawn) pursuant to Article XVI. All Notes issued upon any transfer or exchange of Notes in accordance with this Indenture shall be the valid obligations of the Company, evidencing the same debt, and entitled to the same benefits under this Indenture as the Notes surrendered upon such registration of transfer or exchange. Section 2.6 Mutilated, Destroyed, Lost or Stolen Notes. In case any Note shall become mutilated or be destroyed, lost or stolen, the Company in its discretion may execute, and upon its request the Trustee or an authenticating agent appointed by the Trustee shall authenticate and deliver, a new Note, bearing a number not contemporaneously outstanding, in exchange and -12- 19 substitution for the mutilated Note, or in lieu of and in substitution for the Note so destroyed, lost or stolen. In every case the applicant for a substituted Note shall furnish to the Company, to the Trustee and, if applicable, to such authenticating agent such security or indemnity as may be required by them to save each of them harmless for any loss, liability, cost or expense caused by or connected with such substitution, and, in every case of destruction, loss or theft, the applicant shall also furnish to the Company, to the Trustee and, if applicable, to such authenticating agent evidence to their satisfaction of the destruction, loss or theft of such Note and of the ownership thereof. The Trustee or such authenticating agent may authenticate any such substituted Note and deliver the same upon the receipt of such security or indemnity as the Trustee, the Company and, if applicable, such authenticating agent may require. Upon the issuance of any substituted Note, the Company may require the payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in relation thereto and any other expenses connected therewith. In case any Note which has matured or is about to mature or has been called for redemption or submitted for repurchase (and not withdrawn) or is about to be converted into Common Stock shall become mutilated or be destroyed, lost or stolen, the Company may, instead of issuing a substitute Note, pay or authorize the payment of or convert or authorize the conversion of the same (without surrender thereof except in the case of a mutilated Note), as the case may be, if the applicant for such payment or conversion shall furnish to the Company, to the Trustee and, if applicable, to such authenticating agent such security or indemnity as may be required by them to save each of them harmless for any loss, liability, cost or expense caused by or connected with such substitution, and, in case of destruction, loss or theft, evidence satisfactory to the Company, the Trustee and, if applicable, any paying agent or conversion agent of the destruction, loss or theft of such Note and of the ownership thereof. Every substitute Note issued pursuant to the provisions of this Section 2.6 by virtue of the fact that any Note is destroyed, lost or stolen shall constitute an additional contractual obligation of the Company, whether or not the destroyed, lost or stolen Note shall be found at any time, and shall be entitled to all the benefits of (but shall be subject to all the limitations set forth in) this Indenture equally and proportionately with any and all other Notes duly issued hereunder. To the extent permitted by law, all Notes shall be held and owned upon the express condition that the foregoing provisions are exclusive with respect to the replacement or payment or conversion of mutilated, destroyed, lost or stolen Notes and shall preclude any and all other rights or remedies notwithstanding any law or statute existing or hereafter enacted to the contrary with respect to the replacement or payment or conversion of negotiable instruments or other securities without their surrender. Section 2.7 Temporary Notes. Pending the preparation of definitive Notes, the Company may execute and the Trustee or an authenticating agent appointed by the Trustee shall, upon written request of the Company, authenticate and deliver temporary Notes (printed, typewritten or lithographed). Temporary Notes shall be issuable in any authorized denomination, and substantially in the form of the definitive Notes but with such omissions, insertions and -13- 20 variations as may be appropriate for temporary Notes, all as may be determined by the Company. Every such temporary Note shall be executed by the Company and authenticated by the Trustee or such authenticating agent upon the same conditions and in substantially the same manner, and with the same effect, as the definitive Notes. Without unreasonable delay the Company will execute and deliver to the Trustee or such authenticating agent definitive Notes and thereupon any or all temporary Notes may be surrendered in exchange therefor, at each office or agency maintained by the Company pursuant to Section 5.2 and the Trustee or such authenticating agent shall authenticate and deliver in exchange for such temporary Notes an equal aggregate principal amount of definitive Notes. Such exchange shall be made by the Company at its own expense and without any charge therefor. Until so exchanged, the temporary Notes shall in all respects be entitled to the same benefits and subject to the same limitations under this Indenture as definitive Notes authenticated and delivered hereunder. Section 2.8 Cancellation of Notes Paid, Etc. All Notes surrendered for the purpose of payment, redemption, repurchase, conversion, exchange or registration of transfer, shall, if surrendered to the Company or any paying agent or any Note registrar or any conversion agent, be surrendered to the Trustee and promptly canceled by it, or, if surrendered to the Trustee, shall be promptly canceled by it, and no Notes shall be issued in lieu thereof except as expressly permitted by any of the provisions of this Indenture. Upon written instructions of the Company, the Trustee shall destroy canceled Notes and, after such destruction, shall deliver a certificate of such destruction to the Company. If the Company shall acquire any of the Notes, such acquisition shall not operate as a redemption or satisfaction of the indebtedness represented by such Notes unless and until the same are delivered to the Trustee for cancellation. ARTICLE III REDEMPTION OF NOTES Section 3.1 Right of Redemption. The Notes may be redeemed in accordance with the provisions of the form of Note attached as Exhibit A hereto. Section 3.2 Applicability of Article. Redemption of Notes at the election of the Company or otherwise, as permitted or required by any provision of the Notes or this Indenture, shall be made in accordance with such provision and this Article III. Section 3.3 Election to Redeem; Notice to Trustee. The election of the Company to redeem any Notes shall be evidenced by a Board Resolution. In case of any redemption at the election of the Company of any of the Notes, the Company shall, at least 45 days prior to the Redemption Date fixed by the Company (unless a shorter notice shall be satisfactory to the Trustee), notify the Trustee in writing of such Redemption Date. -14- 21 Section 3.4 Selection by Trustee of Notes to Be Redeemed. If less than all the Notes are to be redeemed, the particular Notes to be redeemed shall be selected by the Trustee within seven Business Days after it receives the notice described in 3.3, from the outstanding Notes not previously called for redemption, by lot or, in the Trustee's sole discretion, on a pro rata basis. If any Note selected for partial redemption is converted in part before termination of the conversion right with respect to the portion of the Note so selected, the converted portion of such Note shall be deemed (so far as may be) to be the portion selected for redemption. Notes which have been converted during a selection of Notes to be redeemed may be treated by the Trustee as Outstanding for the purpose of such selection. The Trustee shall promptly notify the Company and each Note Registrar in writing of the securities selected for redemption and, in the case of any Notes selected for partial redemption, the principal amount thereof to be redeemed. For all purposes of this Indenture, unless the context otherwise requires, all provisions relating to the redemption of Notes shall relate, in the case of any Notes redeemed or to be redeemed only in part, to the portion of the principal amount of such Notes which has been or is to be redeemed. Section 3.5 Notice of Redemption. Notice of redemption shall be mailed to the Holders of Notes to be redeemed not less than 20 nor more than 60 days prior to the Redemption Date, and such notice shall be irrevocable. All notices of redemption shall state: (1) the Redemption Date, (2) the Redemption Price, (3) if less than all outstanding Notes are to be redeemed, the aggregate principal amount of Notes to be redeemed and the aggregate principal amount of Notes which will be outstanding after such partial redemption, (4) that on the Redemption Date the Redemption Price, and accrued interest, if any, to the Redemption Date will become due and payable upon each such Note to be redeemed, and that interest thereon shall cease to accrue on and after said date, (5) the Conversion Price then in effect, the date on which the right to convert the Notes to be redeemed will terminate and the places where such Notes may be surrendered for conversion, -15- 22 (6) the place or places where such Notes are to be surrendered for payment of the Redemption Price and accrued interest, if any, and (7) the CUSIP number for the Notes. Neither failure to receive any such notice so mailed nor any defect therein shall affect the validity of the proceedings for the redemption of such Notes or the cessation of the accrual of interest. In case of a partial redemption, the notice shall specify the serial and CUSIP numbers (if any) and the portions thereof called for redemption and that transfers and exchanges may occur on or prior to the Redemption Date. Notice of redemption of Notes to be redeemed at the election of the Company shall be given by the Company or, at the Company's written request, by the Trustee in the name of, and at the expense of, the Company. Notice of redemption of Notes to be redeemed at the election of the Company received by the Trustee shall be given by the Trustee to each paying agent in the name of and at the expense of the Company. Section 3.6 Deposit of Redemption Price. By 10:00 a.m. (New York time) on any Redemption Date of the Notes, the Company shall deposit with the Trustee or with the paying agent so directed by the Trustee (or, if the Company is acting as its own paying agent, segregate and hold in trust as provided in Section 8.5) an amount of money (which shall be in immediately available funds on such Redemption Date) sufficient to pay the Redemption Price of, and accrued interest to (but excluding) the Redemption Date on, all the Notes which are to be redeemed on that date other than any Notes called for redemption on that date which have been converted prior to the date of such deposit. If any Note called for redemption is converted, any money deposited with the Trustee or with a paying agent or so segregated and held in trust for the redemption of such Note shall (subject to any right of the Holder of such Note, if a Note, or any Predecessor Note to receive interest as provided in the last paragraph of Section 2.3) be paid to the Company upon request as soon as administratively practicable after the Trustee receives such request or, if then held by the Company, shall be discharged from such trust. Section 3.7 Notes Payable on Redemption Date. Notice of redemption having been given as aforesaid, the Notes so to be redeemed shall, on the Redemption Date, become due and payable at the Redemption Price therein specified plus accrued interest to (but excluding) the Redemption Date and from and after such date (unless the Company shall default in the payment of the Redemption Price, including accrued interest to (but excluding) the Redemption Date) such Notes shall cease to bear interest. Upon surrender of any Note for redemption in accordance with said notice, such Note shall be paid by the Company at the Redemption Price together with accrued and unpaid interest to (but excluding) the Redemption Date; provided, -16- 23 however, that any semi-annual payment of interest becoming due on the Redemption Date shall be payable to the holders of record on the Regular Record Date of the Notes being redeemed. If any Note called for redemption shall not be so paid upon surrender thereof for redemption, the principal amount of, premium, if any, and, to the extent permitted by applicable law, accrued interest on such Note shall, until paid, bear interest from the Redemption Date at a rate of _____% per annum and such Note shall remain convertible into Common Stock until the principal of such Note (or portion thereof, as the case may be) shall have been paid or duly provided for. Section 3.8 Notes Redeemed in Part. Any Note which is to be redeemed only in part shall be surrendered at an office or agency of the Company designated for that purpose pursuant to Section 5.2 (with, if the Company or the Trustee so requires, due endorsement by, or a written instrument of transfer in form satisfactory to the Company and the Trustee duly executed by, the Holder thereof or his attorney duly authorized in writing), and the Company shall execute, and the Trustee shall authenticate and make available for delivery to the Holder of such Note without service charge, a new Note or Notes, of any authorized denomination as requested by such Holder, in aggregate principal amount equal to and in exchange for the unredeemed portion of the principal of the Note so surrendered. Section 3.9 Conversion Arrangement on Call for Redemption. In connection with any redemption of Notes, the Company may arrange for the purchase and conversion of any Notes by an agreement with one or more investment bankers or other purchasers (the "Purchasers") to purchase such securities by paying to the Trustee in trust for the Holders, on or before the Redemption Date, an amount not less than the applicable Redemption Price, together with interest accrued to (but excluding) the Redemption Date, of such Notes. Notwithstanding anything to the contrary contained in this Article III, the obligation of the Company to pay the Redemption Price, together with interest accrued to (but excluding) the Redemption Date, shall be deemed to be satisfied and discharged to the extent such amount is so paid by such Purchasers. If such an agreement is entered into (a copy of which shall be filed with the Trustee prior to the close of business on the Business Day immediately prior to the Redemption Date), any Notes called for redemption that are not duly surrendered for conversion by the Holders thereof may, at the option of the Company, be deemed, to the fullest extent permitted by law, and consistent with any agreement or agreements with such Purchasers, to be acquired by such Purchasers from such Holders and (notwithstanding anything to the contrary contained in Article XV) surrendered by such Purchasers for conversion, all as of immediately prior to the close of business on the Redemption Date (and the right to convert any such Notes shall be extended though such time), subject to payment of the above amount as aforesaid. At the direction of the Company, the Trustee shall hold and dispose of any such amount paid to it to the Holders in the same manner as it would monies deposited with it by the Company for the redemption of Notes. Without the Trustee's prior written consent, no arrangement between the Company and such Purchasers for the purchase and conversion of any Notes shall increase or otherwise affect any of the powers, duties, responsibilities or obligations of the Trustee as set -17- 24 forth in this Indenture, and the Company agrees to indemnify the Trustee from, and hold it harmless against, any loss, liability or expense arising out of or in connection with any such arrangement for the purchase and conversion of any Notes between the Company and such Purchasers, including the costs and expenses, including reasonable legal fees, incurred by the Trustee in the defense of any claim or liability arising out of or in connection with the exercise or performance of any of its powers, duties, responsibilities or obligations under this Indenture. ARTICLE IV SUBORDINATION OF NOTES Section 4.1 Agreement of Subordination. The Company covenants and agrees, and each Holder of Notes issued hereunder by his acceptance thereof likewise covenants and agrees, that all Notes shall be issued subject to the provisions of this Article IV; and each Person holding any Note, whether upon original issue or upon transfer, assignment or exchange thereof, accepts and agrees to be bound by such provisions. The payment of the principal of, premium, if any, and interest on all Notes (including, but not limited to, the Redemption Price with respect to the Notes called for redemption in accordance with Article IV, or the Repurchase Price with respect to Notes submitted for repurchase in accordance with Article XVI, as the case may be, as provided in this Indenture) issued hereunder shall, to the extent and in the manner hereinafter set forth, be subordinated and subject in right of payment to the prior payment in full in cash or other payment satisfactory to the holders of Senior Indebtedness of all Senior Indebtedness of the Company, whether outstanding at the date of this Indenture or thereafter incurred. No provision of this Article IV shall prevent the occurrence of any default or Event of Default hereunder. Section 4.2 Payments to Holders. No payment shall be made with respect to the principal of, or premium, if any, or interest on the Notes by the Company (including, but not limited to, the Redemption Price with respect to the Notes to be called for redemption in accordance with Article III or the Repurchase Price with respect to Notes submitted for repurchase in accordance with Article XVI, as the case may be, as provided in this Indenture), except payments and distributions made by the Trustee as permitted by the first or second paragraph of Section 14.5, if: (i) a default in the payment of principal, premium, interest, rent or other obligations due on any Senior Indebtedness of the Company has occurred and is continuing (or, in the case of Senior Indebtedness of the Company for which there is a period of grace, in the event of such a default that continues beyond the period of grace, if any, specified in the instrument or lease evidencing such Senior Indebtedness of the -18- 25 Company), unless and until such default shall have been cured or waived or shall have ceased to exist; or (ii) a default (other than a payment default) on Designated Senior Indebtedness occurs and is continuing that then permits holders of such Designated Senior Indebtedness to accelerate its maturity and the Trustee receives a notice of the default (a "Payment Blockage Notice") from a Representative of Designated Senior Indebtedness or a holder of Designated Senior Indebtedness or the Company. If the Trustee receives any Payment Blockage Notice pursuant to clause (ii) above, no subsequent Payment Blockage Notice shall be effective for purposes of this Section unless and until at least 365 days shall have elapsed since the initial effectiveness of the immediately prior Payment Blockage Notice. No nonpayment default that existed or was continuing on the date of delivery of any Payment Blockage Notice to the Trustee (unless such default was waived, cured or otherwise ceased to exist and thereafter subsequently reoccurred) shall be, or be made, the basis for a subsequent Payment Blockage Notice. The Company may and shall resume payments on and distributions in respect of the Notes upon the earlier of: (1) in the case of a payment default, the date upon which the default is cured or waived or ceases to exist, or (2) in the case of a default referred to in clause (ii) above, the earlier of the date on which such default is cured or waived or ceases to exist or 179 days after the date on which the applicable Payment Blockage Notice is received if the maturity of such Designated Senior Indebtedness has not been accelerated, unless this Article IV otherwise prohibits the payment or distribution at the time of such payment or distribution (including without limitation, in the case of default referred to in clause (ii) above, as a result of a payment default with respect to the applicable Senior Indebtedness as a consequence of the acceleration of the maturity thereof or otherwise). Upon any payment by the Company, or distribution of assets of the Company of any kind or character, whether in cash, property or securities, to creditors upon any dissolution or winding-up or liquidation or reorganization of the Company, whether voluntary or involuntary or in bankruptcy, moratorium of payments, insolvency, receivership or other proceedings, all amounts due or to become due upon all Senior Indebtedness of the Company shall first be paid in full in cash or other payment satisfactory to the holders of such Senior Indebtedness of the Company, or payment thereof in accordance with its terms provided for in cash or other payment satisfactory to the holders of such Senior Indebtedness of the Company before any payment is made on account of the principal of, premium, if any, or interest on the Notes by the Company (except payments by the Company made pursuant to Article XIII from monies deposited with the -19- 26 Trustee pursuant thereto prior to commencement of proceedings for such dissolution, winding-up, liquidation or reorganization); and upon any such dissolution or winding-up or liquidation or reorganization of the Company or bankruptcy, insolvency, receivership or other proceeding, any payment by the Company, or distribution of assets of the Company of any kind or character, whether in cash, property or securities, to which the Holders or the Trustee would be entitled, except for the provision of this Article IV, shall (except as aforesaid) be paid by the Company or by any receiver, trustee in bankruptcy, moratorium of payments, liquidating trustee, agent or other Person making such payment or distribution, or by the Holders or by the Trustee under this Indenture if received by them or it, directly to the holders of Senior Indebtedness of the Company (pro rata to such holders on the basis of the respective amounts of Senior Indebtedness of the Company held by such holders, or as otherwise required by law or a court order) or their Representative or Representatives, or to the trustee or trustees under any indenture pursuant to which any instruments evidencing any Senior Indebtedness of the Company may have been issued, as their respective interests may appear, to the extent necessary to pay all Senior Indebtedness of the Company in full in cash or other payment satisfactory to the holders of such Senior Indebtedness of the Company after giving effect to any concurrent payment or distribution to or for the holders of Senior Indebtedness of the Company, before any payment or distribution is made to the Holders or to the Trustee. For purposes of this Article IV, the words, "cash, property or securities" shall not be deemed to include shares of stock of the Company as reorganized or readjusted, or securities of the Company or any other corporation provided for by a plan of reorganization or readjustment, the payment of which is subordinated at least to the extent provided in this Article IV with respect to the Notes to the payment of all Senior Indebtedness of the Company which may at the time be outstanding; provided that (i) the Senior Indebtedness of the Company is assumed by the new corporation, if any, resulting from any reorganization or readjustment, and (ii) the rights of the holders of Senior Indebtedness of the Company (other than leases which are not assumed by the Company or the new corporation, as the case may be) are not, without the consent of such holders, altered by such reorganization or readjustment. The merger of the Company into another corporation or the liquidation or dissolution of the Company following the conveyance or transfer of its property as an entirety, or substantially as an entirety, to another corporation upon the terms and conditions provided for in Article XII shall not be deemed a dissolution, winding-up, liquidation or reorganization for the purposes of this Section 4.2 if such other corporation shall, as a part of such merger, conveyance or transfer, comply with the conditions stated in Article XII. In the event of the acceleration of the Notes because of an Event of Default, no payment or distribution shall be made to the Trustee or any Holder of Notes in respect of the principal of, premium, if any, or interest on the Notes by the Company (including, but not limited to, the Redemption Price with respect to the Notes called for redemption in accordance with Article III or the Repurchase Price with respect to Notes submitted for repurchase in accordance with Article XVI, as the case may be, as provided in this Indenture), except payments and distributions made by the Trustee as permitted by the first or second paragraph of Section 4.5, -20- 27 until all Senior Indebtedness of the Company has been paid in full in cash or other payment satisfactory to the holders of Senior Indebtedness of the Company of all obligations in respect of such Senior Indebtedness or such acceleration is rescinded in accordance with the terms of this Indenture. If payment of the Notes is accelerated because of an Event of Default, the Company shall promptly notify holders of Senior Indebtedness of the Company of the acceleration. In the event that, notwithstanding the foregoing provisions, any payment or distribution of assets of the Company of any kind or character, whether in cash, property or securities (including, without limitation, by way of setoff or otherwise), prohibited by the foregoing, shall be received by the Trustee or the Holders of the Notes before all Senior Indebtedness of the Company is paid in full in cash or other payment satisfactory to the holders of such Senior Indebtedness of the Company, or provision is made for such payment thereof in accordance with its terms in cash or other payment satisfactory to the holders of such Senior Indebtedness of the Company, such payment or distribution shall be held in trust for the benefit of and shall be paid over or delivered to the holders of Senior Indebtedness of the Company or their Representative or Representatives, or to the trustee or trustees under any indenture pursuant to which any instruments evidencing any Senior Indebtedness of the Company may have been issued, as their respective interests may appear, as calculated by the Company, for application to the payment of all Senior Indebtedness of the Company remaining unpaid to the extent necessary to pay all Senior Indebtedness of the Company in full in cash or other payment satisfactory to the holders of such Senior Indebtedness of the Company, after giving effect to any concurrent payment or distribution, or provision therefor, to or for the holders of such Senior Indebtedness of the Company. Nothing in this Article IV shall apply to claims of, or payments to, the Trustee under or pursuant to Section 8.6. This Section 4.2 shall be subject to the further provisions of Section 4.5. Section 4.3 Subrogation of Notes. Subject to the payment in full in cash or other payment satisfactory to the holders of Senior Indebtedness of all Senior Indebtedness of the Company, the Holders of the Notes shall be subrogated to the extent of the payments or distributions made to the holders of such Senior Indebtedness of the Company pursuant to the provisions of this Article IV (equally and ratably with the holders of all indebtedness of the Company which by its express terms is subordinated to other indebtedness of the Company to substantially the same extent as the Notes are subordinated and is entitled to like rights of subrogation) to the rights of the holders of Senior Indebtedness of the Company to receive payments or distributions of cash, property or securities of the Company applicable to the Senior Indebtedness of the Company until the principal, premium, if any, and interest on the Notes shall be paid in full; and, for the purposes of such subrogation, no payments or distributions to the holders of the Senior Indebtedness of the Company of any cash, property or securities to which the Holders of the Notes or the Trustee would be entitled except for the provisions of this Article IV, and no payment over pursuant to the provisions of this Article IV, to or for the benefit of the holders of Senior Indebtedness of the Company by Holders of the Notes or the Trustee, shall, as between the Company, its creditors other than holders of Senior Indebtedness of the -21- 28 Company, and the Holders of the Notes, be deemed to be a payment by the Company to or on account of the Senior Indebtedness of the Company. It is understood that the provisions of this Article IV are and are intended solely for the purposes of defining the relative rights of the Holders of the Notes, on the one hand, and the holders of the Senior Indebtedness of the Company, on the other hand. Nothing contained in this Article IV or elsewhere in this Indenture or in the Notes is intended to or shall impair, as among the Company, its creditors other than the holders of Senior Indebtedness of the Company, and the Holders of the Notes, the obligation of the Company, which is absolute and unconditional, to pay to the Holders of the Notes the principal of (and premium, if any) and interest on the Notes as and when the same shall become due and payable in accordance with their terms, or is intended to or shall affect the relative rights of the Holders of the Notes and creditors of the Company other than the holders of the Senior Indebtedness of the Company, nor shall anything herein or therein prevent the Trustee or the Holder of any Note from exercising all remedies otherwise permitted by applicable law upon default under this Indenture, subject to the rights, if any, under this Article IV of the holders of Senior Indebtedness of the Company in respect of cash, property or securities of the Company received upon the exercise of any such remedy. Upon any payment or distribution of assets of the Company referred to in this Article IV, the Trustee, subject to the provisions of Section 8.1, and the Holders of the Notes shall be entitled to rely upon any order or decree made by any court of competent jurisdiction in which such bankruptcy, dissolution, winding-up, liquidation or reorganization proceedings are pending, or a certificate of the receiver, trustee in bankruptcy, liquidating trustee, agent or other Person making such payment or distribution, delivered to the Trustee or to the Holders of the Notes, for the purpose of ascertaining the Persons entitled to participate in such distribution, the holders of the Senior Indebtedness of the Company and other Indebtedness of the Company, the amount thereof or payable thereon and all other facts pertinent thereto or to this Article IV. Section 4.4 Authorization to Effect Subordination. Each Holder of a Note by the Holder's acceptance thereof authorizes and directs the Trustee on the Holder's behalf to take such action as may be necessary or appropriate to effectuate the subordination as provided in this Article IV and appoints the Trustee to act as the Holder's attorney-in-fact for any and all such purposes. If the Trustee does not file a proper proof of claim or proof of debt in the form required in any proceeding referred to in Section 7.2 hereof at least 30 days before the expiration of the time to file such claim, the holders of any Senior Indebtedness of the Company or their Representatives are hereby authorized to file an appropriate claim for and on behalf of the Holders of the Notes. Section 4.5 Notice to Trustee. The Company shall give prompt written notice in the form of an Officers' Certificate to a Responsible Officer of the Trustee and to any paying agent of any fact known to the Company which would prohibit the making of any payment of monies deposited by the Company to or by the Trustee or any paying agent in respect of the Notes -22- 29 pursuant to the provisions of this Article IV. Notwithstanding the provisions of this Article IV or any other provision of this Indenture, the Trustee shall not be charged with knowledge of the existence of any facts which would prohibit the making of any payment of monies deposited by the Company to or by the Trustee in respect of the Notes pursuant to the provisions of this Article IV, unless and until a Responsible Officer of the Trustee shall have received written notice thereof at the Corporate Trust Office from the Company (in the form of an Officers' Certificate) or a Representative of Senior Indebtedness or of a holder or holders of Senior Indebtedness of the Company or from any trustee thereof; and before the receipt of any such written notice, the Trustee, subject to the provisions of Section 8.1, shall be entitled in all respects to assume that no such facts exist; provided that if on a date not fewer than two Business Days prior to the date upon which by the terms hereof any such monies may become payable for any purpose (including, without limitation, the payment of the principal of, or premium, if any, or interest on any Note) the Trustee shall not have received, with respect to such monies, the notice provided for in this Section 4.5, then, anything herein contained to the contrary notwithstanding, the Trustee shall have full power and authority to receive such monies deposited by the Company and to apply the same to the purpose for which they were received, and shall not be affected by any notice to the contrary which may be received by it on or after such prior date. Notwithstanding anything in this Article IV to the contrary, nothing shall prevent any payment by the Trustee to the Holders of monies deposited with it pursuant to Section 13.1, and any such payment shall not be subject to the provisions of Section 4.1 or 4.2. The Trustee, subject to the provisions of Section 8.1, shall be entitled to rely on the delivery to it of a written notice by a Representative or a Person representing himself to be a holder of Senior Indebtedness of the Company (or a trustee on behalf of such holder) to establish that such notice has been given by a Representative or a holder of Senior Indebtedness of the Company or a trustee on behalf of any such holder or holders. In the event that the Trustee determines in good faith that further evidence is required with respect to the right of any Person as a holder of Senior Indebtedness of the Company to participate in any payment or distribution pursuant to this Article IV, the Trustee may request such Person to furnish evidence to the reasonable satisfaction of the Trustee as to the amount of Senior Indebtedness of the Company held by such Person, the extent to which such Person is entitled to participate in such payment or distribution and any other facts pertinent to the rights of such Person under this Article IV, and if such evidence is not furnished the Trustee may defer any payment to such Person pending judicial determination as to the right of such Person to receive such payment. Section 4.6 Trustee's Relation to Senior Indebtedness of the Company. The Trustee in its individual capacity shall be entitled to all the rights set forth in this Article IV in respect of any Senior Indebtedness of the Company at any time held by it, to the same extent as any other holder of Senior Indebtedness of the Company, and nothing in this Indenture shall deprive the Trustee of any of its rights as such holder. -23- 30 With respect to the holders of Senior Indebtedness of the Company, the Trustee undertakes to perform or to observe only such of its covenants and obligations as are specifically set forth in this Article IV, and no implied covenants or obligations with respect to the holders of Senior Indebtedness of the Company shall be read into this Indenture against the Trustee. The Trustee shall not be deemed to owe any fiduciary duty to the holders of Senior Indebtedness of the Company and, subject to the provisions of Section 8.1, the Trustee shall not be liable to any holder of Senior Indebtedness of the Company if it shall pay over or deliver to Holders of Notes, the Company or any other Person money or assets to which any holder of Senior Indebtedness of the Company shall be entitled by virtue of this Article IV or otherwise. Section 4.7 No Impairment of Subordination. No right of any present or future holder of any Senior Indebtedness of the Company to enforce subordination as herein provided shall at any time in any way be prejudiced or impaired by any act or failure to act on the part of the Company or by any act or failure to act, in good faith, by any such holder, or by any noncompliance by the Company with the terms, provisions and covenants of this Indenture, regardless of any knowledge thereof which any such holder may have or otherwise be charged with. Section 4.8 Article Applicable to Paying Agents. If at any time any paying agent other than the Trustee shall have been appointed by the Company and be then acting hereunder, the term "Trustee" as used in this Article shall (unless the context otherwise requires) be construed as extending to and including such paying agent within its meaning as fully for all intents and purposes as if such paying agent were named in this Article in addition to or in place of the Trustee; provided, however, that the first paragraph of Section 4.5 shall not apply to the Company or any Affiliate of the Company if it or such Affiliate acts as paying agent. Section 4.9 Senior Indebtedness of the Company Entitled to Rely. The holders of Senior Indebtedness of the Company (including, without limitation, Designated Senior Indebtedness) shall have the right to rely upon this Article IV, and no amendment or modification of the provisions contained herein shall diminish the rights of such holders unless such holders shall have agreed in writing thereto. Section 4.10 Certain Conversions Deemed Payment. For the purposes of this Article IV only, (1) the issuance and delivery of junior securities upon conversion of Notes in accordance with Article XV shall not be deemed to constitute a payment or distribution on account of the principal of (or premium, if any) or interest on Notes or on account of the purchase or other acquisition of Notes, and (2) the payment, issuance or delivery of cash (except in satisfaction of fractional shares pursuant to Section 15.3), property or securities (other than junior securities) upon conversion of a Note shall be deemed to constitute payment on account of the principal of such Note. For the purposes of this Section 4.10, the term "junior securities" means (a) shares of any stock of any class of the Company (including, without limitation, the Common Stock of the Company), or (b) securities of the Company which are subordinated in right of payment to all Senior Indebtedness of the Company which may be outstanding at the -24- 31 time of issuance or delivery of such securities to substantially the same extent as, or to a greater extent than, the Notes are so subordinated as provided in this Article IV. Nothing contained in this Article IV or elsewhere in this Indenture or in the Notes is intended to or shall impair, as among the Company, its creditors other than holders of Senior Indebtedness of the Company and the Holders, the right, which is absolute and unconditional, of the Holder of any Note to convert such Note in accordance with Article XV. ARTICLE V PARTICULAR COVENANTS OF THE COMPANY Section 5.1 Payment of Principal, Premium and Interest. The Company covenants and agrees that it will duly and punctually pay or cause to be paid the principal of and premium, if any, and interest on each of the Notes at the places, at the respective times and in the manner provided herein and in the Notes. Section 5.2 Maintenance of Office or Agency. The Company will maintain in the Borough of Manhattan, The City of New York, an office or agency where the Notes may be surrendered for registration of transfer or exchange or for presentation for payment or for conversion, redemption or repurchase and where notices and demands to or upon the Company in respect of the Notes and this Indenture may be served. The Company will give prompt written notice to the Trustee of the location, and any change in the location, of such office or agency not designated or appointed by the Trustee. If at any time the Company shall fail to maintain any such required office or agency or shall fail to furnish the Trustee with the address thereof, such presentations, surrenders, notices and demands may be made or served at the Corporate Trust Office of the Trustee or the office of the Trustee or an Affiliate of the Trustee in the Borough of Manhattan, the City of New York. The Company may also from time to time designate one or more other offices or agencies where the Notes may be presented or surrendered for any or all such purposes and may from time to time rescind such designations; provided that no such designation or rescission shall in any manner relieve the Company of its obligation to maintain an office or agency in the Borough of Manhattan, The City of New York, for such purposes. The Company will give prompt written notice to the Trustee and the holders of any such designation or rescission and of any change in the location of any such other office or agency. The Company hereby initially designates the Trustee as paying agent, Note registrar and conversion agent and the Corporate Trust Office of the Trustee and the office or agency of the Trustee in the Borough of Manhattan, The City of New York (which shall initially be the office of State Street Bank and Trust Company, N.A., located at 61 Broadway, 15th Floor, Corporate Trust Window, New York, New York 10006) as one such office or agency of the Company for each of the aforesaid purposes. -25- 32 So long as the Trustee is the Note registrar, the Trustee agrees to mail, or cause to be mailed, the notice set forth in Section 8.10(a). Section 5.3 Appointments to Fill Vacancies in Trustee's Office. The Company, whenever necessary to avoid or fill a vacancy in the office of Trustee, will appoint, in the manner provided in Section 8.10, a Trustee, so that there shall at all times be a Trustee hereunder. Section 5.4 Provisions as to Paying Agent. (a) If the Company shall appoint a paying agent other than the Trustee or if the Trustee shall appoint such a paying agent, it will cause such paying agent to execute and deliver to the Trustee an instrument in which such agent shall agree with the Trustee, subject to the provisions of this Section 5.4: (1) that it will hold all sums held by it as such agent for the payment of the principal of and premium, if any, or interest on the Notes (whether such sums have been paid to it by the Company or by any other obligor on the Notes) in trust for the benefit of the holders of the Notes; (2) that it will give the Trustee notice of any failure by the Company (or by any other obligor on the Notes) to make any payment of the principal of and premium, if any, or interest on the Notes when the same shall be due and payable; and (3) that at any time during the continuance of an Event of Default, upon request of the Trustee, it will forthwith pay to the Trustee all sums so held in trust. The Company shall, on or before each due date of the principal of, premium, if any, or interest on the Notes, deposit with the paying agent a sum sufficient to pay such principal, premium, if any, or interest, and (unless such paying agent is the Trustee) the Company will promptly notify the Trustee of any failure to take such action, provided that if such deposit is made on the due date, such deposit must be received by the paying agent by 10:00 a.m., New York City time, on such date. (b) If the Company shall act as its own paying agent, it will, on or before each due date of the principal of, premium, if any, or interest on the Notes, set aside, segregate and hold in trust for the benefit of the holders of the Notes a sum sufficient to pay such principal, premium, if any, or interest so becoming due and will notify the Trustee of any failure to take such action and of any failure by the Company (or any other obligor under the Notes) to make any payment of the principal of, premium, if any, or interest on the Notes when the same shall become due and payable. -26- 33 (c) Anything in this Section 5.4 to the contrary notwithstanding, the Company may, at any time, for the purpose of obtaining a satisfaction and discharge of this Indenture, or for any other reason, pay or cause to be paid to the Trustee all sums held in trust by the Company or any paying agent hereunder as required by this Section 5.4, such sums to be held by the Trustee upon the trusts herein contained and upon such payment by the Company or any paying agent to the Trustee, the Company or such paying agent shall be released from all further liability with respect to such sums. (d) Anything in this Section 5.4 to the contrary notwithstanding, the agreement to hold sums in trust as provided in this Section 5.4 is subject to Sections 13.3 and 13.4. Section 5.5 Existence. Subject to Article XII, the Company will do or cause to be done all things necessary to preserve and keep in full force and effect its existence, rights (charter and statutory) and franchises; provided, however, that the Company shall not be required to preserve any such right or franchise if it shall determine that the preservation thereof is no longer desirable in the conduct of the business of the Company and that the loss thereof is not disadvantageous in any material respect to the Holders. Section 5.6 Stay, Extension and Usury Laws. The Company covenants (to the extent that it may lawfully do so) that it shall not at any time insist upon, plead, or in any manner whatsoever claim or take the benefit or advantage of, any stay, extension or usury law or other law which would prohibit or forgive the Company from paying all or any portion of the principal of or interest on the Notes as contemplated herein, wherever enacted, now or at any time hereafter in force, or which may affect the covenants or the performance of this Indenture; and the Company (to the extent it may lawfully do so) hereby expressly waives all benefit or advantage of any such law, and covenants that it will not, by resort to any such law, hinder, delay or impede the execution of any power herein granted to the Trustee, but will suffer and permit the execution of every such power as though no such law has been enacted. Section 5.7 Statement by Officers as to Default. The Company will deliver to the Trustee within 120 days after the end of each fiscal year of the Company an Officers' Certificate in which one of the two officers signing such certificate is either the principal executive officer, principal financial officer or principal accounting officer at the Company stating that in the course of performance by the signers of their duties as such officers of the Company they would normally obtain knowledge of whether any default exists in the performance and observance of any of the terms, provisions and conditions of this Indenture and whether the Company has kept, observed, performed and fulfilled its obligations under this Indenture. Such Officers' Certificate shall further state, as to each such officer signing such Officers' Certificate, to the best of the knowledge of such officer, as of the date of such Officers' Certificate, (a) whether any such default exists, (b) whether the Company (as applicable) during the preceding fiscal year kept, observed, performed and fulfilled each and every covenant and obligation of the Company under this Indenture and (c) whether there was any default in the performance and observance of any of -27- 34 the terms, provisions or conditions of this Indenture during such preceding fiscal year. If the officer or officers signing the Officers' Certificate know of such a default, whether then existing or occurring during such preceding fiscal year, the Officers' Certificate shall describe such default and its status with particularity. The Company shall also promptly notify the Trustee if the Company's fiscal year is changed so that the end thereof is on any date other than the then current fiscal year end date. The Company will deliver to the Trustee, forthwith upon becoming aware of any default in the performance or observance of any covenant, agreement or condition contained in this Indenture, or any Event of Default, an Officers' Certificate specifying with particularity such default or Event of Default and further stating what action the Company has taken, is taking or proposes to take with respect thereto. Any notice required to be given under this Section 5.7 shall be delivered to the Trustee at its Corporate Trust Office. Section 5.8 Further Instruments and Acts. Upon request of the Trustee, the Company will execute and deliver such further instruments and do such further acts as may be reasonably necessary or proper to carry out more effectively the purposes of this Indenture. ARTICLE VI HOLDERS' LISTS AND REPORTS BY THE COMPANY AND THE TRUSTEE Section 6.1 Holders' Lists. The Company covenants and agrees that it will furnish or cause to be furnished to the Trustee, semi-annually, not more than fifteen (15) days after each February 15 and August 15 in each year beginning with August 15, 1998, and at such other times as the Trustee may request in writing, within thirty (30) days after receipt by the Company of any such request (or such lesser time as the Trustee may reasonably request in order to enable it to timely provide any notice to be provided by it hereunder), a list in such form as the Trustee may reasonably require of the names and addresses of the holders of Notes as of a date not more than fifteen (15) days (or such other date as the Trustee may reasonably request in order to so provide any such notices) prior to the time such information is furnished, except that no such list need be furnished so long as the Trustee is acting as Note registrar. Section 6.2 Preservation and Disclosure of Lists. (a) The Trustee shall preserve, in as current a form as is reasonably practicable, all information as to the names and addresses of the holders of Notes contained in the most recent list furnished to it as provided in Section 6.1 or maintained by the Trustee in its capacity as Note registrar, if so acting. The Trustee may destroy any list furnished to it as provided in Section 6.1 upon receipt of a new list so furnished. -28- 35 (b) The rights of Holders to communicate with other holders of Notes with respect to their rights under this Indenture or under the Notes and the corresponding rights and duties of the Trustee, shall be as provided by the Trust Indenture Act. (c) Every Holder, by receiving and holding the same, agrees with the Company and the Trustee that neither the Company nor the Trustee nor any agent of either of them shall be held accountable by reason of any disclosure of information as to names and addresses of holders of Notes made pursuant to the Trust Indenture Act. Section 6.3 Reports by Trustee. (a) Within sixty (60) days after May 15 of each year commencing with the year 1998, the Trustee shall transmit to holders of Notes such reports dated as of May 15 of the year in which such reports are made concerning the Trustee and its actions under this Indenture as may be required pursuant to the Trust Indenture Act at the times and in the manner provided pursuant thereto. (b) A copy of such report shall, at the time of such transmission to holders of Notes, be filed by the Trustee with each stock exchange and automated quotation system upon which the Notes are listed and with the Company. The Company will notify the Trustee when the Notes are listed on any stock exchange or automated quotation system and when any such listing is discontinued. Section 6.4 Reports by Company. The Company shall file with the Trustee and the Commission, and transmit to holders of Notes, such information, documents and other reports and such summaries thereof, as may be required pursuant to the Trust Indenture Act at the times and in the manner provided pursuant to such Act; provided that any such information, documents or reports required to be filed with the Commission pursuant to Section 13 or 15(d) of the Exchange Act shall be filed with the Trustee within fifteen (15) days after the same is so required to be filed with the Commission. ARTICLE VII DEFAULTS AND REMEDIES Section 7.1 Events of Default. In case one or more of the following Events of Default (whatever the reason for such Event of Default and whether it shall be voluntary or involuntary or be effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body) shall have occurred and be continuing: -29- 36 (a) default in the payment of the principal of and premium, if any, on any of the Notes as and when the same shall become due and payable either at maturity or in connection with any redemption pursuant to Article III or repurchase pursuant to Article XVI, by declaration or otherwise, whether or not such payment is prohibited by the provisions of Article IV; or (b) default in the payment of any installment of interest upon any of the Notes as and when the same shall become due and payable, and continuance of such default for a period of thirty (30) days, whether or not such payment is prohibited by the subordination provisions of Article IV; or (c) failure on the part of the Company duly to observe or perform any other of the covenants or agreements on the part of the Company in the Notes or in this Indenture (other than a covenant or agreement a default in whose performance or whose breach is elsewhere in this Section specifically dealt with) continued for a period of sixty (60) days after the date on which written notice of such failure, requiring the Company to remedy the same, shall have been given to the Company by the Trustee, or to the Company and a Responsible Officer of the Trustee by the holders of at least 25% in aggregate principal amount of the Notes at the time outstanding determined in accordance with Section 9.4; or (d) the Company shall commence a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, or shall consent to any such relief or to the appointment of or taking possession by any such official in an involuntary case or other proceeding commenced against it, or shall make a general assignment for the benefit of creditors, or shall fail generally to pay its debts as they become due; or (e) an involuntary case or other proceeding shall be commenced against the Company seeking liquidation, reorganization or other relief with respect to it or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, and such involuntary case or other proceeding shall remain undismissed and unstayed for a period of sixty (60) consecutive days; then, and in each and every such case (other than an Event of Default specified in Section 7.1(d) or (e)), unless the principal of all of the Notes shall have already become due and payable, either the Trustee or the holders of not less than 25% in aggregate principal amount of the Notes then outstanding hereunder determined in accordance with Section 9.4, by notice in writing to the Company (and to the Trustee if given by Holders), may declare the principal of and premium, if -30- 37 any, on all the Notes and the interest accrue thereon to be due and payable immediately, and upon any such declaration the same shall become and shall be immediately due and payable, anything in this Indenture or in the Notes contained to the contrary notwithstanding. If an Event of Default specified in Section 7.1(d) or (e) occurs and is continuing, the principal of, and premium, if any, on all the Notes and the interest accrued thereon shall be immediately due and payable. This provision, however, is subject to the condition that if, at any time after the principal of the Notes shall have been so declared due and payable, and before any judgment or decree for the payment of the monies due shall have been obtained or entered as hereinafter provided, the Company shall pay or shall deposit with the Trustee a sum sufficient to pay all matured installments of interest upon all Notes and the principal of and premium, if any, on any and all Notes which shall have become due otherwise than by acceleration (with interest on overdue installments of interest (to the extent that payment of such interest is enforceable under applicable law) and on such principal and premium, if any, at the rate borne by the Notes, to the date of such payment or deposit) and amounts due to the Trustee pursuant to Section 8.6, and if any and all defaults under this Indenture, other than the nonpayment of principal of and premium, if any, and accrued interest on Notes which shall have become due by acceleration, shall have been cured or waived pursuant to Section 7.7, then and in every such case the holders of a majority in aggregate principal amount of the Notes then outstanding, by written notice to the Company and to the Trustee, may waive all defaults or Events of Default and rescind and annul such declaration and its consequences; but no such waiver or rescission and annulment shall extend to or shall affect any subsequent default or Event of Default, or shall impair any right consequent thereon. The Company shall notify a Responsible Officer of the Trustee, promptly upon becoming aware thereof, of any Event of Default. In case the Trustee shall have proceeded to enforce any right under this Indenture and such proceedings shall have been discontinued or abandoned because of such waiver or rescission and annulment or for any other reason or shall have been determined adversely to the Trustee, then and in every such case the Company, the holders of Notes, and the Trustee shall be restored respectively to their several positions and rights hereunder, and all rights, remedies and powers of the Company, the holders of Notes, and the Trustee shall continue as though no such proceeding had been instituted. Section 7.2 Payments of Notes on Default; Suit Therefor. The Company covenants that (a) in case default shall be made in the payment by the Company of any installment of interest upon any of the Notes as and when the same shall become due and payable, and such default shall have continued for a period of thirty (30) days, or (b) in case default shall be made in the payment of the principal of or premium, if any, on any of the Notes as and when the same shall have become due and payable, whether at maturity of the Notes or in connection with any redemption or repurchase, by declaration under this Indenture or otherwise, then, upon demand of the Trustee, the Company will pay to the Trustee, for the benefit of the holders of the Notes, the whole amount that then shall have become due and payable on all such Notes for principal and premium, if any, or interest, or both, as the case may be, with interest upon the overdue principal and premium, if any, and (to the extent that payment of such interest is enforceable -31- 38 under applicable law) upon the overdue installments of interest at the rate borne by the Notes; and, in addition thereto, such further amount as shall be sufficient to cover the costs and expenses of collection, including reasonable compensation to the Trustee, its agents, attorneys and counsel, and any expenses or liabilities incurred by the Trustee hereunder other than through its negligence or bad faith. Until such demand by the Trustee, the Company may pay the principal of and premium, if any, and interest on the Notes to the registered holders, whether or not the Notes are overdue. In case the Company shall fail forthwith to pay such amounts upon such demand, the Trustee, in its own name and as trustee of an express trust, shall be entitled and empowered to institute any actions or proceedings at law or in equity for the collection of the sums so due and unpaid, and may prosecute any such action or proceeding to judgment or final decree, and may enforce any such judgment or final decree against the Company or any other obligor on the Notes and collect in the manner provided by law out of the property of the Company or any other obligor on the Notes wherever situated the monies adjudged or decreed to be payable. In the case there shall be pending proceedings for the bankruptcy or for the reorganization of the Company or any other obligor on the Notes under Title 11 of the United States Code, or any other applicable law, or in case a receiver, assignee or trustee in bankruptcy or reorganization, liquidator, sequestrator or similar official shall have been appointed for or taken possession of the Company or such other obligor, the property of the Company or such other obliger, or in the case of any other judicial proceedings relative to the Company or such other obligor upon the Notes, or to the creditors or property of the Company or such other obligor, the Trustee, irrespective of whether the principal of the Notes shall then be due and payable as therein expressed or by declaration or otherwise and irrespective of whether the Trustee shall have made any demand pursuant to the provisions of this Section 7.2, shall be entitled and empowered, by intervention in such proceedings or otherwise, to file and prove a claim or claims for the whole amount of principal, premium, if any, and interest owing and unpaid in respect of the Notes, and, in case of any judicial proceedings, to file such proofs of claim and other papers or documents as may be necessary or advisable in order to have the claims of the Trustee and of the Holders allowed in such judicial proceedings relative to the Company or any other obligor on the Notes, its or their creditors, or its or their property, and to collect and receive any monies or other property payable or deliverable on any such claims, and to distribute the same after the deduction of any amounts due the Trustee under Section 8.6; and any receiver, assignee or trustee in bankruptcy or reorganization, liquidator, custodian or similar official is hereby authorized by each of the Holders to make such payments to the Trustee, and, in the event that the Trustee shall consent to the making of such payments directly to the Holders, to pay to the Trustee any amount due it for reasonable compensation, expenses, advances and disbursements, including counsel fees incurred by it up to the date of such distribution. To the extent that such payment of reasonable compensation, expenses, advances and disbursements out of the estate in any such proceedings shall be denied for any reason, payment of the same shall be secured by a lien on, and shall be paid out of, any and all distributions, dividends, monies, securities and other -32- 39 property which the holders of the Notes may be entitled to receive in such proceedings, whether in liquidation or under any plan of reorganization or arrangement or otherwise. Nothing herein contained shall be deemed to authorize the Trustee to authorize or consent to or adopt on behalf of any Holder any plan of reorganization or arrangement affecting the Notes or the rights of any Holder, or to authorize the Trustee to vote in respect of the claim of any Holder in any such proceeding, provided, however, that the Trustee may, on behalf of the Holders, vote for the election of a trustee in bankruptcy or similar official and may be a member of the creditor's committee established with respect to such bankruptcy. All rights of action and of asserting claims under this Indenture, or under any of the Notes, may be enforced by the Trustee without the possession of any of the Notes, or the production thereof at any trial or other proceeding relative thereto, and any such suit or proceeding instituted by the Trustee shall be brought in its own name as trustee of an express trust, and any recovery of judgment shall, after provision for the payment of the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel, be for the ratable benefit of the holders of the Notes. In any proceedings brought by the Trustee (and in any proceedings involving the interpretation of any provision of this Indenture to which the Trustee shall be a party) the Trustee shall be held to represent all the holders of the Notes, and it shall not be necessary to make any holders of the Notes parties to any such proceedings. Section 7.3 Application of Monies Collected by Trustee. Any monies collected by the Trustee pursuant to this Article VII shall be applied in the order following, at the date or dates fixed by the Trustee for the distribution of such monies, upon presentation of the several Notes, and stamping thereon the payment, if only partially paid, and upon surrender thereof, if fully paid: First: To the payment of all amounts due the Trustee under Section 8.6; Second: Subject to the provisions of Article IV, in case the principal of the outstanding Notes shall not have become due and be unpaid, to the payment of interest on the Notes in default in the order of the maturity of the installments of such interest, with interest (to the extent that such interest has been collected by the Trustee) upon the overdue installments of interest at the rate borne by the Notes, such payments to be made ratably to the Persons entitled thereto; Third: Subject to the provisions of Article IV, in case the principal of the outstanding Notes shall have become due, by declaration or otherwise, and be unpaid, to the payment of the whole amount then owing and unpaid upon the Notes for principal and premium, if any, and interest, with interest on the overdue principal and premium, if any, and (to the extent that such interest has been collected by the Trustee) upon overdue -33- 40 installments of interest at the rate borne by the Notes; and in case such monies shall be insufficient to pay in full the whole amounts so due and unpaid upon the Notes, then to the payment of such principal and premium, if any, and interest without preference or priority of principal and premium, if any, over interest, or of interest over principal and premium, if any, or of any installment of interest over any other installment of interest, or of any Note over any other Note, ratably to the aggregate of such principal and premium, if any, and accrued and unpaid interest; and Fourth: Subject to the provisions of Article IV, to the payment of the remainder, if any, to the Company or any other Person lawfully entitled thereto. Section 7.4 Proceedings by Holder. No Holder of any Note shall have any right by virtue of or by availing of any provision of this Indenture to institute any suit, action or proceeding in equity or at law upon or under or with respect to this Indenture, or for the appointment of a receiver, trustee, liquidator, custodian or other similar official, or for any other remedy hereunder, unless such holder previously shall have given to the Trustee written notice of an Event of Default and of the continuance thereof, as hereinbefore provided, and unless also the holders of not less than 25% in aggregate principal amount of the Notes then outstanding shall have made written request upon the Trustee to institute such action, suit or proceeding in its own name as Trustee hereunder and shall have offered to the Trustee such reasonable security or indemnity as it may require against the costs, expenses and liabilities to be incurred therein or thereby, and the Trustee for sixty (60) days after its receipt of such notice, request and offer of indemnity, shall have neglected or refused to institute any such action, suit or proceeding and no direction inconsistent with such written request shall have been given to the Trustee pursuant to Section 7.7; it being understood and intended, and being expressly covenanted by the taker and holder of every Note with every other taker and holder and the Trustee, that no one or more holders of Notes shall have any right in any manner whatever by virtue of or by availing of any provision of this Indenture to affect, disturb or prejudice the rights of any other holder of Notes, or to obtain or seek to obtain priority over or preference to any other such holder, or to enforce any right under this Indenture, except in the manner herein provided and for the equal, ratable and common benefit of all holders of Notes (except as otherwise provided herein). For the protection and enforcement of this Section 7.4, each and every Holder and the Trustee shall be entitled to such relief as can be given either at law or in equity. Notwithstanding any other provision in this Indenture, the Holder of any Note shall have the right, which is absolute and unconditional, to receive payment of the principal of, premium, if any, and interest on such Note on the respective stated maturities expressed in such Note (or, in the case of redemption or repurchase, on the Redemption Date or Repurchase Date, as the case may be), and to convert such Note in accordance with Article XV, and to institute suit for the enforcement of any such payment and right to convert, and such rights shall not be impaired without the consent of such Holder. -34- 41 Section 7.5 Proceedings by Trustee. In case of an Event of Default the Trustee may in its discretion proceed to protect and enforce the rights vested in it by this Indenture by such appropriate judicial proceedings as the Trustee shall deem most effectual to protect and enforce any of such rights, either by suit in equity or by action at law or by proceeding in bankruptcy or otherwise, whether for the specific enforcement of any covenant or agreement contained in this Indenture or in aid of the exercise of any power granted in this Indenture, or to enforce any other legal or equitable right vested in the Trustee by this Indenture or by law. Section 7.6 Remedies Cumulative and Continuing. Except as provided in the last paragraph of Section 2.6, all powers and remedies given by this Article VII to the Trustee or to the Holders shall, to the extent permitted by law, be deemed cumulative and not exclusive of any thereof or of any other powers and remedies available to the Trustee or the holders of the Notes, by judicial proceedings or otherwise, to enforce the performance or observance of the covenants and agreements contained in this Indenture, and no delay or omission of the Trustee or of any holder of any of the Notes to exercise any right or power accruing upon any default or Event of Default occurring and continuing as aforesaid shall impair any such right or power, or shall be construed to be a waiver of any such default or any acquiescence therein; and, subject to the provisions of Section 7.4, every power and remedy given by this Article VII or by law to the Trustee or to the Holders may be exercised from time to time, and as often as shall be deemed expedient, by the Trustee or by the Holders. Section 7.7 Direction of Proceedings and Waiver of Defaults by Majority of Holders. Subject to Section 8.2(d) the Holders of a majority in aggregate principal amount of the Notes at the time outstanding determined in accordance with Section 9.4 shall have the right to direct the time, method, and place of conducting any proceeding for any remedy available to the Trustee or exercising any trust or power conferred on the Trustee; provided, however, that (a) such direction shall not be in conflict with any rule of law or with this Indenture, and (b) the Trustee may, but shall have no obligation to, take any other action deemed proper by the Trustee which is not inconsistent with such direction. The holders of a majority in aggregate principal amount of the Notes at the time outstanding determined in accordance with Section 9.4 may on behalf of the holders of all of the Notes waive any past default or Event of Default hereunder and its consequences except (i) a default in the payment of interest or premium, if any, on, or the principal of, the Notes (including the payment of any Redemption Price or Repurchase Price), (ii) a failure by the Company to convert any Notes into Common Stock or (iii) a default in respect of a covenant or provisions hereof which under Article XI cannot be modified or amended without the consent of the holders of all Notes then outstanding. Upon any such waiver the Company, the Trustee and the holders of the Notes shall be restored to their former positions and rights hereunder; but no such waiver shall extend to any subsequent or other default or Event of Default or impair any right consequent thereon. Whenever any default or Event of Default hereunder shall have been waived as permitted by this Section 7.7, said default or Event of Default shall for all purposes of the Notes and this Indenture be deemed to have been cured and to be not continuing; but no such waiver shall extend to any subsequent or other default or Event of Default or impair any right consequent thereon. -35- 42 Section 7.8 Notice of Defaults. The Trustee shall, within ninety (90) days after the occurrence of a default, mail to all Holders, as the names and addresses of such holders appear upon the Note register, notice of all defaults known to a Responsible Officer, unless such defaults shall have been cured or waived before the giving of such notice; and provided that, except in the case of default in the payment of the principal of, or premium, if any, or interest on any of the Notes, or in the payment of any redemption or repurchase obligation, the Trustee shall be protected in withholding such notice if and so long as a trust committee of directors and/or Responsible Officers of the Trustee in good faith determines that the withholding of such notice is in the best interest of the Holders. Section 7.9 Undertaking to Pay Costs. All parties to this Indenture agree, and each holder of any Note by his acceptance thereof shall be deemed to have agreed, that any court may, in its discretion, require, in any suit for the enforcement of any right or remedy under this Indenture, or in any suit against the Trustee for any action taken or omitted by it as Trustee, the filing by any party litigant in such suit of an undertaking to pay the costs of such suit and that such court may in its discretion assess reasonable costs, including reasonable attorneys' fees, against any party litigant in such suit, having due regard to the merits and good faith of the claims or defenses made by such party litigant; provided that the provisions of this Section 7.9 shall not apply to any suit instituted by the Trustee, to any suit instituted by any Holder, or group of Holders, holding in the aggregate more than 10% in principal amount of the Notes at the time outstanding determined in accordance with Section 9.4, or to any suit instituted by any Holder for the enforcement of the payment of the principal of or premium, if any, or interest on any Note on or after the due date expressed in such Note or to any suit for the enforcement of the right to convert any Note in accordance with the provisions of Article XV or to require the Company to repurchase any Note in accordance with Article XVI. Section 7.10 Delay or Omission Not Waiver. No delay or omission of the Trustee or of any holder of any Note to exercise any right or remedy accruing upon any Event of Default shall impair any such right or remedy or constitute a waiver of any such Event of Default or any acquiescence therein. Every right and remedy given by this Article or by law to the Trustee or to the holders of Notes may be exercised from time to time, and as often as may be deemed expedient, by the Trustee or by the holders of Notes, as the case may be. ARTICLE VIII CONCERNING THE TRUSTEE Section 8.1 Duties and Responsibilities of Trustee. The Trustee, prior to the occurrence of an Event of Default and after the curing of all Events of Default which may have occurred, undertakes to perform such duties and only such duties as are specifically set forth in this Indenture. In case an Event of Default has occurred (which has not been cured or waived) the Trustee shall exercise such of the rights and powers vested in it by this Indenture, and use the -36- 43 same degree of care and skill in its exercise, as a prudent person would exercise or use under the circumstances in the conduct of such person's own affairs. No provision of this Indenture shall be construed to relieve the Trustee from liability for its own negligent action, its own negligent failure to act or its own willful misconduct, except that (a) prior to the occurrence of an Event of Default and after the curing or waiving of all Events of Default which may have occurred: (1) the duties and obligations of the Trustee shall be determined solely by the express provisions of this Indenture and the Trust Indenture Act, and the Trustee shall not be liable except for the performance of such duties and obligations as are specifically set forth in this Indenture and no implied covenants or obligations shall be read into this Indenture and the Trust Indenture Act against the Trustee; and (2) in the absence of bad faith and willful misconduct on the part of the Trustee, the Trustee may conclusively rely, as to the truth of the statements and the correctness of the opinions expressed therein, upon any certificates or opinions furnished to the Trustee and conforming to the requirements of this Indenture; but, in the case of any such certificates or opinions which by any provisions hereof are specifically required to be furnished to the Trustee, the Trustee shall be under a duty to examine the same to determine whether or not they conform to the requirements of this Indenture; (b) the Trustee shall not be liable for any error of judgment made in good faith by a Responsible Officer or Officers of the Trustee, unless it shall be provided that the Trustee was negligent in ascertaining the pertinent facts; (c) the Trustee shall not be liable to any Holder with respect to any action taken or omitted to be taken by it in good faith in accordance with the direction of the holders of not less than a majority in principal amount of the Notes at the time outstanding determined as provided in Section 9.4 relating to the time, method and place of conducting any proceeding for any remedy available to the Trustee, or exercising any trust or power conferred upon the Trustee, under this Indenture; and (d) whether or not therein provided, every provision of this Indenture relating to the conduct or affecting the liability of, or affording protection to, the Trustee shall be subject to the provisions of this Section. None of the provisions contained in this Indenture shall require the Trustee to expend or risk its own funds or otherwise incur personal financial liability in the performance of -37- 44 any of its duties or in the exercise of any of its rights or powers, if there is reasonable ground for believing that the repayment of such funds or adequate indemnity against such risk or liability is not reasonably assured to it. Section 8.2 Reliance on Documents, Opinions, Etc. Except as otherwise provided in Section 8.1: (a) the Trustee may rely and shall be protected in acting upon any resolution, certificate, statement, instrument, opinion, report, notice, request, consent, order, bond, note, coupon or other paper or document believed by it in good faith to be genuine and to have been signed or presented by the proper party or parties; (b) any request, direction, order or demand of the Company mentioned herein shall be sufficiently evidenced by an Officers' Certificate (unless other evidence in respect thereof be herein specifically prescribed); and any resolution of the Board of Directors may be evidenced to the Trustee by a copy thereof certified by the Secretary or an Assistant Secretary of the Company; (c) the Trustee may consult with counsel and any advice or Opinion of Counsel shall be full and complete authorization and protection in respect of any action taken or omitted by it hereunder in good faith and in accordance with such advice or Opinion of Counsel; (d) the Trustee shall be under no obligation to exercise any of the rights or powers vested in it by this Indenture at the request, order or direction of any of the Holders pursuant to the provisions of this Indenture, unless such Holders shall have offered to the Trustee reasonable security or indemnity against the costs, expenses and liabilities which may be incurred therein or thereby; (e) the Trustee shall not be bound to make any investigation into the facts or matters stated in any resolution, certificate, statement, instrument, opinion, report, notice, request, direction, consent, order, bond, debenture or other paper or document, but the Trustee, in its discretion, may make such further inquiry or investigation into such facts or matters as it may see fit, and, if the Trustee shall determine to make such further inquiry or investigation, it shall be entitled to examine the books, records and premises of the Company, personally or by agent or attorney; provided, however, that if the payment within a reasonable time to the Trustee of the costs, expenses or liabilities likely to be incurred by it in the making of such investigation is, in the opinion of the Trustee, not reasonably assured to the Trustee by the security afforded to it by the terms of this Indenture, the Trustee may require reasonable indemnity from the Holders against such expenses or liability as a condition to so proceeding; the reasonable expenses of every such examination shall be paid by the Company or, if paid by the Trustee or any predecessor Trustee, shall be repaid by the Company upon demand; and -38- 45 (f) the Trustee may execute any of the trusts or powers hereunder or perform any duties hereunder either directly or by or through agents or attorneys and the Trustee shall not be responsible for any misconduct or negligence on the part of any agent or attorney appointed by it with due care hereunder. Section 8.3 No Responsibility for Recitals, Etc. The recitals contained herein and in the Notes (except in the Trustee's certificate of authentication) shall be taken as the statements of the Company, and the Trustee assumes no responsibility for the correctness of the same. The Trustee makes no representations as to the validity or sufficiency of this Indenture or of the Notes. The Trustee shall not be accountable for the use or application by the Company of any Notes or the proceeds of any Notes authenticated and delivered by the Trustee in conformity with the provisions of this Indenture. Section 8.4 Trustee, Paying Agents, Conversion Agents or Registrar May Own Notes. The Trustee, any paying agent, any conversion agent or Note registrar, in its individual or any other capacity, may become the owner or pledgee of Notes with the same rights it would have if it were not Trustee, paying agent, conversion agent or Note registrar. Section 8.5 Monies to Be Held in Trust. Subject to the provisions of Section 13.4, all monies received by the Trustee shall, until used or applied as herein provided, be held in trust for the purposes for which they were received. Money held by the Trustee in trust hereunder need not be segregated from other funds except to the extent required by law. The Trustee shall be under no liability for interest on any money received by it hereunder except as may be agreed from time to time by the Company and the Trustee. Section 8.6 Compensation and Expenses of Trustee. The Company covenants and agrees to pay to the Trustee from time to time, and the Trustee shall be entitled to, reasonable compensation for all services rendered by it hereunder in any capacity (which shall not be limited by any provision of law in regard to the compensation of a trustee of an express trust), and the Company will pay or reimburse the Trustee upon its request for all reasonable expenses, disbursements and advances reasonably incurred or made by the Trustee in accordance with any of the provisions of this Indenture (including the reasonable compensation and the expenses and disbursements of its counsel and of all persons not regularly in its employ) except any such expense, disbursement or advance as may arise from its negligence or bad faith. The Company also covenants to indemnify the Trustee in any capacity under this Indenture and its agents and any authenticating agent for, and to hold them harmless against, any loss, liability or expense incurred without negligence, willful misconduct, recklessness or bad faith on the part of the Trustee or such agent or authenticating agent, as the case may be, and arising out of or in connection with the acceptance or administration of this trust or in any other capacity hereunder, including the costs and expenses of defending themselves against any claim of liability in the premises. The obligations of the Company under this Section 8.6 to compensate or indemnify the Trustee and to pay or reimburse the Trustee for expenses, disbursements and advances shall be secured by a lien upon all property and funds held or collected by the Trustee as such, except -39- 46 funds held in trust for the benefit of the holders of particular Notes. The obligation of the Company under this Section shall survive the satisfaction and discharge of this Indenture. When the Trustee and its agents and any authenticating agent incur expenses or render services after an Event of Default specified in Section 7.1(d) or (e) occurs, the expenses and the compensation for the services are intended to constitute expenses of administration under any bankruptcy, insolvency or similar laws. Section 8.7 Officers' Certificate as Evidence. Except as otherwise provided in Section 8.1, whenever in the administration of the provisions of this Indenture the Trustee shall deem it necessary or desirable that a matter be proved or established prior to taking or omitting any action hereunder, such matter (unless other evidence in respect thereof be herein specifically prescribed) may, in the absence of negligence, willful misconduct, recklessness and bad faith on the part of the Trustee, be deemed to be conclusively proved and established by an Officers' Certificate delivered to the Trustee, and such Officers' Certificate, in the absence of negligence, willful misconduct, recklessness and bad faith on the part of the Trustee, shall be full warrant to the Trustee for any action taken or omitted by it under the provisions of this Indenture upon the faith thereof. Section 8.8 Conflicting Interests of Trustee. If the Trustee has or shall acquire a conflicting interest within the meaning of the Trust Indenture Act, the Trustee shall either eliminate such interest or resign, to the extent and in the manner provided by, and subject to the provisions of, the Trust Indenture Act and this Indenture. Section 8.9 Eligibility of Trustee. There shall at all times be a Trustee hereunder which shall be a Person that is eligible pursuant to the Trust Indenture Act to act as such and has (or if the Trustee is a member of a bank holding company, its bank holding company has) a combined capital and surplus of at least $50,000,000. If such Person publishes reports of condition at least annually, pursuant to law or to the requirements of any supervising or examining authority, then for the purposes of this Section, the combined capital and surplus of such Person shall be deemed to be its combined capital and surplus as set forth in its most recent report of condition so published. If at any time the Trustee shall cease to be eligible in accordance with the provisions of this Section, it shall resign immediately in the manner and with the effect hereinafter specified in this Article. Section 8.10 Resignation or Removal of Trustee. (a) The Trustee may at any time resign by giving written notice of such resignation to the Company and by mailing notice thereof to the holders of Notes at their addresses as they shall appear on the Note register. Upon receiving such notice of resignation, the Company shall promptly appoint a successor trustee by written instrument, in duplicate, executed by order of the Board of Directors, one copy of which instrument shall be delivered to the resigning Trustee and one copy to the successor -40- 47 trustee. If no successor trustee shall have been so appointed and have accepted appointment sixty (60) days after the mailing of such notice of resignation to the Holders, the resigning Trustee may petition any court of competent jurisdiction for the appointment of a successor trustee, or any Holder who has been a bona fide holder of a Note or Notes for at least six months may, subject to the provisions of Section 7.9, on behalf of himself and all others similarly situated, petition any such court for the appointment of a successor trustee. Such court may thereupon, after such notice, if any, as it may deem proper and prescribe, appoint a successor trustee. (b) In case at any time any of the following shall occur: (1) the Trustee shall fail to comply with Section 8.8 after written request therefor by the Company or by any Holder who has been a bona fide holder of a Note or Notes for at least six months, or (2) the Trustee shall cease to be eligible in accordance with the provisions of Section 8.9 and shall fail to resign after written request therefor by the Company or by any such Holder, or (3) the Trustee shall become incapable of acting, or shall be adjudged a bankrupt or insolvent, or a receiver of the Trustee or of its property shall be appointed, or any public officer shall take charge or control of the Trustee or of its property or affairs for the purpose of rehabilitation, conservation or liquidation, then, in any such case, the Company may remove the Trustee and appoint a successor trustee by written instrument, in duplicate, executed by order of the Board of Directors, one copy of which instrument shall be delivered to the Trustee so removed and one copy to the successor trustee, or, subject to the provisions of Section 7.9, any Holder who has been a bona fide holder of a Note or Notes for at least six months may, on behalf of himself and all others similarly situated, petition any court of competent jurisdiction for the removal of the Trustee and the appointment of a successor trustee. Such court may thereupon, after such notice, if any, as it may deem proper and prescribe, remove the Trustee and appoint a successor trustee. (c) The holders of a majority in aggregate principal amount of the Notes at the time outstanding may at any time remove the Trustee and nominate a successor trustee which shall be deemed appointed as successor trustee unless within ten (10) days after notice to the Company of such nomination the Company objects thereto, in which case the Trustee so removed or any Holder, upon the terms and conditions and otherwise as in Section 8.10(a) provided, may petition any court of competent jurisdiction for an appointment of a successor trustee. -41- 48 (d) Any resignation or removal of the Trustee and appointment of a successor trustee pursuant to any of the provisions of this Section 8.10 shall become effective upon acceptance of appointment by the successor trustee as provided in Section 8.11. Section 8.11 Acceptance by Successor Trustee. Any successor trustee appointed as provided in Section 8.10 shall execute, acknowledge and deliver to the Company and to its predecessor trustee an instrument accepting such appointment hereunder, and thereupon the resignation or removal of the predecessor trustee shall become effective and such successor trustee, without any further act, deed or conveyance, shall become vested with all the rights, powers, duties and obligations of its predecessor hereunder, with like effect as if originally named as trustee herein; but, nevertheless, on the written request of the Company or of the successor trustee, the trustee ceasing to act shall, upon payment of any amounts then due it pursuant to the provisions of Section 8.6, execute and deliver an instrument transferring to such successor trustee all the rights and powers of the trustee so ceasing to act. Upon request of any such successor trustee, the Company shall execute any and all instruments in writing for more fully and certainly vesting in and confirming to such successor trustee all such rights and powers. Any trustee ceasing to act shall, nevertheless, retain a lien upon all property and funds held or collected by such trustee as such, except for funds held in trust for the benefit of holders of particular Notes, to secure any amounts then due it pursuant to the provisions of Section 8.6. No successor trustee shall accept appointment as provided in this Section 8.11 unless at the time of such acceptance such successor trustee shall be qualified under the provisions of Section 8.8 and be eligible under the provisions of Section 8.9. Upon acceptance of appointment by a successor trustee as provided in this Section 8.11, the Company shall mail or cause to be mailed notice of the succession of the former trustee hereunder to the holders of Notes at their addresses as they shall appear on the Note register. If the Company fails to mail such notice within ten (10) days after acceptance of appointment by the successor trustee, the successor trustee shall cause such notice to be mailed at the expense of the Company. Section 8.12 Succession by Merger, Etc. Any corporation into which the Trustee may be merged or converted or with which it may be consolidated, or any corporation resulting from any merger, conversion or consolidation to which the Trustee shall be a party, or any corporation succeeding to all or substantially all of the corporate trust business of the Trustee, including the trust created by this Indenture, shall be the successor to the Trustee hereunder without the execution or filing of any paper or any further act on the part of any of the parties hereto, provided that in the case of any corporation succeeding to all or substantially all of the trust business of the Trustee such corporation shall be qualified under the provisions of Section 8.8 and eligible under the provisions of Section 8.9. In case at the time such successor to the Trustee shall succeed to the trusts created by this Indenture, any of the Notes shall have been authenticated but not delivered, any such successor to -42- 49 the Trustee may adopt the certificate of authentication of any predecessor trustee or authenticating agent appointed by such predecessor trustee, and deliver such Notes so authenticated; and in case at that time any of the Notes shall not have been authenticated, any successor to the Trustee or an authenticating agent appointed by such successor trustee may authenticate such Notes either in the name of any predecessor trustee hereunder or in the name of the successor trustee; and in all such cases such certificates shall have the full force which it is anywhere in the Notes or in this Indenture provided that the certificate of the Trustee shall have; provided, however, that the right to adopt the certificate of authentication of any predecessor Trustee or to authenticate Notes in the name of any predecessor Trustee shall apply only to its successor or successors by merger, conversion or consolidation. Section 8.13 Limitation on Rights of Trustee as Creditor. If and when the Trustee shall be or become a creditor of the Company (or any other obligor upon the Notes), the Trustee shall be subject to the provisions of the Trust Indenture Act regarding the collection of the claims against the Company (or any such other obligor). ARTICLE IX CONCERNING THE HOLDERS Section 9.1 Action by Holders. Whenever in this Indenture it is provided that the holders of a specified percentage in aggregate principal amount of the Notes may take any action (including the making of any demand or request, the giving of any notice, consent or waiver or the taking of any other action), the fact that at the time of taking any such action, the holders of such specified percentage have joined therein may be evidenced (a) by any instrument or any number of instruments of similar tenor executed by Holders in person or by agent or proxy appointed in writing, or (b) by the record of the holders of Notes voting in favor thereof at any meeting of Holders duly called and held in accordance with the provisions of Article X, or (c) by a combination of such instrument or instruments and any such record of such a meeting of Holders. Whenever the Company or the Trustee solicits the taking of any action by the holders of the Notes, the Company or the Trustee may fix in advance of such solicitation, a date as the record date for determining holders entitled to take such action. The record date shall be not more than fifteen (15) days prior to the date of commencement of solicitation of such action. Section 9.2 Proof of Execution by Holders. Subject to the provisions of Sections 8.1, 8.2 and 10.5, proof of the execution of any instrument by a Holder or his agent or proxy shall be sufficient if made in accordance with such reasonable rules and regulations as may be prescribed by the Trustee or in such manner as shall be satisfactory to the Trustee. The holding of Notes shall be proved by the Note register or by a certificate of the Note registrar. The record of any Holders' meeting shall be proved in the manner provided in Section 10.6. -43- 50 Section 9.3 Who Are Deemed Absolute Owners. The Company, the Trustee, any authenticating agent, any paying agent, any conversion agent and any Note registrar may deem the Person in whose name such Note shall be registered upon the Note register to be, and may treat him as, the absolute owner of such Note (whether or not such Note shall be overdue and notwithstanding any notation of ownership or other writing thereon) for the purpose of receiving payment of or on account of the principal of, premium, if any, and interest on such Note, for conversion of such Note and for all other purposes; and neither the Company nor the Trustee, nor any paying agent, nor any conversion agent nor any Note registrar shall be affected by any notice to the contrary. All such payments so made to any holder for the time being, or upon his order, shall be valid, and, to the extent of the sum or sums so paid, effectual to satisfy and discharge the liability for monies payable upon any such Note. Section 9.4 Company-Owned Notes Disregarded. In determining whether the holders of the requisite aggregate principal amount of Notes have concurred in any direction, consent, waiver or other action under this Indenture, Notes which are owned by the Company or any other obligor on the Notes or by any Person directly or indirectly controlling or controlled by or under direct or indirect common control with the Company or any other obligor on the Notes shall be disregarded and deemed not to be outstanding for the purpose of any such determination; provided that for the purposes of determining whether the Trustee shall be protected in relying on any such direction, consent, waiver or other action only Notes which a Responsible Officer knows are so owned shall be so disregarded. Notes so owned which have been pledged in good faith may be regarded as outstanding for the purposes of this Section 9.4 if the pledgee shall establish to the satisfaction of the Trustee the pledgee's right to vote such Notes and that the pledgee is not the Company, any other obligor on the Notes or a Person directly or indirectly controlling or controlled by or under direct or indirect common control with the Company or any such other obligor. In the case of a dispute as to such right, any decision by the Trustee taken upon the advice of counsel shall be full protection to the Trustee. Upon request of the Trustee, the Company shall furnish to the Trustee promptly an Officers' Certificate listing and identifying all Notes, if any, known by the Company to be owned or held by or for the account of any of the above described Persons; and, subject to Section 8.1, the Trustee shall be entitled to accept such Officers' Certificate as conclusive evidence of the facts therein set forth and of the fact that all Notes not listed therein are outstanding for the purpose of any such determination. Section 9.5 Revocation of Consents; Future Holders Bound. At any time prior to (but not after) the evidencing to the Trustee, as provided in Section 9.1, of the taking of any action by the holders of the percentage in aggregate principal amount of the Notes specified in this Indenture in connection with such action, any holder of a Note which is shown by the evidence to be included in the Notes the holders of which have consented to such action may, by filing written notice with the Trustee at its Corporate Trust Office and upon proof of holding as provided in Section 9.2, revoke such action so far as it concerns such Note. Except as aforesaid, any such action taken by the holder of any Note shall be conclusive and binding upon such holder and upon all future holders and owners of such Note and of any Notes issued in exchange -44- 51 or substitution therefor, irrespective of whether any notation in regard thereto is made upon such Note or any Note issued in exchange or substitution therefor. ARTICLE X HOLDERS' MEETINGS Section 10.1 Purpose of Meetings. A meeting of Holders may be called at any time and from time to time pursuant to the provisions of this Article X for any of the following purposes: (1) to give any notice to the Company or to the Trustee or to give any directions to the Trustee permitted under this Indenture, or to consent to the waiving of any default or Event of Default hereunder and its consequences, or to take any other action authorized to be taken by Holders pursuant to any of the provisions of Article VII; (2) to remove the Trustee and nominate a successor trustee pursuant to the provisions of Article VIII; (3) to consent to the execution of an indenture or indentures supplemental hereto pursuant to the provisions of Section 11.2; (4) to take any other action authorized to be taken by or on behalf of the holders of any specified aggregate principal amount of the Notes under any other provision of this Indenture or under applicable law; or (5) to take any other action authorized by this Indenture or under applicable law. Section 10.2 Call of Meetings by Trustee. The Trustee may at any time call a meeting of Holders to take any action specified in Section 10.1, to be held at such time and at such place in the Borough of Manhattan, The City of New York, or any other reasonably convenient city in the continental United States, as the Trustee shall determine. Notice of every meeting of the Holders, setting forth the time and the place of such meeting and in general terms the action proposed to be taken at such meeting and the establishment of any record date pursuant to Section 9.1, shall be mailed to holders of Notes at their addresses as they shall appear on the Note register. Such notice shall also be mailed to the Company. Such notices shall be mailed not less than twenty (20) nor more than ninety (90) days prior to the date fixed for the meeting. Any meeting of Holders shall be valid without notice if the holders of all Notes then outstanding are present in person or by proxy or if notice is waived before or after the meeting by the holders of all Notes outstanding, and if the Company and the Trustee are either present by duly authorized representatives or have, before or after the meeting, waived notice. -45- 52 Section 10.3 Call of Meetings by Company or Holders. In case at any time the Company, pursuant to a resolution of its Board of Directors, or the holders of at least 10% in aggregate principal amount of the Notes then outstanding, shall have requested the Trustee to call a meeting of Holders, by written request setting forth in reasonable detail the action proposed to be taken at the meeting, and the Trustee shall not have mailed the notice of such meeting within twenty (20) days after receipt of such request, then the Company or such Holders may determine the time and the place for such meeting and may call such meeting to take any action authorized in Section 10.1, by mailing notice thereof as provided in Section 10.2. Section 10.4 Qualifications for Voting. To be entitled to vote at any meeting of Holders a Person shall (a) be a holder of one or more Notes on the record date pertaining to such meeting or (b) be a Person appointed by an instrument in writing as proxy by a holder of one or more Notes. The only Persons who shall be entitled to be present or to speak at any meeting of Holders shall be the Persons entitled to vote at such meeting and their counsel and any representatives of the Trustee and its counsel and any representatives of the Company and its counsel. Section 10.5 Regulations. Notwithstanding any other provisions of this Indenture, the Trustee may make such reasonable regulations as it may deem advisable for any meeting of Holders, in regard to proof of the holding of Notes and of the appointment of proxies, and in regard to the appointment and duties of inspectors of votes, the submission and examination of proxies, certificates and other evidence of the right to vote, and such other matters concerning the conduct of the meeting as it shall think fit. The Trustee shall, by an instrument in writing, appoint a temporary chairman of the meeting, unless the meeting shall have been called by the Company or by Holders as provided in Section 10.3, in which case the Company or the Holders calling the meeting, as the case may be, shall in like manner appoint a temporary chairman. A permanent chairman and a permanent secretary of the meeting shall be elected by vote of the holders of a majority in principal amount of the Notes represented at the meeting and entitled to vote at the meeting. Subject to the provisions of Section 9.4, at any meeting each Holder or proxyholder shall be entitled to one vote for each $1,000 principal amount of Notes held or represented by him; provided, however, that no vote shall be cast or counted at any meeting in respect of any Note challenged as not outstanding and ruled by the chairman of the meeting to be not outstanding. The chairman of the meeting shall have no right to vote other than by virtue of Notes held by him or instruments in writing as aforesaid duly designating him as the proxy to vote on behalf of other Holders. Any meeting of Holders duly called pursuant to the provisions of Section 10.2 or 10.3 may be adjourned from time to time by the holders of a majority of the aggregate principal amount of Notes represented at the meeting, whether or not constituting a quorum, and the meeting may be held as so adjourned without further notice. -46- 53 Section 10.6 Voting. The vote upon any resolution submitted to any meeting of Holders shall be by written ballot on which shall be subscribed the signatures of the holders of Notes or of their representatives by proxy and the principal amount of the Notes held or represented by them. The permanent chairman of the meeting shall appoint two inspectors of votes who shall count all votes cast at the meeting for or against any resolution and who shall make and file with the secretary of the meeting their verified written reports in duplicate of all votes cast at the meeting. A record in duplicate of the proceedings of each meeting of Holders shall be prepared by the secretary of the meeting and there shall be attached to said record the original reports of the inspectors of votes on any vote by ballot taken thereat and affidavits by one or more Persons having knowledge of the facts setting forth a copy of the notice of the meeting and showing that said notice was mailed as provided in Section 10.2. The record shall show the principal amount of the Notes voting in favor of or against any resolution. The record shall be signed and verified by the affidavits of the permanent chairman and secretary of the meeting and one of the duplicates shall be delivered to the Company and the other to the Trustee to be preserved by the Trustee, the latter to have attached thereto the ballots voted at the meeting. Any record so signed and verified shall be conclusive evidence of the matters therein stated. Section 10.7 No Delay of Rights by Meeting. Nothing in this Article X contained shall be deemed or construed to authorize or permit, by reason of any call of a meeting of Holders or any rights expressly or impliedly conferred hereunder to make such call, any hindrance or delay in the exercise of any right or rights conferred upon or reserved to the Trustee or to the Holders under any of the provisions of this Indenture or of the Notes. ARTICLE XI SUPPLEMENTAL INDENTURES Section 11.1 Supplemental Indentures Without Consent of Holders. Without the consent of the Holders, the Company, when authorized by the resolutions of the Board of Directors, and the Trustee may from time to time and at any time enter into an indenture or indentures supplemental hereto for one or more of the following purposes: (a) to make provisions with respect to the conversion rights of the holders of Notes pursuant to the requirements of Section 15.6 and the repurchase obligations of the Company pursuant to 16.3; (b) subject to Article IV, to convey, transfer, assign, mortgage or pledge to the Trustee as security for the Notes, any property or assets; -47- 54 (c) to evidence the succession of another corporation to the Company, or successive successions, and the assumption by the successor corporation of the covenants, agreements and obligations of the Company pursuant to Article XII; (d) to add to the covenants of the Company such further covenants, restrictions or conditions as the Board of Directors and the Trustee shall consider to be for the benefit of the holders of Notes, and to make the occurrence, or the occurrence and continuance, of a default in any such additional covenants, restrictions or conditions a default or an Event of Default permitting the enforcement of all or any of the several remedies provided in this Indenture as herein set forth; provided, however, that in respect of any such additional covenant, restriction or condition such supplemental indenture may provide for a particular period of grace after default (which period may be shorter or longer than that allowed in the case of other defaults) or may provide for an immediate enforcement upon such default or may limit the remedies available to the Trustee upon such default; (e) to provide for the issuance under this Indenture of Notes in coupon form (including Notes registrable as to principal only) and to provide for exchange of such Notes with the Notes issued hereunder in fully registered form and to make all appropriate changes for such purpose; (f) to cure any ambiguity or to correct or supplement any provision contained herein or in any supplemental indenture which may be defective or inconsistent with any other provision contained herein or in any supplemental indenture, or to make such other provisions in regard to matters or questions arising under this Indenture which shall not materially adversely affect the interests of the holders of the Notes; (g) to evidence and provide for the acceptance of appointment hereunder by a successor Trustee with respect to the Notes; (h) to modify, eliminate or add to the provisions of this Indenture to such extent as shall be necessary to effect the qualification of this Indenture under the Trust Indenture Act, or under any similar federal statute hereafter enacted; or (i) to permit or facilitate the issuance of Notes in uncertificated form. The Trustee is hereby authorized to join with the Company in the execution of any such supplemental indenture, to make any further appropriate agreements and stipulations which may be therein contained and to accept the conveyance, transfer and assignment of any property thereunder, but the Trustee shall not be obligated to, but may in its discretion, enter into any supplemental indenture which affects the Trustee's own rights, duties or immunities under this Indenture or otherwise. -48- 55 Any supplemental indenture authorized by the provisions of this Section 11.1 may be executed by the Company and the Trustee without the consent of the holders of any of the Notes at the time outstanding, notwithstanding any of the provisions of Section 11.2. Section 11.2 Supplemental Indentures With Consent of Holders. With the consent (evidenced as provided in Article IX) of the holders of not less than a majority in aggregate principal amount of the Notes at the time outstanding (determined in accordance with Section 9.4), the Company, when authorized by the resolutions of the Board of Directors, and the Trustee may from time to time and at any time enter into an indenture or indentures supplemental hereto for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Indenture or any supplemental indenture or of modifying in any manner the rights of the holders of the Notes; provided, however, that no such supplemental indenture shall (i) extend the fixed maturity of any Note, reduce the rate or extend the time for payment of interest thereon, reduce the principal amount thereof or premium, if any, thereon, reduce any amount payable on redemption or repurchase thereof, impair or change in any respect adverse to the Holders of Notes the obligation of the Company to make an offer, to repurchase Notes, and repurchase Notes in accordance with such offer, upon the happening of a Fundamental Change, impair or adversely affect the right of any Holder to institute suit for the payment thereof, make the principal thereof or interest or premium, if any, thereon payable in any coin or currency other than that provided in the Notes, or impair or change in any respect adverse to the Holders of the Notes the right to convert the Notes into Common Stock subject to the terms set forth herein, including Section 15.6, or modify the provisions of this Indenture with respect to the subordination of the Notes in a manner adverse to the Holders, without the consent of the holder of each Note so affected, or (ii) reduce the aforesaid percentage of Notes, the holders of which are required to consent to any such supplemental indenture, without the consent of the holders of all Notes then outstanding. Upon the request of the Company, accompanied by a copy of the resolutions of the Board of Directors certified by its Secretary or Assistant Secretary authorizing the execution of any such supplemental indenture, and upon the filing with the Trustee of evidence of the consent of Holders as aforesaid, the Trustee shall join with the Company in the execution of such supplemental indenture unless such supplemental indenture affects the Trustee's own rights, duties or immunities under this Indenture or otherwise, in which case the Trustee may in its discretion, but shall not be obligated to, enter into such supplemental indenture. It shall not be necessary for the consent of the Holders under this Section 11.2 to approve the particular form of any proposed supplemental indenture, but it shall be sufficient if such consent shall approve the substance thereof. Section 11.3 Effect of Supplemental Indentures. Any supplemental indenture executed pursuant to the provisions of this Article XI shall comply with the Trust Indenture Act, as then in effect. Upon the execution of any supplemental indenture pursuant to the provisions of this Article XI, this Indenture shall be and be deemed to be modified and amended in accordance -49- 56 therewith and the respective rights, limitation of rights, obligations, duties and immunities under this Indenture of the Trustee, the Company and the holders of Notes shall thereafter be determined, exercised and enforced hereunder subject in all respects to such modifications and amendments and all the terms and conditions of any such supplemental indenture shall be and be deemed to be part of the terms and conditions of this Indenture for any and all purposes. Section 11.4 Notation on Notes. Notes authenticated and delivered after the execution of any supplemental indenture pursuant to the provisions of this Article XI may (but need not) bear a notation in form approved by the Trustee as to any matter provided for in such supplemental indenture. If the Company or the Trustee shall so determine, new Notes so modified as to conform, in the opinion of the Trustee and the Board of Directors, to any modification of this Indenture contained in any such supplemental indenture may (but need not), at the Company's expense, be prepared and executed by the Company, authenticated by the Trustee (or an authenticating agent duly appointed by the Trustee pursuant to Section 17.11) and delivered in exchange for the Notes then outstanding, upon surrender of such Notes then outstanding. Section 11.5 Evidence of Compliance of Supplemental Indenture to Be Furnished Trustee. The Trustee, subject to the provisions of Sections 8.1 and 8.2, shall be entitled to receive an Officers' Certificate and an Opinion of Counsel as conclusive evidence that any supplemental indenture executed pursuant hereto complies with the requirements of this Article XI. ARTICLE XII MERGER, SALE OR CONSOLIDATION Section 12.1 Limitation on Merger, Sale or Consolidation. The Company shall not consolidate with or merge into any other Person or transfer or lease its properties and assets substantially as an entirety to any Person, and shall not transfer and assign all its obligations of, and position as, the Company hereunder, except for a consolidation or merger in which the Company is the surviving party, unless: (a) the Person formed by such consolidation or into which the Company is merged or which acquires by conveyance, lease or transfer the properties and assets of the Company substantially as an entirety, or to which obligations of, and position as, the Company hereunder are transferred and assigned (the "Successor") (i) shall be a corporation, limited liability company, partnership or trust organized and existing under the laws of the United States of America or any political subdivision thereof, and (ii) shall expressly assume, by an indenture supplemental hereto, executed and delivered to the Trustee, in form satisfactory to the Trustee, due and punctual payment of the -50- 57 principal of premium, of any, and interest on all of the Notes and the performance of every covenant of this Indenture and in the Notes on the part of the Company to be performed or observed; (b) no default and no Event of Default shall have occurred and be continuing as a result of such consolidation, merger, transfer or lease; and (c) the Company has delivered to the Trustee an Officers' Certificate and an Opinion of Counsel, each stating that such consolidation, merger, conveyance or transfer, or such transfer and assignment, and such supplemental indenture comply with this Article and that all conditions precedent herein provided for relating to such transaction have been compiled with. Section 12.2 Successor Corporation to Be Substituted. In case of any such consolidation, merger, sale, conveyance or lease and upon the assumption by the Successor, by supplemental indenture, executed and delivered to the Trustee and satisfactory in form to the Trustee, of the due and punctual payment of the principal of and premium, if any, and interest on all of the Notes and the due and punctual performance of all of the covenants and conditions of this Indenture to be performed by the Company, such Successor shall succeed to and be substituted for the Company, with the same effect as if it had been named herein as the party of the first part. Such Successor thereupon may cause to be signed, and may issue either in its own name or in the name of HNC Software Inc. any or all of the Notes issuable hereunder which theretofore shall not have been signed by the Company and delivered to the Trustee; and, upon the order of such Successor instead of the Company and subject to all the terms, conditions and limitations in this Indenture prescribed, the Trustee shall authenticate and shall deliver, or cause to be authenticated and delivered, any Notes which previously shall have been signed and delivered by the officers of the Company to the Trustee for authentication, and any Notes which such successor corporation thereafter shall cause to be signed and delivered to the Trustee for that purpose. All the Notes so issued shall in all respects have the same legal rank and benefit under this Indenture as the Notes theretofore or thereafter issued in accordance with the terms of this Indenture as though all of such Notes had been issued at the date of the execution hereof. In the event of any such consolidation, merger, sale or conveyance (but not in the event of such lease), the Person named as the "Company" in the first paragraph of this Indenture, or any successor which shall thereafter have become such in the manner prescribed in this Article XII and which shall have transferred its rights and obligations hereunder to another successor in the manner prescribed in this Article XII, may be dissolved, wound up and liquidated at any time thereafter and such Person shall be released from its liabilities as obligor and maker of the Notes and from its obligations under this Indenture. In case of any such consolidation, merger, sale, conveyance or lease, such changes in phraseology and form (but not in substance) may be made in the Notes thereafter to be issued as may be appropriate. -51- 58 ARTICLE XIII SATISFACTION AND DISCHARGE OF INDENTURE Section 13.1 Discharge of Indenture. When (a) the Company shall deliver to the Trustee for cancellation all Notes theretofore authenticated (other than any Notes which have been destroyed, lost or stolen and in lieu of or in substitution for which other Notes shall have been authenticated and delivered) and not theretofore canceled, or (b) all the Notes not theretofore canceled or delivered to the Trustee for cancellation shall have become due and payable, or are by their terms to become due and payable within one year or are to be called for redemption within one year under arrangements satisfactory to the Trustee for the giving of notice of redemption, and the Company shall deposit with the Trustee, in trust, funds sufficient to pay at maturity or upon redemption of all of the outstanding Notes (other than any Notes which shall have been mutilated, destroyed, lost or stolen and in lieu of or in substitution for which other Notes shall have been authenticated and delivered) not theretofore canceled or delivered to the Trustee for cancellation, including principal and premium, if any, and interest due or to become due to such date of maturity or redemption date, as the case may be, and if in either case the Company shall also pay or cause to be paid all other sums payable hereunder by the Company, then this Indenture shall cease to be of further effect (except as to (i) remaining rights of registration of transfer, substitution and exchange and conversion of Notes, (ii) rights hereunder of Holders to receive payments of principal of and premium, if any, and interest on the Notes and the other rights, duties and obligations of Holders, as beneficiaries hereof with respect to the amounts, if any, so deposited with the Trustee and (iii) the rights, obligations and immunities of the Trustee hereunder), and the Trustee, on demand of the Company accompanied by an Officers' Certificate and an Opinion of Counsel as required by Section 17.5 and at the cost and expense of the Company, shall execute proper instruments acknowledging satisfaction of and discharging this Indenture; the Company, however, hereby agrees to reimburse the Trustee for any costs or expenses thereafter reasonably and properly incurred by the Trustee and to compensate the Trustee for any services thereafter reasonably and properly rendered by the Trustee in connection with this Indenture or the Notes. Section 13.2 Deposited Monies to Be Held in Trust by Trustee. Subject to Section 13.4, all monies deposited with the Trustee pursuant to Section 13.1 shall be held in trust and applied by it to the payment, notwithstanding the provisions of Article IV, either directly or through any paying agent (including the Company if acting as its own paying agent), to the holders of the particular Notes for the payment or redemption of which such monies have been deposited with the Trustee, of all sums due and to become due thereon for principal and interest and premium, if any. Section 13.3 Paying Agent to Repay Monies Held. Upon the satisfaction and discharge of this Indenture, all monies then held by any paying agent of the Notes (other than the Trustee) shall, upon demand of the Company or the Trustee, be repaid to it or paid to the Trustee, and -52- 59 thereupon such paying agent shall be released from all further liability with respect to such monies. Section 13.4 Return of Unclaimed Monies. Subject to the requirements of applicable law, any monies deposited with or paid to the Trustee for payment of the principal of, premium, if any, or interest on Notes and not applied but remaining unclaimed by the holders of Notes for two years after the date upon which the principal of, premium, if any, or interest on such Notes, as the case may be, shall have become due and payable, shall be repaid to the Company by the Trustee on demand and all liability of the Trustee shall thereupon cease with respect to such monies; and the holder of any of the Notes shall thereafter look only to the Company for any payment which such holder may be entitled to collect unless an applicable abandoned property law designates another Person. Section 13.5 Reinstatement. If (i) the Trustee or the paying agent is unable to apply any money in accordance with Section 13.2 by reason of any order or judgment of any court or governmental authority enjoining, restraining or otherwise prohibiting such application and (ii) the holders of at least a majority in principal amount of the then outstanding Notes so request by written notice to the Trustee, the Company's obligations under this Indenture and the Notes shall be revived and reinstated as though no deposit had occurred pursuant to Section 13.1 until such time as the Trustee or the paying agent is permitted to apply all such money in accordance with Section 13.2; provided, however, that if the Company makes any payment of interest or premium, if any, on or principal of any Note following the reinstatement of its obligations, the Company shall be subrogated to the rights of the holders of such Notes to receive such payment from the money held by the Trustee or paying agent. ARTICLE XIV IMMUNITY OF INCORPORATORS, STOCKHOLDERS, OFFICERS AND DIRECTORS Section 14.1 Indenture and Notes Solely Corporate Obligations. No recourse for the payment of the principal of or premium, if any, or interest on any Note, or for any claim based thereon or otherwise in respect thereof, and no recourse under or upon any obligation, covenant or agreement of the Company in this Indenture or in any supplemental indenture or in any Note, or because of the creation of any indebtedness represented thereby, shall be had against any incorporator, stockholder, employee, agent, officer or director or Subsidiary, as such, past, present or future, of the Company or of any successor corporation, either directly or through the Company or any successor corporation, whether by virtue of any constitution, statute or rule of law, or by the enforcement of any assessment or penalty or otherwise; it being expressly understood that all such liability is hereby expressly waived and released as a condition of, and as a consideration for, the execution of this Indenture and the issue of the Notes. -53- 60 ARTICLE XV CONVERSION OF NOTES Section 15.1 Conversion Privilege and Conversion Price. Subject to and upon compliance with the provisions of this Article XV, at the option of the Holder thereof, the Holder of any Note is entitled at his option, at any time prior to the close of business on March 1, 2003, subject to prior redemption or repurchase, to convert such Note or portions thereof (in denominations of $1,000 or integral multiples thereof) into fully paid and nonassessable shares (calculated as to each conversion to the nearest 1/100th of a share) of Common Stock of the Company at the Conversion Price, determined as hereinafter provided, in effect at the time of conversion. In case a Note or portion thereof is called for redemption, such conversion right in respect of the Note or portion called for redemption shall expire at the close of business on the Business Day prior to the Redemption Date, unless the Company defaults in making the payment of the Redemption Price in which case the right to convert the Note or portion thereof shall terminate on the date such default is cured and such Note or portion thereof is redeemed. A Note for which a Holder has delivered a Fundamental Change repurchase notice pursuant to Section 16.2 exercising the option of such Holder to require the Company to repurchase such Note may be converted only if such notice is withdrawn by a written notice of withdrawal delivered by the Holder to the Company prior to the close of business on the Business Day preceding the Repurchase Date. The price at which shares of Common Stock shall be delivered upon conversion (herein called the "Conversion Price") shall be initially U.S.$_____ per share of Common Stock. The Conversion Price shall be adjusted in certain instances as provided in this Article XV. Section 15.2 Exercise of Conversion Privilege. To convert a Note into shares of Common Stock, a Holder must (i) complete and manually sign the conversion notice in the form provided on the Note (or complete and manually sign a facsimile thereof) and deliver such notice to an office or agency maintained by the Company for conversion of Notes pursuant to Section 5.2 (ii) surrender the Note at such office, (iii) if required, furnish appropriate endorsements and transfer documents, (iv) if required, pay all transfer or similar taxes, and (v) if required, pay funds equal to interest payable on the next interest payment date. The date on which all of the foregoing requirements have been satisfied is the date of surrender for conversion. Each Note surrendered for conversion (in whole or in part) during the period from the close of business on any Regular Record Date to the close of business on the Business Day prior to the next succeeding interest payment date (except Notes called for redemption pursuant to a notice of redemption mailed to the Holders in accordance with Section 3.5) shall be accompanied by payment in New York Clearing House funds or other funds acceptable to the Company of an amount equal to the interest payable on such interest payment date on the principal amount of such Note (or part thereof, as the case may be) being surrendered for conversion; provided however that no such payment need be made if there shall exist at the time of conversion a default in the payment of interest on the Notes. No such payment will be -54- 61 required with respect to interest payable on March 1, 2001. Except as provided in this 15.2, no payment or other adjustment shall be made for interest accrued on any Note converted or for dividends on any Shares issued upon conversion of such Note as provided in this Article. The Company's delivery to the Holder of the number of shares of Common Stock (and cash in lieu of fractions thereof, as provided in this Indenture) into which a Note is convertible will be deemed to satisfy the Company's obligation to pay the principal amount of the Note. Notes shall be deemed to have been converted immediately prior to the close of business on the day of surrender of such Notes for conversion, in accordance with the foregoing provisions, and at such time the rights of the Holders of such Notes as Holders shall cease, and the Person or Persons entitled to receive the shares of Common Stock issuable upon conversion shall be treated for all purposes as the record holder or holders of such Common Stock at such time. As promptly as practicable on or after the conversion date, the Company shall issue and deliver to the Trustee, for delivery to the Holder, a certificate or certificates for the number of full shares of Common Stock issuable upon conversion, together with payment in lieu of any fraction of a share, as provided in Section 15.3. In the case of any Note which is converted in part only, upon such conversion the Company shall execute and the Trustee shall authenticate and deliver to the Holder thereof, at the expense of the Company, a new Note or Notes of authorized denominations in an aggregate principal amount equal to the unconverted portion of the principal amount of such Note. A Note may be converted in part, but only if the principal amount of such Note to be converted is any integral multiple of U.S.$1,000 and the principal amount of such security to remain outstanding after such conversion is equal to U.S.$1,000 or any integral multiple thereof. Section 15.3 Fractions of Shares. No fractional shares of Common Stock shall be issued upon conversion of any Notes. If more than one Note shall be surrendered for conversion at one time by the same Holder, the number of full shares which shall be issuable upon conversion thereof shall be computed on the basis of the aggregate principal amount of the Notes (or specified portions thereof) so surrendered. Instead of any fractional share of Common Stock which would otherwise be issuable upon conversion of any Notes (or specified portions thereof), the Company shall calculate and pay a cash adjustment in respect of such fraction (calculated to the nearest 1/100th of a share) in an amount equal to the same fraction of the Current Market Price per share of Common Stock (calculated in accordance with Section 15.4(8) below) at the close of business on the last Business Day prior to the date of conversion. Section 15.4 Adjustment of Conversion Price. The Conversion Price shall be subject to adjustments from time to time as follows: (1) In case the Company shall hereafter pay a dividend or make a distribution to all holders of the outstanding Common Stock in shares of Common Stock, the Conversion Price in effect at the opening of business on the date following the date fixed for the determination of stockholders entitled to receive such dividend or other distribution shall be -55- 62 reduced by multiplying such Conversion Price by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding at the close of business on the date fixed for such determination and the denominator of which shall be the sum of such number of shares and the total number of shares constituting such dividend or other distribution, such reduction to become effective immediately after the opening of business on the day following the date fixed for such determination. If any dividend or distribution of the type described in this Section 15.4 is declared but not so paid or made, the Conversion Price shall again be adjusted to the Conversion Price which would then be in effect if such dividend or distribution had not been declared. (2) In case the Company shall issue rights or warrants to all holders of its outstanding Common Stock entitling them (for a period expiring within 45 days after the date fixed for determination of stockholders entitled to receive such rights or warrants) to subscribe for or purchase Common Stock at a price per share less than the Current Market Price on the date fixed for determination of stockholders entitled to receive such rights or warrants, the Conversion Price shall be adjusted so that the same shall equal the price determined by multiplying the Conversion Price in effect immediately prior to the date fixed for determination of shareholders entitled to receive such rights or warrants by a fraction, the numerator of which shall be the number of shares of Common Stock outstanding at the close of business on the date fixed for determination of stockholders entitled to receive such rights and warrants plus the number of shares which the aggregate offering price of the total number of shares so offered would purchase at such Current Market Price, and the denominator of which shall be the number of shares of Common Stock outstanding on the date fixed for determination of stockholders entitled to receive such rights and warrants plus the total number of additional shares of Common Stock offered for subscription or purchase. Such adjustment shall be successively made whenever any such rights and warrants are issued, and shall become effective immediately after the opening of business on the day following the date fixed for determination of stockholders entitled to receive such rights or warrants. To the extent that shares of Common Stock are not delivered after the expiration of such rights or warrants, the Conversion Price shall be readjusted to the Conversion Price which would then be in effect had the adjustments made upon the issuance of such rights or warrants been made on the basis of delivery of only the number of shares of Common Stock actually delivered. In the event that such rights or warrants are not so issued, the Conversion Price shall again be adjusted to be the Conversion Price which would then be in effect if such date fixed for the determination of stockholders entitled to receive such rights or warrants had not been fixed. In determining whether any rights or warrants entitle the holders to subscribe for or purchase Common Stock at less than such Current Market Price, and in determining the aggregate offering price of such Common Stock, there shall be taken into account any consideration received by the Company for such rights or warrants, the value of such consideration, if other than cash, to be determined by the Board of Directors. (3) In case outstanding Common Stock shall be subdivided into a greater number of shares of Common Stock, the Conversion Price in effect at the opening of business on the day following the day upon which such subdivision becomes effective shall be -56- 63 proportionately reduced, and conversely, in case outstanding shares of Common Stock shall be combined into a smaller number of shares of Common Stock, the Conversion Price in effect at the opening of business on the day following the day upon which such combination becomes effective shall be proportionately increased. (4) In case the Company shall, by dividend or otherwise, distribute to all holders of its Common Stock shares of any class of capital stock of the Company (other than any dividends or distributions to which Section 15.4(1) applies) or evidences of its indebtedness or assets (including securities, but excluding any rights or warrants referred to in Section 15.4(2), and excluding any dividend or distribution (x) paid exclusively in cash or (y) referred to in Section 15.4(1) (any of the foregoing hereinafter in this Section 15.4(4) called the "Distribution Notes")), then, in each such case, the Conversion Price shall be reduced so that the same shall be equal to the price determined by multiplying the Conversion Price in effect on the Distribution Record Date with respect to such distribution by a fraction the numerator of which shall be the Current Market Price per share of Common Stock on such Distribution Record Date less the fair market value (as determined by the Board of Directors whose determination shall be conclusive and described in a resolution of the Board of Directors) on the Distribution Record Date of the portion of the Distribution Notes so distributed applicable to one share of Common Stock and the denominator of which shall be the Current Market Price per share of Common Stock, such reduction to become effective immediately prior to the opening of business on the day following such Distribution Record Date; provided, however, that in the event the then fair market value (as so determined) of the portion of the Distribution Notes so distributed applicable to one share of Common Stock is equal to or greater than the Current Market Price per share of the Common Stock on the Distribution Record Date, in lieu of the foregoing adjustment, adequate provision shall be made so that each Holder shall have the right to receive upon conversion the amount of Distribution Notes such Holder would have received had such Holder converted each Note on the Distribution Record Date. In the event that such dividend or distribution is not so paid or made, the Conversion Price shall again be adjusted to be the Conversion Price which would then be in effect if such dividend or distribution had not been declared. If the Company's Board of Directors determines the fair market value of any distribution for purposes of this Section 15.4(4) by reference to the actual or when issued trading market for any securities, it must in doing so consider the prices in such market over the same period used in computing the Current Market Price of the Common Stock. In the event that the Company implements a stockholder rights plan, such rights plan shall provide that upon conversion of the Notes the Holders will receive, in addition to the Common Stock issuable upon such conversion, the rights issued under such rights plan (notwithstanding the occurrence of an event causing such rights to separate from the Common Stock at or prior to the time of conversion). Any distribution of rights or warrants pursuant to a stockholder rights plan complying with the requirements set forth in the immediately preceding sentence of this paragraph shall not constitute a distribution of rights or warrants for the purposes of this Section 15.4. -57- 64 Rights or warrants distributed by the Company to all holders of Common Stock entitling the holders thereof to subscribe for or purchase shares of the Company's capital stock (either initially or under certain circumstances), which rights or warrants, until the occurrence of a specified event or events ("Trigger Event"): (i) are deemed to be transferred with such shares of Common Stock; (ii) are not exercisable; and (iii) are also issued in respect of future issuances of shares of Common Stock, shall be deemed not to have been distributed for purposes of this Section 15.4 (and no adjustment to the Conversion Price under this Section 15.4 will be required) until the occurrence of the earliest Trigger Event, whereupon such rights and warrants shall be deemed to have been distributed and an appropriate adjustment (if any is required) to the Conversion Price shall be made under this Section 15.4(4). If any such right or warrant, including any such existing rights or warrants distributed prior to the date of this Indenture, are subject to events, upon the occurrence of which such rights or warrants become exercisable to purchase different securities, evidences of indebtedness or other assets, then the date of the occurrence of any and each such event shall be deemed to be the date of distribution and record date with respect to new rights or warrants with such rights (and a termination or expiration of the existing rights or warrants without exercise by any of the holders thereof). In addition, in the event of any distribution (or deemed distribution) of rights or warrants, or any Trigger Event or other event (of the type described in the preceding sentence) with respect thereto that was counted for purposes of calculating a distribution amount for which an adjustment to the Conversion Price under this Section 15.4 was made, (1) in the case of any such rights or warrants which shall all have been redeemed or repurchased without exercise by any holders thereof, the Conversion Price shall be readjusted upon such final redemption or repurchase to give effect to such distribution or Trigger Event, as the case may be, as though it were a cash distribution, equal to the per share redemption or repurchase price received by a holder or holders of shares of Common Stock with respect to such rights or warrants (assuming such holder had retained such rights or warrants), made to all holders of shares of Common Stock as of the date of such redemption or repurchase, and (2) in the case of such rights or warrants which shall have expired or been terminated without exercise by any holders thereof, the Conversion Price shall be readjusted as if such rights and warrants had not been issued. Notwithstanding the foregoing, in the event that the Company shall distribute rights or warrants to subscribe for additional shares of the Common Stock (other than rights or warrants described in Section 15.4(2)), pro rata to holders of Common Stock, the Company may, in lieu of making any adjustment pursuant to this Section 15.4(4), make proper provision so that each holder of a Note who converts such Note (or any portion thereof) after the Distribution Record Date for such distribution and prior to the expiration or redemption of such rights or warrants shall be entitled to receive upon such conversion, in addition to the shares of Common Stock issuable upon such conversion (the "Conversion Shares"), a number of rights or warrants to be determined as follows: (i) if such conversion occurs on or prior to the date for the distribution to the holders of such rights or warrants of separate certificates evidencing such rights or warrants (the "Distribution Date"), the same number of rights or warrants to which a holder of a number of shares of Common Stock equal to the number of Conversion Shares is entitled at the time of such conversion in accordance with the terms and provisions of and applicable to such rights or -58- 65 warrants; and (ii) if such conversion occurs after the Distribution Date, the same number of rights or warrants to which a holder of the number of shares of Common Stock into which the principal amount of the Note so converted was convertible immediately prior to the Distribution Date would have been entitled on the Distribution Date in accordance with the terms and provisions of, and applicable to such rights or warrants. For purposes of this Section 15.4(4) and Sections 15.4(1) and (2), any dividend or distribution to which this Section 15.4(4) is applicable that also includes shares of Common Stock, or rights or warrants to subscribe for or purchase shares of Common Stock (or both), shall be deemed instead to be (1) a dividend or distribution of the evidences of indebtedness, assets or shares of capital stock other than such shares of Common Stock or rights or warrants (and any Conversion Price reduction required by this Section 15.4(4) with respect to such dividend or distribution shall then be made) immediately followed by (2) a dividend or distribution of such shares of Common Stock or such rights or warrants (and any further Conversion Price reduction required by Sections 15.4(1) and (2) with respect to such dividend or distribution shall then be made), except (A) the Distribution Record Date of such dividend or distribution shall be substituted as "the date fixed for the determination of shareholders entitled to receive such dividend or other distribution" and "the date fixed for such determination" within the meaning of Sections 15.4(1) and (2) and (B) any shares of Common Stock included in such dividend or distribution shall not be deemed "outstanding at the close of business on the date fixed for such determination" within the meaning of Section 15.4(1). (5) In case the Company shall, by dividend or otherwise, distribute to all holders of its Common Stock cash (excluding (x) any quarterly cash dividend on the Common Stock to the extent the aggregate cash dividend per share of Common Stock in any quarterly period does not exceed the greater of (A) the amount per share of Common Stock of the next preceding quarterly cash dividend on the Common Stock to the extent that such preceding quarterly dividend did not require any adjustment of the Conversion Price pursuant to this Section 15.4(5) (as adjusted to reflect subdivisions or combinations of the Common Stock), and (B) 3.75% of the arithmetic average of the Closing Prices (determined as set forth in Section 15.4(8)(a)) during the ten Trading Days immediately prior to the date of declaration of such dividend, (y) any dividend or distribution in connection with the liquidation, dissolution or winding up of the Company, whether voluntary or involuntary and (z) any cash that is distributed as part of a distribution requiring a Conversion Price adjustment pursuant to Section 15.4(4)), then, in such case, the Conversion Price shall be reduced so that the same shall equal the price determined by multiplying the Conversion Price in effect immediately prior to the close of business on such Distribution Record Date by a fraction of which the numerator shall be the Current Market Price of the Common Stock on the Distribution Record Date less the amount of cash so distributed (and not excluded as provided above) applicable to one share of Common Stock and the denominator shall be such Current Market Price of the Common Stock, such reduction to be effective immediately prior to the opening of business on the day following the Distribution Record Date; provided, however, that in the event the portion of the cash so distributed applicable to one share of Common Stock is equal to or greater than the Current -59- 66 Market Price of the Common Stock on the Distribution Record Date, in lieu of the foregoing adjustment, adequate provision shall be made so that each Holder shall have the right to receive upon conversion the amount of cash such Holder would have received had such Holder converted each Note on the Distribution Record Date. In the event that such dividend or distribution is not so paid or made, the Conversion Price shall again be adjusted to be the Conversion Price which would then be in effect if such dividend or distribution had not been declared. If any adjustment is required to be made as set forth in this Section 15.4(5) as a result of a distribution that is a quarterly dividend, such adjustment shall be based upon the amount by which such distribution exceeds the amount of the quarterly cash dividend permitted to be excluded pursuant hereto. If an adjustment is required to be made as set forth in this Section 15.4(5) above as a result of a distribution that is not a quarterly dividend, such adjustment shall be based upon the full amount of the distribution. (6) In case a tender or exchange offer made by the Company for all or any portion of the Common Stock shall expire and such tender or exchange offer (as amended upon the expiration thereof) shall require the payment to stockholders of consideration per share of Common Stock having a fair market value (as determined by the Board of Directors, whose determination shall be conclusive and described in a Board Resolution) that as of the last time (the "Expiration Time") tenders or exchanges may be made pursuant to such tender or exchange offer (as it may be amended) that exceeds the Current Market Price per share of the Common Stock on the Trading Day next succeeding the Expiration Time, the Conversion Price shall be reduced so that the same shall equal the price determined by multiplying the Conversion Price in effect immediately prior to the Expiration Time by a fraction of which the numerator shall be the number of shares of Common Stock outstanding (including any tendered or exchanged shares) on the Expiration Time multiplied by the Current Market Price of the Common Stock on the Trading Day next succeeding the Expiration Time and the denominator shall be the sum of (x) the fair market value (determined as aforesaid) of the aggregate consideration payable to stockholders based on the acceptance (up to any maximum specified in the terms of the tender or exchange offer) of all shares validly tendered or exchanged and not withdrawn as of the Expiration Time (the shares deemed so accepted, up to any such maximum, being referred to as the "Purchased Shares") and (y) the product of the number of shares of Common Stock outstanding (less any Purchased Shares) on the Expiration Time and the Current Market Price of the Common Stock on the Trading Day next succeeding the Expiration Time, such reduction to become effective immediately prior to the opening of business on the day following the Expiration Time. In the event that the Company is obligated to purchase shares pursuant to any such tender or exchange offer, but the Company is permanently prevented by applicable law from effecting any such purchases or all such purchases are rescinded, the Conversion Price shall again be adjusted to be the Conversion Price which would then be in effect if such tender or exchange offer had not been made. (7) In case of a tender or exchange offer made by a Person other than the Company for an amount which increases the offeror's ownership of Common Stock to more than 25% of the total shares of the Common Stock outstanding and which provides for the -60- 67 payment by such Person of cash and other consideration per share of Common Stock having a fair market value (as determined by the Board of Directors, whose determination shall be conclusive, and described in a resolution of the Board) at the last time (the "Tender Expiration Time") tenders or exchanges may be made pursuant to such tender or exchange offer (as it shall have been amended) that exceeds the Current Market Price of the Common Stock on the Trading Day next succeeding the Tender Expiration Time, and in which, as of the Tender Expiration Time the Board of Directors is not recommending rejection of the offer, the Conversion Price shall be reduced so that the same shall equal the price determined by multiplying the Conversion Price in effect immediately prior to the Tender Expiration Time by a fraction of which the numerator shall be the number of shares of Common Stock outstanding (including any tendered or exchanged shares) on the Tender Expiration Time multiplied by the Current Market Price of the Common Stock on the Trading Day next succeeding the Tender Expiration Time and the denominator shall be the sum of (x) the fair market value (determined as aforesaid) of the aggregate consideration payable to stockholders based on the acceptance (up to any maximum specified in the terms of the tender or exchange offer) of all shares validly tendered or exchanged and not withdrawn as of the Tender Expiration Time (the shares deemed so accepted, up to any such maximum, being referred to as the "Accepted Purchased Shares") and (y) the product of the number of shares of Common Stock outstanding (less any Accepted Purchased Shares) on the Tender Expiration Time and the Current Market Price of the Common Stock on the Trading Day next succeeding the Tender Expiration Time, such reduction to become effective immediately prior to the opening of business on the day following the Tender Expiration Time. In the event that such Person is obligated to purchase shares pursuant to any such tender or exchange offer, but such Person is permanently prevented by applicable law from effecting any such purchases or all such purchases are rescinded, the Conversion Price shall again be adjusted to be the Conversion Price which would then be in effect if such tender or exchange offer had not been made. Notwithstanding the foregoing, the adjustment described in this Section 15.4(7) shall not be made if, as of the Tender Expiration Time, the offering documents with respect to such offer disclose a plan or intention to cause the Company to engage in a consolidation or merger of the Company or a sale of all or substantially all of the Company's assets. (8) For purposes of this Section 15.4, the following terms shall have the meaning indicated: (a) "Closing Price" with respect to any securities on any day shall mean the closing sale price regular way on such day or, in case no such sale takes place on such day, the average of the reported closing bid and asked prices, regular way, in each case on the New York Stock Exchange, or, if such security is not listed or admitted to trading on such Exchange, on the principal security exchange or quotation system in the United States on which such security is quoted or listed or admitted to trading, or, the average of the closing bid and asked prices of such security on the over-the-counter market on the day in question as reported by the Nasdaq National Market or a similar generally accepted reporting service, or if not so available, in such manner as furnished by any New York Stock Exchange member firm selected from time to time by the Board of Directors -61- 68 for that purpose, or a price determined in good faith by the Board of Directors or, to the extent permitted by applicable law, a duly authorized committee thereof, whose determination shall be conclusive. (b) "Current Market Price" shall mean the average of the daily Closing Prices per share of Common Stock for the ten consecutive Trading Days immediately prior to the date in question; provided, however, that (1) if the "ex" date (as hereinafter defined) for any event (other than the issuance or distribution or Fundamental Change requiring such computation) that requires an adjustment to the Conversion Price pursuant to Section 15.4(1), (2), (3), (4), (5), (6) or (7) occurs during such ten consecutive Trading Days, the Closing Price for each Trading Day prior to the "ex" date for such other event shall be adjusted by multiplying such Closing Price by the same fraction by which the Conversion Price is so required to be adjusted as a result of such other event, (2) if the "ex" date for any event (other than the issuance, distribution or Fundamental Change requiring such computation) that requires an adjustment to the Conversion Price pursuant to Section 15.4(1), (2), (3), (4), (5), (6) or (7) occurs on or after the "ex" date for the issuance or distribution requiring such computation and prior to the day in question, the Closing Price for each Trading Day on and after the "ex" date for such other event shall be adjusted by multiplying such Closing Price by the reciprocal of the fraction by which the Conversion Price is so required to be adjusted as a result of such other event, and (3) if the "ex" date for the issuance, distribution or Fundamental Change requiring such computation is prior to the day in question, after taking into account any adjustment required pursuant to clause (1) or (2) of this proviso, the Closing Price for each Trading Day on or after such "ex" date shall be adjusted by adding thereto the amount of any cash and the fair market value (as determined by the Board of Directors in a manner consistent with any determination of such value for purposes of Section 15.4(4), (6) or (7), whose determination shall be conclusive and described in a resolution of the Board of Directors) of the evidences of indebtedness, shares of capital stock or assets being distributed applicable to one share of Common Stock as of the close of business on the day before such "ex" date. For purposes of any computation under Section 15.4(6) or (7), the Current Market Price of the Common Stock on any date shall be deemed to be the average of the daily Closing Prices per share of Common Stock for such day and the next two succeeding Trading Days; provided, however, that if the "ex" date for any event (other than the tender or exchange offer requiring such computation) that requires an adjustment to the Conversion Price pursuant to Section 15.4(1), (2), (3), (4), (5), (6) or (7) occurs on or after the Expiration Time or Tender Expiration Time, as the case may be, for the tender or exchange offer requiring such computation and prior to the day in question, the Closing Price for each Trading Day on and after the "ex" date for such other event shall be adjusted by multiplying such Closing Price by the reciprocal of the fraction by which the Conversion Price is so required to be adjusted as a result of such other event. For purposes of this paragraph, the term "ex" date, (1) when used with respect to any issuance or distribution, means the first date on which the Common Stock trades regular way on the relevant exchange or in the relevant market from which the Closing Price was -62- 69 obtained without the right to receive such issuance or distribution, (2) when used with respect to any subdivision or combination of shares of Common Stock, means the first date on which the Common Stock trades regular way on such exchange or in such market after the time at which such subdivision or combination becomes effective, and (3) when used with respect to any tender or exchange offer means the first date on which the Common Stock trades regular way on such exchange or in such market after the Expiration Time or Tender Expiration Time, as the case may be, of such offer. (c) "fair market value" shall mean the amount which a willing buyer would pay a willing seller in an arm's length transaction. (d) "Distribution Record Date" shall mean, with respect to any dividend, distribution or other transaction or event in which the holders of Common Stock have the right to receive any cash, securities or other property or in which the Common Stock (or other applicable security) is exchanged for or converted into any combination of cash, securities or other property, the date fixed for determination of stockholders entitled to receive such cash, securities or other property (whether such date is fixed by the Board of Directors or by statute, contract or otherwise). (e) "Trading Day" shall mean (x) if the applicable security is listed or admitted for trading on the New York Stock Exchange or another national security exchange, a day on which the New York Stock Exchange or another national security exchange is open for business or (y) if the applicable security is quoted on the Nasdaq National Market, a day on which trades may be made on thereon or (z) if the applicable security is not so listed, admitted for trading or quoted, any day other than a Saturday or Sunday or a day on which banking institutions in the State of New York are authorized or obligated by law or executive order to close. (9) No adjustment in the Conversion Price shall be required unless such adjustment (plus any adjustments not previously made by reason of this paragraph (9)) would require an increase or decrease of at least one percent in such price; provided, however, that any adjustments which by reason of this paragraph (9) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Article shall be made to the nearest cent or to the nearest one-hundredth of a share, as the case may be. (10) The Company may, at its option, make such reductions in the Conversion Price as the Board deems advisable, in addition to those required by paragraphs (1), (2), (3), (4), (5), (6) or (7) of this Section 15.4 in order to avoid or diminish any income tax to any holders of Common Stock or rights to purchase Common Stock resulting from any dividend or distribution on Common Stock (or rights to acquire such shares) or from any event treated as such for income tax purposes, resulting from any dividend or distribution of shares or issuance of -63- 70 rights or warrants to purchase or subscribe for shares or from any event treated as such for income tax purposes. To the extent permitted by applicable law, the Company from time to time may reduce the Conversion Price by any amount for any period of time if the period is (i) at least twenty (20) days, (ii) the reduction is irrevocable during the period and (iii) the Board shall have made a determination that such reduction would be in the best interests of the Company, which determination shall be conclusive. Whenever the Conversion Price is reduced pursuant to the preceding sentence, the Company shall give notice of the reduction to the Holders of Notes at least fifteen (15) days prior to the date the reduced Conversion Price takes effect, and such notice shall state the reduced Conversion Price and the period during which it will be in effect. (11) No adjustment of the Conversion Price will result in zero or a negative number. Section 15.5 Notice of Adjustments of Conversion Price. Whenever the Conversion Price is adjusted as herein provided: (1) the Company shall compute the adjusted Conversion Price in accordance with Section 15.4 and shall prepare a certificate signed by the President, Treasurer or Chief Financial Officer of the Company setting forth the adjusted Conversion Price and showing in reasonable detail the facts upon which such adjustment is based, and such certificate shall promptly be filed with the Trustee; and (2) a notice stating that the Conversion Price has been adjusted and setting forth the adjusted Conversion Price shall promptly be prepared and as soon as practicable thereafter, such notice shall be provided by the Company to all Holders. The Trustee shall not be under any duty or responsibility with respect to any such certificate or the information and calculations contained therein, except to exhibit the same to any Holder of Notes desiring inspection thereof at its office during normal business hours. Section 15.6 Notice of Certain Corporate Action. In case: (a) the Company shall declare a dividend (or any other distribution) on all or substantially all of its Common Stock payable (i) otherwise than exclusively in cash or (ii) exclusively in cash in an amount that would require any adjustment pursuant to Section 15.4; or (b) the Company shall authorize the granting to the holders of its Common Stock of rights, options or warrants to subscribe for or purchase any shares of capital -64- 71 stock of any class or of any other rights that would require any adjustment pursuant to Section 15.4; or (c) of any reclassification of the Common Stock of the Company (other than a subdivision or combination of its outstanding Common Stock), or of any consolidation or merger to which the Company is a party and for which approval of any stockholders of the Company is required, or of the sale or transfer of all or substantially all of the assets of the Company; or (d) of the voluntary or involuntary dissolution, liquidation or winding up of the Company; or (e) the Company or any Subsidiary of the Company shall commence a tender offer for all or a portion of the Company's outstanding Common Stock (or shall amend any such tender offer); then the Company shall cause to be filed at each office or agency maintained for the purpose of conversion of Notes pursuant to Section 5.2, and shall cause to be provided to all Holders, at least 20 days (or 10 days in any case specified in clause (a) or (b) above) prior to the applicable record, expiration or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, rights, options or warrants, or, if a record is not to be taken, the date as of which the holders of Common Stock of record to be entitled to such dividend, distribution, rights, options or warrants are to be determined, (y) the date on which the right to make tenders under such tender offer expires or (z) the date on which such reclassification, consolidation, merger, share exchange, conveyance, transfer, sale, dissolution, liquidation or winding up is expected to become effective, and the date as of which it is expected that holders of shares of Common Stock of record shall be entitled to exchange their shares of Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, share exchange, conveyance, transfer, sale, lease, dissolution, liquidation or winding up. If at the time the Trustee shall not be the conversion agent, a copy of such notice and any notice referred to in the following paragraph shall also forthwith be filed by the Company with the Trustee. The preceding paragraph to the contrary notwithstanding, the Company shall cause to be filed at each office or agency maintained for the purpose of conversion of Notes pursuant to Section 5.2, and shall cause to be provided to all Holders, notice of any tender offer by the Company or any Subsidiary of the Company for all or any portion of the Common Stock at or about the time that such notice of tender offer is provided to the public generally (such notice to be sent to all Holders within five days after receipt of such notice by the Trustee from the Company). -65- 72 Section 15.7 Company to Provide Common Stock. The Company shall ensure that the Company has, free from preemptive rights, out of its authorized but unissued Common Stock, the full number of shares of Common Stock for the purpose of effecting the conversion of Notes. Section 15.8 Taxes on Conversions. The Company will pay any and all taxes and duties that may be payable in respect of the issue or delivery of Common Stock on conversion of Notes pursuant hereto. The Company shall not, however, be required to pay any tax or duty which may be payable in respect of any transfer involved in the issue and delivery of Common Stock in a name other than that of the Holder of the Note or Notes to be converted, and no such issue or delivery shall be made unless and until the Person requesting such issue has paid to the Company the amount of any such tax or duty, or has established to the satisfaction of the Company that such tax or duty has been paid. Section 15.9 Company Covenants as to Common Stock. The Company covenants that all Common Stock which may be delivered upon conversion of Notes, upon such delivery, will have been duly authorized and validly issued and will be fully paid and nonassessable and, except as provided in Section 15.8, the Company will pay all taxes, liens and charges with respect to the issue thereof. Before taking any action which would cause an adjustment reducing the Conversion Price below the then par value, if any, of the shares of Common Stock issuable upon conversion of the Notes, the Company will take all corporate action which may, in the opinion of its counsel, be necessary in order that the Company may validly and legally issue shares of such Common Stock at such adjusted Conversion Price. The Company covenants that if any shares of Common Stock to be provided for the purpose of conversion of Notes hereunder require registration with or approval of any governmental authority under any federal or state law before such shares may be validly issued upon conversion, the Company will in good faith and as expeditiously as possible endeavor to secure such registration or approval, as the case may be. The Company further covenants that if at any time the Common Stock shall be listed on the Nasdaq National Market or any other national securities exchange or automated quotation system the Company will, if permitted by the rules of such exchange or automated quotation system, list and keep listed, so long as the Common Stock shall be so listed on such exchange or automated quotation systems, all Common Stock issuable upon conversion of the Notes; provided, however, that if rules of such exchange or automated quotation system permit the Company to defer the listing of such Common Stock until the first conversion of the Notes into Common Stock in accordance with the provisions of this Indenture, the Company covenants to list such Common Stock issuable upon conversion of the Notes in accordance with the requirements of such exchange or automated quotation system at such time. -66- 73 Section 15.10 Cancellation of Converted Notes. All Notes delivered for conversion shall be delivered to the Trustee which shall dispose of the same as provided in Section 2.8. Section 15.11 Effect of Reclassification, Consolidation, Merger or Sale. If any of the following events occur, namely (i) any reclassification of Common Stock (other than a subdivision or combination to which Section 15.4(3) applies), (ii) any consolidation, merger or combination of the Company with another corporation as a result of which holders of Common Stock shall be entitled to receive stock, securities or other property or assets (including cash) with respect to or in exchange for such Common Stock, or (iii) any sale or conveyance of the properties and assets of the Company as, or substantially as, an entirety to any other corporation as a result of which holders of Common Stock shall be entitled to receive stock, other securities or other property or assets (including cash) with respect to or in exchange for such Common Stock, then the Company or the successor or purchasing corporation, as the case may be, shall execute with the Trustee a supplemental indenture (which shall comply with the Trust Indenture Act as in force at the date of execution of such supplemental indenture) providing that such Note shall be convertible into the kind and amount of shares of stock and other securities or property or assets (including cash) that the holder of such Note would have owned or been entitled to receive upon such reclassification, change, consolidation, merger, combination, sale or conveyance by a holder of a number of shares of Common Stock issuable upon conversion of such Notes (assuming, for such purposes, a sufficient number of authorized shares of Common Stock available to convert all such Notes) immediately prior to such reclassification, change, consolidation, merger, combination, sale or conveyance assuming such holder of Common Stock is (i) not a Person with which the Company consolidated or into which the Company merged or which merged into the Company or to which such sale or transfer was made, as the case may be (a "Constituent Person"), or an Affiliate of a Constituent Person, and (ii) failed to exercise his rights of election, if any, as to the kind or amount of securities, cash or other property receivable upon such reclassification, change, consolidation, merger, combination, sale or conveyance (provided that, if the kind or amount of securities, cash or other property receivable upon such reclassification, change, consolidation, merger, combination, sale or conveyance is not the same for each share of Common Stock in respect of which such rights of election shall not have been exercised ("Non-electing Share")), then for the purposes of this Section 15.11 the kind and amount of securities, cash or other property receivable upon such reclassification, change, consolidation, merger, combination, sale or conveyance for each Non-electing Share shall be deemed to be the kind and amount so receivable per share by a plurality of the non-electing shares. Such supplemental indenture shall provide for adjustments which, for events subsequent to the effective date of such supplemental indenture, shall be as nearly equivalent as may be practicable to the adjustments provided for in this Article. The above provisions of this Section 12.11 shall similarly apply to successive reclassifications, changes, consolidations, mergers, combinations, sales or conveyances. Notice of the execution of such a supplemental indenture shall be given by the Company to the Holder of each Note as provided in Section 1.6 promptly upon such execution. -67- 74 Neither the Trustee, any paying agent nor any conversion agent shall be under any responsibility to determine the correctness of any provisions contained in any such supplemental indenture relating either to the kind or amount of shares of stock or other securities or property or cash receivable by Holders of Notes upon the conversion of their Notes after any such reclassification, change, consolidation, merger, combination, sale or conveyance or to any such adjustment, but may accept as conclusive evidence of the correctness of any such provisions, and shall be protected in relying upon, an Opinion of Counsel with respect thereto, which the Company shall cause to be furnished to the Trustee. Section 15.12 Responsibility of Trustee for Conversion Provisions. The Trustee, subject to the provisions of Section 8.1, shall not at any time be under any duty or responsibility to any Holder of Notes to determine whether any facts exist which may require any adjustment of the Conversion Price, or with respect to the nature or extent of any such adjustment when made, or with respect to the method employed, or herein or in any supplemental indenture provided to be employed, in making the same, or whether a supplemental indenture need be entered into. The Trustee, subject to the provisions of Section 8.1, shall not be accountable with respect to the validity or value (or the kind or amount) of any Common Stock, or of any other securities or property or cash, which may at any time be issued or delivered upon the conversion of any Note; and it or they do not make any representation with respect thereto. The Trustee, subject to the provisions of Section 8.1, shall not be responsible for any failure of the Company to make or calculate any cash payment or to issue, transfer or deliver any Common Stock or share certificates or other securities or property or cash upon the surrender of any Note for the purpose of conversion; and the Trustee, subject to the provisions of Section 8.1, shall not be responsible for any failure of the Company to comply with any of the covenants of the Company contained in this Article. Unless and until a Responsible Officer of the Trustee shall have received a notice of an adjustment of the Conversion Price delivered pursuant to Section 15.5, the Trustee shall not be deemed to have knowledge of any such adjustment and may assume without inquiry that the last Conversion Price of which it has knowledge remains in effect. ARTICLE XVI REPURCHASE UPON A FUNDAMENTAL CHANGE Section 16.1 Right to Require Repurchase. In the event that a Fundamental Change (as hereinafter defined) shall occur, then each Holder shall have the right, at the Holder's option, to require the Company to repurchase, and upon the exercise of such right the Company shall repurchase, all of such Holder's Notes, or any portion of the principal amount thereof that is equal to U.S.$1,000 or any integral multiple thereof (provided that no single Note may be repurchased in part unless the portion of the principal amount of such Note to be Outstanding after such repurchase is equal to U.S.$1,000 or integral multiples of U.S.$1,000 in excess thereof), on the date (the "Repurchase Date") that is 45 days after the date of the Company -68- 75 Notice (as defined in Section 16.2) at the following prices (expressed as percentages of the principal amount thereof) (the "Repurchase Price") in the event of a Fundamental Change occurring during the 12-month period beginning March 1 of the years set forth below (plus interest accrued to, but excluding, the Repurchase Date):
Year Repurchase Price - ---- ---------------- 1998 % 1999 2000
and thereafter at the Redemption Price that would then be applicable as set forth on the reverse of the form of Note for the years therein indicated, attached hereto as Exhibit A; provided that if the Applicable Price with respect to the Fundamental Change is less than the Reference Market Price, the Company shall repurchase such Notes at a price equal to the foregoing Repurchase Price multiplied by the fraction obtained by dividing the Applicable Price by the Reference Market Price; and provided, further, that if the Repurchase Date is March 1 or September 1, then the interest payable on the Repurchase Date shall be paid to the holder or record of the Note on the immediately preceding Record Date. Such right to require the repurchase of the Notes shall not continue after a discharge of the Company from its obligations with respect to the Notes in accordance with Article XIII, unless a Fundamental Change shall have occurred prior to such discharge. Whenever in this Indenture there is a reference, in any context, to the principal of any Note as of any time, such reference shall be deemed to include reference to the Repurchase Price payable in respect of such Note to the extent that such Repurchase Price is, was or would be so payable at such time, and express mention of the Repurchase Price in any provision of this Indenture shall not be construed as excluding the Repurchase Price in those provisions of this Indenture when such express mention is not made. Section 16.2 Notices; Method of Exercising Repurchase Right, Etc. (a) Unless the Company shall have theretofore called for redemption all of the outstanding Notes, on or before the 30th day after the occurrence of a Fundamental Change, the Company or, at the request and expense of the Company, the Trustee, shall give to all Holders of Notes, notice (the "Company Notice") of the occurrence of the Fundamental Change and of the repurchase right set forth herein arising as a result thereof. The Company shall also deliver a copy of such notice of a repurchase right to the Trustee. Each notice of a repurchase right shall state: (1) the Repurchase Date, (2) the date by which the repurchase right must be exercised, (3) the Repurchase Price, -69- 76 (4) a description of the procedure which a Holder must follow to exercise a repurchase right, and the place or places where such Notes are to be surrendered for payment of the Repurchase Price and accrued interest, if any, (5) that on the Repurchase Date the Repurchase Price, and accrued interest, if any, will become due and payable upon each such Note designated by the Holder to be repurchased, and that interest thereon shall cease to accrue on and after said date, and (6) the Conversion Price then in effect, the date on which the right to convert the principal amount of the Notes to be repurchased will terminate and the place or places where such Notes may be surrendered for conversion. If any of the foregoing provisions or other provisions of this Article are inconsistent with applicable law, such law shall govern. (b) To exercise a repurchase right, a Holder shall deliver to the Trustee or any paying agent on or before the 30th day after the date of the Company Notice (i) written notice of the Holder's exercise of such right, which notice shall set forth the name of the Holder, the principal amount of the Notes to be repurchased (and, if any Note is to be repurchased in part, the serial number thereof, the portion of the principal amount thereof to be repurchased and the name of the Person in which the portion thereof to remain outstanding after such repurchase is to be registered) and a statement that an election to exercise the repurchase right is being made thereby, and (ii) the Notes with respect to which the repurchase right is being exercised. Such written notice shall be irrevocable, except that the right of the Holder to convert the Notes with respect to which the repurchase right is being exercised shall continue until the close of business on the Business Day prior to the Repurchase Date as set forth in the immediate succeeding sentence. A Note for which a Holder has delivered a repurchase notice exercising the option of such Holder to require the Company to repurchase such Note may be converted only if such notice is withdrawn by a written notice of withdrawal delivered by the Holder to the Company prior to the close of business on the Business Day preceding the Repurchase Date. (c) In the event a repurchase right shall be exercised in accordance with the terms hereof, the Company shall pay or cause to be paid to the Trustee or the paying agent the Repurchase Price in cash, as provided above, for payment to the Holder on the Repurchase Date together with accrued and unpaid interest to (but excluding) the Repurchase Date payable with respect to the Notes as to which their purchase right has been exercised; provided, however, that installments of interest that mature on to the Repurchase Date shall be payable in cash, in the case of Notes, to the Holders of such Notes, or one or more Predecessor Notes, registered as such at the close of business on the relevant Regular Record Date. (d) If any Note (or portion thereof) surrendered for repurchase shall not be so paid on the Repurchase Date, the principal amount of such Note (or portion thereof, as the case may be) shall, until paid, bear interest to the extent permitted by applicable law from the -70- 77 Repurchase Date at the rate of _____% per annum, and each Note shall remain convertible into Common Stock until the principal of such Note (or portion thereof, as the case may be) shall have been paid or duly provided for. (e) Any Note which is to be repurchased only in part shall be surrendered to the Trustee (with, if the Company or the Trustee so requires, due endorsement by, or a written instrument of transfer in form satisfactory to the Company and the Trustee duly executed by, the Holder thereof or his attorney duly authorized in writing), and the Company shall execute, and the Trustee shall authenticate and make available for delivery to the Holder of such Note without service charge, a new Note or Notes, containing identical terms and conditions, each in an authorized denomination in aggregate principal amount equal to and in exchange for the unrepurchased portion of the principal of the Note so surrendered. (f) All securities delivered for repurchase shall be delivered to the Trustee, the paying agent or any other agents (as shall be set forth in the Company Notice) to be canceled by or at the direction of the Trustee, which shall dispose of the same as provided in Section 2.8. Section 16.3 Merger, Consolidation, etc. In the case of any merger, consolidation, sale or transfer of all or substantially all of the assets of the Company to which Section 15.11 applies, in which the Common Stock of the Company is changed or exchanged as a result into the right to receive shares of stock and other securities or property or assets (including cash) which includes Common Stock of the Company or common stock of another Person that are, or upon issuance will be, traded on a United States national securities exchange or approved for trading on an established automated over-the-counter trading market in the United States and such shares constitute at the time such change or exchange becomes effective in excess of 50% of the aggregate fair market value of such shares of stock and other securities, property and assets (including cash) (as determined by the Company, which determination shall be conclusive and binding), then the Company and the Person resulting from such merger or consolidation or which acquires the properties or assets (including cash) of the Company, as the case may be, shall execute and deliver to the Trustee a supplemental indenture (which shall comply with the Trust Indenture Act as in force at the date of execution of such supplemental indenture) modifying the provisions of this Indenture relating to the right of Holders to cause the Company to repurchase the Notes following a Fundamental Change, including, without limitation, the applicable provisions of this Article XVI and the definitions of the Common Stock and Fundamental Change, as appropriate, and such other related definitions set forth herein, as determined in good faith by the Company (which determination shall be conclusive and binding), to make such provisions apply in the event of a subsequent Fundamental Change to the common stock and the issuer thereof if different from the Company and the Common Stock of the Company (in lieu of the Company and Common Stock of the Company). -71- 78 ARTICLE XVII MISCELLANEOUS PROVISIONS Section 17.1 Provisions Binding on Company's Successors. All the covenants, stipulations, promises and agreements of the Company in this Indenture contained shall bind its successors and assigns whether so expressed or not. Section 17.2 Official Acts by Successor Corporation. Any act or proceeding by any provision of this Indenture authorized or required to be done or performed by any board, committee or officer of the Company shall and may be done and performed with like force and effect by the like board, committee or officer of any corporation that shall at the time be the lawful sole successor of the Company. Section 17.3 Addresses for Notices, Etc. Any notice or demand which by any provision of this Indenture is required or permitted to be given or served by the Trustee or by the holders of Notes on the Company shall be deemed to have been sufficiently given or made, for all purposes if given or served by being sent by overnight courier, or deposited postage prepaid by registered or certified mail in a post office letter box addressed (until another address is filed by the Company with the Trustee) to HNC Software Inc., 5930 Cornerstone Court West, San Diego, California, 92121, Attention: Raymond V. Thomas. Any notice, direction, request or demand hereunder to or upon the Trustee shall be deemed to have been sufficiently given or made, for all purposes, if given or served by being sent by overnight courier, or deposited postage prepaid by registered or certified mail in a post office letter box addressed to the Corporate Trust Office of the Trustee, which office is, at the date as of which this Indenture is dated, located at 633 West 5th Street, 12th Floor, Los Angeles, California 90071, Attention: Corporate Trust Division (HNC Software Inc. __% Convertible Subordinated Notes due 2003). The Trustee, by notice to the Company, may designate additional or different addresses for subsequent notices or communications. Any notice or communication mailed to a Holder shall be mailed to him by first class mail, postage prepaid, at his address as it appears on the Note register and shall be sufficiently given to him if so mailed within the time prescribed. In any case where notice to Holders of Notes is given by mail, neither the failure to mail such notice, nor any defect in any notice so mailed, to any particular Holder of a Note shall affect the sufficiency of such notice with respect to other Holders of Notes given as provided above. In case by reason of the suspension of or irregularities in regular mail service or by reason of any other cause it shall be impracticable to give such notice by mail, then such notification to Holders of Notes as shall be made with the approval of the Trustee, which approval shall not be unreasonably withheld, shall constitute a sufficient notification to such Holders for every purpose hereunder. -72- 79 Where this Indenture provides for notice in any manner, such notice may be waived in writing by the Person entitled to receive such notice, either before or after the event, and such waiver shall be the equivalent of such notice. Waivers of notice by Holders of Notes shall be filed with the Trustee, but such filing shall not be a condition precedent to the validity of any action taken in reliance upon such waiver. Section 17.4 Governing Law. The laws of the State of New York shall govern this Indenture and the Notes, without regard to the principles of conflicts of laws. Section 17.5 Evidence of Compliance with Conditions Precedent; Certificates to Trustee. Upon any application or demand by the Company to the Trustee to take any action under any of the provisions of this Indenture, the Company shall furnish to the Trustee an Officers' Certificate stating that all conditions precedent, if any, provided for in this Indenture relating to the proposed action have been complied with, and an Opinion of Counsel, stating that, in the opinion of such counsel, all such conditions precedent have been complied with. Each certificate or opinion provided for in this Indenture and delivered to the Trustee with respect to compliance with a condition or covenant provided for in this Indenture shall include (1) a statement that the Person making such certificate or opinion has read such covenant or condition; (2) a brief statement as to the nature and scope of the examination or investigation upon which the statement or opinion contained in such certificate or opinion is based; (3) a statement that, in the opinion of such Person, he has made such examination or investigation as is necessary to enable him to express an informed opinion as to whether or not such covenant or condition has been complied with; and (4) a statement as to whether or not, in the opinion of such Person, such condition or covenant has been complied with. Section 17.6 Legal Holidays. In any case where the date of maturity of interest on or principal of the Notes or the date fixed for redemption or repurchase of any Note will not be a Business Day, then payment of such interest on or principal of the Notes need not be made on such date, but may be made on the next succeeding Business Day with the same force and effect as if made on the date of maturity or the date fixed for redemption or repurchase, and no interest shall accrue for the period from and after such date. Section 17.7 No Note Interest Created. Nothing in this Indenture or in the Notes, expressed or implied, shall be construed to constitute a security interest under the Uniform Commercial Code or similar legislation, as now or hereafter enacted and in effect, in any jurisdiction. Section 17.8 Trust Indenture Act. If and to the extent that any provision of this Indenture limits, qualifies or conflicts with another provision included in this Indenture which is required to be included in this Indenture by any of Section 310 to 317, inclusive, of the Trust Indenture Act, such required provision shall control. If any provision of this Indenture modifies or excludes any provision of the Trust Indenture Act that may be so modified or excluded, the -73- 80 latter provision shall be deemed to apply to this Indenture as so modified or excluded, as the case may be. Section 17.9 Benefits of Indenture. Nothing in this Indenture or in the Notes, expressed or implied, shall give to any Person, other than the parties hereto, any paying agent, any authenticating agent, any Note registrar, any conversion agent and their successors hereunder, the holders of Notes and the holders of Senior Indebtedness, any benefit or any legal or equitable right, remedy or claim under this Indenture. Section 17.10 Table of Contents, Headings, Etc. The table of contents and the titles and headings of the articles and sections of this Indenture have been inserted for convenience of reference only, are not to be considered a part hereof, and shall in no way modify or restrict any of the terms or provisions hereof. Section 17.11 Authenticating Agent. The Trustee may appoint an authenticating agent which shall be authorized to act on its behalf and subject to its direction in the authentication and delivery of Notes in connection with the original issuance thereof and transfers and exchanges of Notes hereunder, including under Sections 2.4, 2.5, 2.6, 2.7, 3.7, 15.2 and 16.2 as fully to all intents and purposes as though the authenticating agent had been expressly authorized by this Indenture and those Sections to authenticate and deliver Notes. For all purposes of this Indenture, the authentication and delivery of Notes by the authenticating agent shall be deemed to be authentication and delivery of such Notes "by the Trustee" and a certificate of authentication executed on behalf of the Trustee by an authenticating agent shall be deemed to satisfy any requirement hereunder or in the Notes for the Trustee's certificate of authentication. Such authenticating agent shall at all times be a Person eligible to serve as trustee hereunder pursuant to Section 8.9. Any corporation into which any authenticating agent may be merged or converted or with which it may be consolidated, or any corporation resulting from any merger, consolidation or conversion to which any authenticating agent shall be a party, or any corporation succeeding to the corporate trust business of any authenticating agent, shall be the successor of the authenticating agent hereunder, if such successor corporation is otherwise eligible under this Section, without the execution or filing of any paper or any further act on the part of the parties hereto or the authenticating agent or such successor corporation. Any authenticating agent may at any time resign by giving written notice of resignation to the Trustee and to the Company. The Trustee may at any time terminate the agency of any authenticating agent by giving written notice of termination to such authenticating agent and to the Company. Upon receiving such a notice of resignation or upon such a termination, or in case at any time any authenticating agent shall cease to be eligible under this Section, the Trustee shall promptly appoint a successor authenticating agent (which may be the Trustee), shall give written notice of such appointment to the Company and shall mail notice of such appointment to all holders of Notes as the names and addresses of such holders appear on the Note register. -74- 81 The Trustee agrees to pay to the authenticating agent from time to time reasonable compensation for its services (to the extent pre-approved by the Company in writing), and the Trustee shall be entitled to be reimbursed for such pre-approved payments, subject to Section 8.6. The provisions of Sections 8.2, 8.3, 8.4, 9.3 and this Section 17.11 shall be applicable to any authenticating agent. Section 17.12 Execution in Counterparts. This Indenture may be executed in any number of counterparts, each of which shall be an original, but such counterparts shall together constitute but one and the same instrument. State Street Bank and Trust Company of California, N.A. hereby accepts the trusts in this Indenture declared and provided, upon the terms and conditions hereinabove set forth. -75- 82 IN WITNESS WHEREOF, the parties hereto have caused this Indenture to be duly signed all as of the date first written above. HNC SOFTWARE INC. By:________________________________________ Title: ____________________________________ STATE STREET BANK AND TRUST COMPANY OF CALIFORNIA, N.A., as Trustee By:________________________________________ Title: ____________________________________ -76- 83 EXHIBIT A - FORM OF NOTE [FORM OF FACE OF NOTE] No.___________ $______________ CUSIP: ______________ HNC SOFTWARE INC. ___% Convertible Subordinated Note Due 2003 HNC SOFTWARE INC., a corporation duly organized and validly existing under the laws of the State of Delaware (herein called the "Company", which term includes any successor corporation under the Indenture referred to on the reverse hereof), for value received hereby promises to pay to _____________________, or registered assigns, the principal sum of______________ ______________________________ Dollars on March 1, 2003, and to pay interest on said principal sum semiannually on March 1 and September 1 of each year, commencing September 1, 1998, at the rate per annum specified in the title of this Note, accrued from the March 1 or September 1, as the case may be, next preceding the date of this Note to which interest has been paid or duly provided for, unless the date of this Note is a date to which interest has been paid or duly provided for, in which case interest shall accrue from the date of this Note, or unless no interest has been paid or duly provided for on this Note, in which case interest shall accrue from March ___, 1998, until payment of said principal sum has been made or duly provided for. Notwithstanding the foregoing, if the date hereof is after any February 15 or August 15, as the case may be, and before the following March 1 or September 1, this Note shall bear interest from such March 1 or September 1, respectively; provided, however, that if the Company shall default in the payment of interest due on such March 1 or September 1, then this Note shall bear interest from the next preceding March 1 or September 1 to which interest has been paid or duly provided for or, if no interest has been paid or duly provided for on this Note, from March __, 1998. The interest so payable on any March 1 or September 1 will be paid to the Person in whose name this Note (or one or more Predecessor Notes) is registered at the close of business on the record date, which shall be the February 15 or August 15 (whether or not a Business Day) next preceding such March 1 or September 1, respectively; provided that any such interest not punctually paid or duly provided for shall be payable as provided in the Indenture. Payment of the principal of and interest accrued on this Note shall be made at the office or agency of the Company maintained for that purpose in the Borough of Manhattan, The City of New York, or, at the option of the holder of this Note, at the Corporate Trust Office of the Trustee, in such coin or currency of the United States of America as at the time of payment shall be legal tender for the payment of public and private debts; provided, however, that at the option of the Company, payment of interest may be made by check mailed to the registered address of A-1 84 the Person entitled thereto; provided that, with respect to any Holder of Notes with an aggregate principal amount equal to or in excess of $1,000,000, at the request of such Holder in writing, interest on such Holder's Notes shall be paid by wire transfer in immediately available funds in accordance with the wire transfer instruction supplied by such Holder to the Trustee and paying agent (if different from the Trustee). Reference is made to the further provisions of this Note set forth on the reverse hereof, including, without limitation, provisions subordinating the payment of principal of and premium, if any, and interest on this Note to the prior payment in full of all Senior Indebtedness as defined in the Indenture and provisions giving the holder of this Note the right to convert this Note into Common Stock of the Company on the terms and subject to the limitations referred to on the reverse hereof and as more fully specified in the Indenture. Such further provisions shall for all purposes have the same effect as though fully set forth at this place. This Note shall be deemed to be a contract made under the laws of the State of New York, and for all purposes shall be construed in accordance with and governed by the laws of said State. This Note shall not be valid or become obligatory for any purpose until the certificate of authentication hereon shall have been manually signed by the Trustee or a duly authorized authenticating agent under the Indenture. IN WITNESS WHEREOF, the Company has caused this Note to be duly executed under its corporate seal. HNC SOFTWARE INC. Dated:____________________ By:________________________________________ Title: ____________________________________ Attest: ____________________________________________ Secretary A-2 85 [FORM OF CERTIFICATE OF AUTHENTICATION] TRUSTEE'S CERTIFICATE OF AUTHENTICATION This is one of the Notes described in the within-named Indenture. STATE STREET BANK AND TRUST COMPANY OF CALIFORNIA, N.A., as Trustee By:_____________________________________________ Authorized Signatory [By:____________________________________________ As Authentication Agent (if different from Trustee)] [FORM OF REVERSE OF NOTE] HNC SOFTWARE INC. [ %] Convertible Subordinated Note Due 2003 This Note is one of a duly authorized issue of Notes of the Company, designated as its [___%] Convertible Subordinated Notes due 2003 (herein called the "Notes"), limited to the aggregate principal amount of $100,000,000 all issued or to be issued under and pursuant to an Indenture dated as of March 1, 1998 (herein called the "Indenture"), between the Company and State Street Bank and Trust Company of California, N.A. (herein called the "Trustee"), to which Indenture and all indentures supplemental thereto reference is hereby made for a description of the rights, limitations of rights, obligations, duties and immunities thereunder of the Trustee, the Company and the holders of the Notes. In case an Event of Default, as defined in the Indenture, shall have occurred and be continuing, the principal of and accrued interest on all Notes may be declared, and upon said declaration shall become, due and payable in the manner, with the effect and subject to the conditions provided in the Indenture. The Indenture contains provisions permitting the Company and the Trustee, with the consent of the holders of not less than a majority of the aggregate principal amount of the Notes at the time outstanding, evidenced as in the Indenture provided, to execute supplemental A-3 86 indentures adding any provisions to or changing in any manner or eliminating any of the provisions of the Indenture or of any supplemental indenture or modifying in any manner the rights of the holders of the Notes; provided, however, that no such supplemental indenture shall (i) extend the fixed maturity of any Note, or reduce the rate or extend the time of payment of interest thereon, or reduce the principal amount thereof or premium, if any, thereon, or reduce any amount payable on redemption or repurchase thereof, impair or change in any respect adverse to the Holders of Notes the obligation of the Company to make an offer to repurchase Notes and repurchase Notes in accordance with such offer upon the happening of a Fundamental Change (as defined in the Indenture), or impair or adversely affect the right of any Holder to institute suit for the payment thereof, or make the principal thereof or interest or premium, if any, thereon payable in any coin or currency other than that provided in the Notes, or impair or change in any respect adverse to the Holders of the Notes the right to convert the Notes into Common Stock subject to the terms set forth in the Indenture, including Section 15.11 thereof, or modify the provisions of the Indenture with respect to the subordination of the Notes in a manner adverse to the Holders, without the consent of the holder of each Note so affected or (ii) reduce the aforesaid percentage of Notes, the holders of which are required to consent to any such supplemental indenture, without the consent of the holders of all Notes then outstanding. It is also provided in the Indenture that the holders of a majority in aggregate principal amount of the Notes at the time outstanding may on behalf of the holders of all of the Notes waive any past default or Event of Default under the Indenture and its consequences except a default in the payment of interest or any premium on or the principal of any of the Notes, a default in the payment of Redemption Price pursuant to Article III or Repurchase Price pursuant to Article XVI or a failure by the Company to convert any Notes into Common Stock of the Company. Any such consent or waiver by the holder of this Note (unless revoked as provided in the Indenture) shall be conclusive and binding upon such holder and upon all future holders and owners of this Note and any Notes which may be issued in exchange or substitution hereof, irrespective of whether or not any notation thereof is made upon this Note or such other Notes. The indebtedness evidenced by the Notes is, to the extent and in the manner provided in the Indenture, expressly subordinate and subject in right of payment to the prior payment in full of all Senior Indebtedness of the Company, as defined in the Indenture, whether outstanding at the date of the Indenture or thereafter incurred, and this Note is issued subject to the provisions of the Indenture with respect to such subordination. Each holder of this Note, by accepting the same, agrees to and shall be bound by such provisions and authorizes the Trustee on his behalf to take such action as may be necessary or appropriate to effectuate the subordination so provided and appoints the Trustee his attorney in fact for such purpose. No reference herein to the Indenture and no provision of this Note or of the Indenture shall alter or impair the obligation of the Company, which is absolute and unconditional, to pay the principal of and any premium and interest on this Note at the place, at the respective times, at the rate and in the coin or currency herein prescribed. A-4 87 Interest on the Notes shall be computed on the basis of a 360-day year comprised of twelve 30-day months. The Notes are issuable in registered form without coupons in denominations of $1,000 principal amount and integral multiples thereof. At the office or agency of the Company referred to on the face hereof, and in the manner and subject to the limitations provided in the Indenture, without payment of any service charge but with payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in connection with any registration or exchange of Notes, Notes may be exchanged for a like aggregate principal amount of Notes of other authorized denominations. The Notes will not be redeemable at the option of the Company prior to March 6, 2001. On or after such date and prior to maturity the Notes may be redeemed at the option of the Company as a whole, or from time to time in part, upon mailing a notice of such redemption not less than 20 nor more than 60 days before the Redemption Date to the holders of Notes at their last registered addresses, all as provided in the Indenture, at the following Redemption Prices (expressed as percentages of the principal amount), together in each case with accrued interest to, but excluding, the date fixed for redemption. If redeemed during the 12-month period beginning March 1, 2001 (beginning March 6, 2001 and ending February 28, 2002, in the case of the first such period):
Year Percentage - ---- ---------- 2001 % 2002
and 100% at March 1, 2003; provided that any semi-annual payment of interest becoming due on the Redemption Date shall be payable to the Holders of record on the Regular Record Date of the Notes being redeemed. The Notes are not subject to redemption through the operation of any sinking fund. Upon the occurrence of a Fundamental Change, as defined in the Indenture, prior to March 1, 2003, the Holder has the right, at such holder's option, to require the Company to repurchase this Note or any portion of the principal amount hereof that is an integral multiple of $1,000 on the date (the "Repurchase Date") that is 45 days after the date of the Company Notice (as defined in the Indenture) at a price (the "Repurchase Price") (expressed as a percentage of the principal amount) equal to (i) ___% if the Repurchase Date is during the 12-month period beginning March 1, 1998, (ii) ___% if the Repurchase Date is during the 12-month period beginning March 1, 1999, (iii) ___% if the Repurchase Date is during the 12-month period beginning March 1, 2000 and (iv) thereafter at the redemption price set forth in the preceding paragraph which would be applicable to a redemption at the option of the Company on the Repurchase Date; provided that, if the Applicable Price (as defined in the Indenture) is less than A-5 88 the Reference Market Price (as defined in the Indenture), the Company shall repurchase such Notes at a price equal to the foregoing redemption price multiplied by the fraction obtained by dividing the Applicable Price by the Reference Market Price. In each case, the Company shall also pay accrued interest on the repurchased Notes to, but excluding, the Repurchase Date, provided, however, that if the Repurchase Date is March 1 or September 1, then the interest payable on the Repurchase Date shall be paid to the holder of record of the Note on the immediately preceding Record Date. The Company shall mail to all holders of record of the Notes a notice of the occurrence of a Fundamental Change and of the repurchase right arising as a result thereof on or before 30 calendar days after the occurrence of such Fundamental Change. Subject to the provisions of the Indenture, the holder hereof has the right, at its option, at any time after issuance of the Notes and prior to the close of business on March 1, 2003, or, as to all or any portion hereof called for redemption, prior to the close of business on the Business Day next preceding the date fixed for redemption (unless the Company shall default in payment due upon redemption), to convert the principal hereof or any portion of such principal which is $1,000 or an integral multiple thereof, into that number of fully paid and non-assessable shares of the Company's Common Stock, as said shares shall be constituted at the date of conversion, obtained by dividing the principal amount of this Note or portion thereof to be converted by the conversion price of $ as such conversion price is adjusted from time to time as provided in the Indenture, upon surrender of this Note, together with a conversion notice as provided in the Indenture and this Note, to the Company at the office or agency of the Company maintained for that purpose in the Borough of Manhattan, The City of New York, or at the option of such holder, the Corporate Trust Office of the Trustee, and, unless the shares issuable on conversion are to be issued in the same name as this Note, duly endorsed by, or accompanied by instruments of transfer in form satisfactory to the Company duly executed by, the holder or by his duly authorized attorney. No adjustment in respect of interest or dividends will be made upon any conversion; provided, however, that if this Note shall be surrendered for conversion during the period from the close of business on any Regular Record Date for the payment of interest through the close of business on the Business Day prior to the next succeeding interest payment date, this Note (unless it or the portion thereof being converted shall have been called for redemption pursuant to a notice of redemption mailed to the Holders in accordance with the Indenture) must be accompanied by an amount, in funds acceptable to the Company, equal to the interest otherwise payable on such interest payment date on the principal amount being converted. No fractional shares of Common Stock will be issued upon any conversion, but an adjustment in cash will be paid to the holder, as provided in the Indenture, in respect of any fraction of a share which would otherwise be issuable upon the surrender of any Note or Notes for conversion. Any Notes called for redemption, unless surrendered for conversion on or before the close of business on the last Business Day prior to the Redemption Date, may be deemed to be purchased from the holder of such Notes at an amount equal to the applicable Redemption Price, together with accrued interest to (but excluding) the Redemption Date, by one or more investment bankers or other purchasers who may agree with the Company to purchase such A-6 89 Notes from the holders thereof and convert them into Common Stock of the Company and to make payment for such Notes as aforesaid to the Trustee in trust for such holders. Upon due presentment for registration of transfer of this Note at the office or agency of the Company in the Borough of Manhattan, The City of New York, or at the option of the holder of this Note, at the Corporate Trust Office of the Trustee, a new Note or Notes of authorized denominations for an equal aggregate principal amount will be issued to the transferee in exchange thereof, subject to the limitations provided in the Indenture, without charge except for any tax or other governmental charge imposed in connection therewith. The Company, the Trustee, any authenticating agent, any paying agent, any conversion agent and any Note registrar may deem and treat the registered holder hereof as the absolute owner of this Note (whether or not this Note shall be overdue and notwithstanding any notation of ownership or other writing hereon), for the purpose of receiving payment hereof, or on account hereof, for the conversion hereof and for all other purposes, and neither the Company nor the Trustee nor any other authenticating agent nor any paying agent nor any other conversion agent nor any Note registrar shall be affected by any notice to the contrary. All payments made to or upon the order of such registered holder shall, to the extent of the sum or sums paid, satisfy and discharge liability for monies payable on this Note. No recourse for the payment of the principal of or premium, if any, or interest on this Note, or for any claim based hereon or otherwise in respect hereof, and no recourse under or upon any obligation, covenant or agreement of the Company in the Indenture or any indenture supplemental thereto or in any Note, or because of the creation of any indebtedness represented thereby, shall be had against any incorporator, stockholder, employee, agent, officer, director or Subsidiary, as defined in the Indenture, as such, past, present or future, of the Company or of any successor corporation, either directly or through the Company or any successor corporation, whether by virtue of any constitution, statute or rule of law or by the enforcement of any assessment or penalty or otherwise, all such liability being, by the acceptance hereof and as part of the consideration for the issue hereof, expressly waived and released. Terms used in this Note and defined in the Indenture are used herein as therein defined. A-7 90 ABBREVIATIONS The following abbreviations, when used in the inscription of the face of this Note, shall be construed as though they were written out in full according to applicable laws or regulations: TEN COM - as tenants in common UNIF GIFT MIN ACT - TEN ENT - as tenants by the _________________ Custodian entireties (Cust) JT TEN - as joint tenants with _________________ under right of survivorship (Minor) and not as tenants in common Uniform Gifts to Minors Act_________________ (State) Additional abbreviations may also be used though not in the above list. A-8 91 [FORM OF CONVERSION NOTICE] CONVERSION NOTICE To: HNC SOFTWARE INC. The undersigned registered owner of this Note hereby irrevocably exercises the option to convert this Note, or the portion hereof (which is $1,000 principal amount or an integral multiple thereof) below designated, into shares of Common Stock in accordance with the terms of the Indenture referred to in this Note, and directs that the shares issuable and deliverable upon such conversion, together with any check in payment for fractional shares and any Notes representing any unconverted principal amount hereof, be issued and delivered to the registered holder hereof unless a different name has been indicated below. If shares or any portion of this Note not converted are to be issued in the name of a Person other than the undersigned, the undersigned will pay all transfer taxes payable with respect thereto. Any amount required to be paid to the undersigned on account of interest accompanies this Note. Dated:_________________ ___________________________________ ___________________________________ Signature(s) Signature(s) must be guaranteed by an eligible Guarantor Institution (banks, stock brokers, savings and loan associations and credit unions) with membership in an approved signature guarantee medallion program pursuant to Securities and Exchange Commission Rule 17Ad-15 if shares of Common Stock are to be issued, or Notes are to be delivered, other than to and in the name of the registered holder. ________________________________ Signature Guarantee A-9 92 Fill in for registration of shares if to be issued, and Notes if to be delivered, other than to and in the name of the registered holder: ________________________________ (Name) ________________________________ (Street Address) ________________________________ (City, State and Zip Code) Please print name and address Principal amount to be converted (if less than all): $_____,000 ______________________________________ Social Security or Other Taxpayer Identification Number A-10 93 [FORM OF OPTION TO ELECT REPURCHASE UPON A FUNDAMENTAL CHANGE] To: HNC Software Inc. The undersigned registered owner of this Note hereby acknowledges receipt of a notice from HNC Software Inc. (the "Company") as to the occurrence of a Fundamental Change with respect to the Company and requests and instructs the Company to repay the entire principal amount of this Note, or the portion thereof (which is $1,000 principal amount or an integral multiple thereof) below designated, in accordance with the terms of the Indenture referred to in this Note, together with accrued interest to such date, to the registered holder hereof. Dated:______________________ __________________________________ __________________________________ Signature(s) __________________________________ Social Security or Other Taxpayer Identification Number Principal amount to be repaid (if less than all): $_____,000 NOTICE: The above signatures of the holder(s) hereof must correspond with the name as written upon the face of the Note in every particular without alteration or enlargement or any change whatever. A-11 94 [FORM OF ASSIGNMENT] For value received __________________________ hereby sell(s), assign(s) and transfer(s) unto ________________________________ (Please insert social security or other identifying number of assignee) the within Note, and hereby irrevocably constitutes and appoints___________________________________________ attorney to transfer the said Note on the books of the Company, with full power of substitution in the premises. Dated:_______________________ ______________________________ Signature(s) Signature(s) must be guaranteed by an eligible Guarantor Institution (banks, stock brokers, savings and loan associations and credit unions) with membership in an approved signature guarantee medallion program pursuant to Securities and Exchange Commission Rule 17Ad-15 _______________________________ Signature Guarantee NOTICE: The signature on the conversion notice, the option to elect repurchase upon a Fundamental Change or the assignment must correspond with the name as written upon the face of the Note in every particular without alteration or enlargement or any change whatever. A-12 EX-5.01 5 OPINION OF FENWICK & WEST LLP - NOTE OFFERING 1 EXHIBIT 5.01 February 26, 1998 HNC Software Inc. 5930 Cornerstone Court West San Diego, California 92121 Gentlemen/Ladies: At your request, we have examined the Registration Statement on Form S-3 (File Number 333-46419) (the "Registration Statement") filed by you with the Securities and Exchange Commission (the "Commission") on February 17, 1998 in connection with the registration under the Securities Act of 1933, as amended, of (a) up to $100,000,000 aggregate principal amount of your ___% Convertible Subordinated Notes due 2003 (the "Notes") and (b) the shares of Common Stock, $0.001 par value per share (the "New Shares") issuable upon conversion of the Notes. The Notes are to be issued under an Indenture between you and the First National Bank of Boston as trustee (the "Indenture"). The Notes are to be sold to the underwriters named in the Registration Statement for resale to the public. In rendering this opinion, we have examined the following: (1) your Registration Statement, together with the Exhibits filed as a part thereof; (2) the Prospectuses prepared in connection with the Registration Statement; (3) the Indenture between you and the First National Bank of Boston as trustee; (4) the Opinion Letter of Winthrop, Stimson, Putnam & Roberts dated February 26, 1998; (5) the minutes of the meetings of the Board of Directors held on February 13, 1998 and February 25, 1998; (6) a Management Certificate addressed to us and dated of even date herewith executed by the Company containing certain factual and other representations; (7) a list of the Company's stockholders, dated December 16, 1997, issued by the Company's transfer agent, Boston EquiServe Limited Partnership, and a list of outstanding options, warrants, convertible securities and other rights to purchase the Company's securities; and 2 HNC Software Inc. February 26, 1998 Page 2 (8) your registration statement on Form 8-A (File Number 0-26146) filed with the Commission on May 26, 1995, together with the order of effectiveness issued by the Commission therefor on June 20, 1995. In our examination of documents for purposes of this opinion, we have assumed, and express no opinion as to, the genuineness of all signatures on original documents, the authenticity of all documents submitted to us as originals, the conformity to originals of all documents submitted to us as copies, the legal capacity of all natural persons executing the same, the lack of any undisclosed terminations, modifications, waivers or amendments to any documents reviewed by us and the due execution and delivery of all documents where due execution and delivery are prerequisites to the effectiveness thereof. We have confirmed the continued effectiveness of the Company's registration under the Securities Exchange Act of 1934, as amended, by a telephone call to the offices of the Commission. As to matters of fact relevant to this opinion, we have relied solely upon our examination of the documents referred to above and have assumed the current accuracy and completeness of the information referred to above. We have made no independent investigation or other attempt to verify the accuracy of any of such information or to determine the existence or non-existence of any other factual matters; however, we are not aware of any facts that would lead us to believe that the opinion expressed herein is not accurate. We are admitted to practice law in the State of California. Except for the matters referred to in the last sentence of this paragraph, the opinions expressed herein are limited to the existing laws of the State of California and the Delaware General Corporation Law. In rendering the opinions expressed herein relating to matters governed by the laws of the State of New York, we have relied solely on the opinion of Winthrop, Stimson, Putnam & Roberts described above. Based upon the foregoing, it is our opinion that (a) up to $100,000,000 aggregate principal amount of the Notes that may be issued and sold by you, when issued and sold in the manner referred to in the Registration Statement and the Indenture, will be validly issued, fully paid and nonassessable and will be binding obligations of HNC Software Inc. and (b) the New Shares issued upon conversion of the Notes in the manner referred to in the Registration Statement, the Notes and the Indenture will be validly issued, fully paid and nonassessable. We consent to the use of this opinion as an exhibit to the Registration Statement and further consent to all references to us, if any, in the Registration Statement, the Prospectuses constituting a part thereof and any amendments thereto. 3 HNC Software Inc. February 26, 1998 Page 3 This opinion speaks only as of its date and is intended solely for your use as an exhibit to the Registration Statement for the purpose of the above sale of the Notes and is not to be relied upon for any other purpose. Very truly yours, FENWICK & WEST LLP EX-5.02 6 OPINION OF FENWICK & WEST LLP COMMON STOCK OFFERIN 1 EXHIBIT 5.02 February 26, 1998 HNC Software Inc. 5930 Cornerstone Court West San Diego, California 92121 Gentlemen/Ladies: At your request, we have examined the Registration Statement on Form S-3 (File Number 333-46419) (the "Registration Statement") filed by you with the Securities and Exchange Commission (the "Commission") on February 17, 1998 in connection with the registration under the Securities Act of 1933, as amended, of an aggregate of 2,415,000 shares of your Common Stock (the "Stock"), 2,395,000 of which are presently issued and outstanding and will be sold by certain selling stockholders (the "Selling Stockholders"). In rendering this opinion, we have examined the following: (1) your Registration Statement together with the Exhibits filed as a part thereof; (2) the Prospectuses prepared in connection with the Registration Statement; (3) your registration statement on Form 8-A (File Number 0-26146) filed with the Commission on May 26, 1995, together with the order of effectiveness issued by the Commission therefor on June 20, 1995; (4) the minutes of the meetings of the Board of Directors held on February 13, 1998 and February 25, 1998; (5) a Management Certificate addressed to us and dated of even date herewith executed by the Company containing certain factual and other representations; (6) a list of the Company's stockholders, dated December 16, 1997, issued by the Company's transfer agent, Boston EquiServe Limited Partnership, and a list of outstanding options, warrants, convertible securities and other rights to purchase the Company's securities; and (7) the Custody Agreement, Transmittal Letter and Powers of Attorney signed by the Selling Stockholders in connection with the sale of Stock described in the Registration Statement. 2 HNC Software Inc. February 26, 1998 Page 2 In our examination of documents for purposes of this opinion, we have assumed, and express no opinion as to, the genuineness of all signatures on original documents, the authenticity of all documents submitted to us as originals, the conformity to originals of all documents submitted to us as copies, the legal capacity of all natural persons executing the same, the lack of any undisclosed terminations, modifications, waivers or amendments to any documents reviewed by us and the due execution and delivery of all documents where due execution and delivery are prerequisites to the effectiveness thereof. We have confirmed the continued effectiveness of the Company's registration under the Securities Exchange Act of 1934, as amended, by a telephone call to the offices of the Commission. As to matters of fact relevant to this opinion, we have relied solely upon our examination of the documents referred to above and have assumed the current accuracy and completeness of the information referred to above. We have made no independent investigation or other attempt to verify the accuracy of any of such information or to determine the existence or non-existence of any other factual matters; however, we are not aware of any facts that would lead us to believe that the opinion expressed herein is not accurate. Based upon the foregoing, it is our opinion that the up to 2,395,000 shares of Stock to be sold by the Selling Stockholders pursuant to the Registration Statement are validly issued, fully paid and nonassessable and that the 20,000 shares of Stock to be issued and sold by you, when issued and sold in accordance in the manner referred to in the relevant Prospectus associated with the Registration Statement, will be validly issued, fully paid and nonassessable. We consent to the use of this opinion as an exhibit to the Registration Statement and further consent to all references to us, if any, in the Registration Statement, the Prospectuses constituting a part thereof and any amendments thereto. This opinion speaks only as of its date and is intended solely for your use as an exhibit to the Registration Statement for the purpose of the above sale of the Stock and is not to be relied upon for any other purpose. Very truly yours, FENWICK & WEST LLP EX-23.01 7 CONSENT OF PRICE WATERHOUSE LLP 1 EXHIBIT 23.01 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the use in the Prospectuses constituting part of this Registration Statement on Form S-3 of our report dated January 29, 1998, except as to Note 11 which is as of February 13, 1998, relating to the financial statements of HNC Software Inc., which appears in such Prospectuses. We also consent to the incorporation by reference in the Prospectuses constituting part of this Registration Statement on Form S-3 of our report dated January 29, 1998, except as to Note 11 which is as of February 13, 1998, appearing on page 36 of HNC Software Inc.'s Annual Report on Form 10-K, as amended, for the year ended December 31, 1997. We also consent to the incorporation by reference of our report on the Financial Statement Schedule, which appears on page 62 of such Annual Report on Form 10-K, as amended. We also consent to the references to us under the headings "Experts" and "Selected Consolidated Financial Data" in such Prospectuses. However, it should be noted that Price Waterhouse LLP has not prepared or certified such "Selected Consolidated Financial Data." PRICE WATERHOUSE LLP San Diego, California February 25, 1998 EX-25.01 8 STATEMENT OF ELIGIBILITY OF TRUSTEE 1 EXHIBIT 25.01 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM T-1 --------- STATEMENT OF ELIGIBILITY UNDER THE TRUST INDENTURE ACT OF 1939 OF A CORPORATION DESIGNATED TO ACT AS TRUSTEE Check if an Application to Determine Eligibility of a Trustee Pursuant to Section 305(b)(2) STATE STREET BANK AND TRUST COMPANY OF CALIFORNIA, N.A. (Exact name of trustee as specified in its charter) United States 06-1143380 (Jurisdiction of incorporation or (I.R.S. Employer organization if not a U.S. national bank) Identification No.) 633 West 5th Street, 12th Floor, Los Angeles, California 90071 (Address of principal executive offices) (Zip Code) Lynda A. Vogel, Senior Vice President and Managing Director 633 West 5th Street, 12th Floor, Los Angeles, California 90071 (213) 362-7399 (Name, address and telephone number of agent for service) HNC SOFTWARE, INC. (Exact name of obligor as specified in its charter) Delaware 33-0248788 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5850 Cornerstone Court West San Diego, California 93121 (Address of principal executive offices) (Zip Code) Convertible Subordinated Notes % Convertible Subordinated Notes due 2003 (proposed maximum aggregate offering price of $100,000,000) 2 GENERAL ITEM 1. GENERAL INFORMATION. FURNISH THE FOLLOWING INFORMATION AS TO THE TRUSTEE: (A) NAME AND ADDRESS OF EACH EXAMINING OR SUPERVISORY AUTHORITY TO WHICH IT IS SUBJECT. Comptroller of the Currency, Western District Office, 50 Fremont Street, Suite 3900, San Francisco, California, 94105-2292 (B) WHETHER IT IS AUTHORIZED TO EXERCISE CORPORATE TRUST POWERS. Trustee is authorized to exercise corporate trust powers. ITEM 2. AFFILIATIONS WITH OBLIGOR. IF THE OBLIGOR IS AN AFFILIATE OF THE TRUSTEE, DESCRIBE EACH SUCH AFFILIATION. The obligor is not an affiliate of the trustee or of its parent, State Street Bank and Trust Company. (See note on page 2.) ITEM 3. THROUGH ITEM 15. NOT APPLICABLE. ITEM 16. LIST OF EXHIBITS. LIST BELOW ALL EXHIBITS FILED AS PART OF THIS STATEMENT OF ELIGIBILITY. 1. A COPY OF THE ARTICLES OF ASSOCIATION OF THE TRUSTEE AS NOW IN EFFECT. A copy of the Articles of Association of the trustee, as now in effect, is on file with the Securities and Exchange Commission as Exhibits with corresponding exhibit numbers to the Form T-1of Oasis Residential, Inc., filed pursuant to Section 305(b)(2) of the Act, on November 18, 1996 (Registration No. 033-90488), and are incorporated herein by reference. 2. A COPY OF THE CERTIFICATE OF AUTHORITY OF THE TRUSTEE TO COMMENCE BUSINESS, IF NOT CONTAINED IN THE ARTICLES OF ASSOCIATION. A Certificate of Corporate Existence (with fiduciary powers) from the Comptroller of the Currency, Administrator of National Banks is on file with the Securities and Exchange Commission as Exhibits with corresponding exhibit numbers to the Form T-1 of Oasis Residential, Inc., filed pursuant to Section 305(b)(2) of the Act, on November 18, 1996 (Registration No. 033-90488), and are incorporated herein by reference. 3. A COPY OF THE AUTHORIZATION OF THE TRUSTEE TO EXERCISE CORPORATE TRUST POWERS, IF SUCH AUTHORIZATION IS NOT CONTAINED IN THE DOCUMENTS SPECIFIED IN PARAGRAPH (1) OR (2), ABOVE. Authorization of the Trustee to exercise fiduciary powers (included in Exhibits 1 and 2; no separate instrument). 4. A COPY OF THE EXISTING BY-LAWS OF THE TRUSTEE, OR INSTRUMENTS CORRESPONDING THERETO. A copy of the by-laws of the trustee, as now in effect, is on file with the Securities and Exchange Commission as Exhibits with corresponding exhibit numbers to the Form T-1 of Oasis Residential, Inc., filed pursuant to Section 305(b)(2) of the Act, on November 18, 1996 (Registration No. 033-90488), and are incorporated herein by reference. 1 3 5. A COPY OF EACH INDENTURE REFERRED TO IN ITEM 4. IF THE OBLIGOR IS IN DEFAULT. Not applicable. 6. THE CONSENTS OF UNITED STATES INSTITUTIONAL TRUSTEES REQUIRED BY SECTION 321(B) OF THE ACT. The consent of the trustee required by Section 321(b) of the Act is annexed hereto as Exhibit 6 and made a part hereof. 7. A COPY OF THE LATEST REPORT OF CONDITION OF THE TRUSTEE PUBLISHED PURSUANT TO LAW OR THE REQUIREMENTS OF ITS SUPERVISING OR EXAMINING AUTHORITY. A copy of the latest report of condition of the trustee published pursuant to law or the requirements of its supervising or examining authority is annexed hereto as Exhibit 7 and made a part hereof. NOTES In answering any item of this Statement of Eligibility which relates to matters peculiarly within the knowledge of the obligor or any underwriter for the obligor, the trustee has relied upon information furnished to it by the obligor and the underwriters, and the trustee disclaims responsibility for the accuracy or completeness of such information. The answer furnished to Item 2. of this statement will be amended, if necessary, to reflect any facts which differ from those stated and which would have been required to be stated if known at the date hereof. SIGNATURE Pursuant to the requirements of the Trust Indenture Act of 1939, as amended, the trustee, State Street Bank and Trust Company of California, N.A., organized and existing under the laws of the United States of America, has duly caused this statement of eligibility to be signed on its behalf by the undersigned, thereunto duly authorized, all in the City of Los Angeles, and State of California, on the February 25, 1998. STATE STREET BANK AND TRUST COMPANY OF CALIFORNIA, N.A. By: /s/ JEANIE MAR -------------------------------------- NAME: JEANIE MAR TITLE: ASSISTANT VICE PRESIDENT 4 EXHIBIT 6 CONSENT OF THE TRUSTEE Pursuant to the requirements of Section 321(b) of the Trust Indenture Act of 1939, as amended, in connection with the proposed issuance by HNC Software, Inc. of its % Convertible Subordinated Notes due 2003, we hereby consent that reports of examination by Federal, State, Territorial or District authorities may be furnished by such authorities to the Securities and Exchange Commission upon request therefor. STATE STREET BANK AND TRUST COMPANY OF CALIFORNIA, N.A. By: /s/ JEANIE MAR ----------------------------------- NAME: JEANIE MAR TITLE: ASSISTANT VICE PRESIDENT DATED: February 25, 1998 5 EXHIBIT 7 Consolidated Report of Condition and Income for A Bank With Domestic Offices Only and Total Assess of Less Than $100 Million of State Street Bank and Trust Company of California, a national banking association duly organized and existing under and by virtue of the laws of the United States of America, at the close of business December 31, 1997, published in accordance with a call made by the Federal Deposit Insurance Corporation pursuant to the required law: 12 U.S.C. Section 324 (State member banks); 12 U.S.C. Section 1817 (State nonmember banks); and 12 U.S.C. Section 161 (National banks).
Thousands of Dollars ASSETS Cash and balances due from depository institutions: Noninterest-bearing balances and currency and coin..................... 5,580 Interest-bearing balances ............................................. 0 Securities .................................................................... 38 Federal funds sold and securities purchased under agreements to resell in domestic offices of the bank and its Edge subsidiary ................................... 0 Loans and lease financing receivables: Loans and leases, net of unearned income ........................ 0 Allowance for loan and lease losses ............................. 0 Allocated transfer risk reserve.................................. 0 Loans and leases, net of unearned income and allowances ............... 0 Assets held in trading accounts ............................................... 0 Premises and fixed assets ..................................................... 276 Other real estate owned ....................................................... 0 Investments in unconsolidated subsidiaries .................................... 0 Customers' liability to this bank on acceptances outstanding .................. 0 Intangible assets ............................................................. 0 Other assets................................................................... 726 ----- Total assets .................................................................. 6,620 ===== LIABILITIES Deposits: In domestic offices ................................................... 0 Noninterest-bearing ...................................... 0 Interest-bearing ......................................... 0 In foreign offices and Edge subsidiary ................................ 0 Noninterest-bearing ...................................... 0 Interest-bearing ......................................... 0 Federal funds purchased and securities sold under agreements to repurchase in domestic offices of the bank and of its Edge subsidiary ................................... 0 Demand notes issued to the U.S. Treasury and Trading Liabilities .............. 0 Other borrowed money .......................................................... 0 Subordinated notes and debentures ............................................. 0 Bank's liability on acceptances executed and outstanding ...................... 0 Other liabilities ............................................................. 3,076 Total liabilities ............................................................. 3,076 ===== EQUITY CAPITAL Perpetual preferred stock and related surplus.................................. 0 Common stock .................................................................. 500 Surplus ....................................................................... 750 Undivided profits and capital reserves/Net unrealized holding gains (losses)... 2,294 Cumulative foreign currency translation adjustments ........................... 0 Total equity capital .......................................................... 3,544 ----- Total liabilities and equity capital .......................................... 6,620 =====
4 6 I, Kevin R. Wallace, Vice President and Comptroller of the above named bank do hereby declare that this Report of Condition and Income for this report date have been prepared in conformance with the instructions issued by the appropriate Federal regulatory authority and is true to the best of my knowledge and belief. Kevin R. Wallace We, the undersigned directors, attest to the correctness of this Report of Condition and declare that it has been examined by us and to the best of our knowledge and belief has been prepared in conformance with the instructions issued by the appropriate Federal regulatory authority and is true and correct. Lynda A. Vogel Donald W. Beatty Stephen Rivero 5 -----END PRIVACY-ENHANCED MESSAGE-----