-----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, FhJagkNh9Pp72C2hKNTBBkAmADLG11jYZUlonNKuLCnGVKlT8oZKvlJ64Y8Vl1yX QyrE7xoG5KnOWHXQYQ98jg== 0001095811-01-502305.txt : 20010516 0001095811-01-502305.hdr.sgml : 20010516 ACCESSION NUMBER: 0001095811-01-502305 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HNC SOFTWARE INC/DE CENTRAL INDEX KEY: 0000945093 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 330248788 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-26146 FILM NUMBER: 1637917 BUSINESS ADDRESS: STREET 1: 5935 CORNERSTONE CT W CITY: SAN DIEGO STATE: CA ZIP: 92121-3728 BUSINESS PHONE: 8585468877 MAIL ADDRESS: STREET 1: 5935 CORNERSTONE CT WEST CITY: SAN DIEGO STATE: CA ZIP: 92121-3728 10-Q 1 a72721e10-q.txt FORM 10-Q PERIOD ENDED MARCH 31, 2001 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO . COMMISSION FILE NUMBER 0-26146 - -------------------------------------------------------------------------------- HNC SOFTWARE INC. (Exact name of registrant as specified in its charter) - -------------------------------------------------------------------------------- DELAWARE 33-0248788 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5935 CORNERSTONE COURT WEST SAN DIEGO, CA 92121 (Address of principal executive offices, including zip code) (858) 546-8877 (Registrant's telephone number, including area code) ---------------- INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS: YES [X] NO [ ] AS OF APRIL 30, 2001 THERE WERE 34,648,997 SHARES OF REGISTRANT'S COMMON STOCK, $0.001 PAR VALUE, OUTSTANDING. ================================================================================ 1 2 TABLE OF CONTENTS
PAGE ---- PART I. FINANCIAL INFORMATION ITEM 1: FINANCIAL STATEMENTS Consolidated Balance Sheet as of March 31, 2001 (unaudited) and December 31, 2000. 3 Consolidated Statement of Operations (unaudited) for the quarters ended March 31, 2001 and 2000...................... 4 Consolidated Statement of Cash Flows (unaudited) for the quarters ended March 31, 2001 and 2000...................... 5 Consolidated Statement of Changes in Stockholders' Equity and Comprehensive Income (Loss) for the quarter ended March 31, 2001 (unaudited)............................................ 6 Notes to Consolidated Financial Statements (unaudited)........ 7 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION..................................... 11 ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........................................................ 25 PART II. OTHER INFORMATION ITEM 1: LEGAL PROCEEDINGS............................................. 25 ITEM 6: EXHIBITS AND REPORTS FILED ON FORM 8-K........................ 26 Signatures................................................................ 27
2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS HNC SOFTWARE INC. CONSOLIDATED BALANCE SHEET (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
MARCH 31, DECEMBER 31, 2001 2000 --------- ------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents $ 46,858 $ 69,271 Marketable securities available for sale - debt 42,148 44,779 Marketable securities available for sale - equity 42 250 Trade accounts receivable, net 42,220 43,856 Current portion of deferred income taxes 18,399 15,045 Other current assets 6,784 8,402 --------- --------- Total current assets 156,451 181,603 Marketable securities available for sale - debt 73,762 48,453 Equity investments 14,719 14,719 Property and equipment, net 21,926 20,826 Goodwill, net 87,685 96,810 Intangible assets, net 42,949 47,522 Deferred income taxes, less current portion 26,234 33,844 Other assets 2,683 3,964 --------- --------- $ 426,409 $ 447,741 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Contingencies (Note 7) Current liabilities: Accounts payable and accrued liabilities $ 19,908 $ 38,675 Deferred revenue 8,613 9,876 --------- --------- Total current liabilities 28,521 48,551 Non-current liabilities 294 259 Convertible Subordinated Notes -- 16,357 --------- --------- Total liabilities 28,815 65,167 --------- --------- Stockholders' equity: Preferred stock, $0.001 par value -- 4,000 shares authorized; no shares issued or outstanding -- -- Common stock, $0.001 par value -- 120,000 shares authorized; 34,590 and 32,286 shares issued and outstanding, respectively 35 32 Common stock in treasury, at cost -- 49 and 49 shares, respectively (3,251) (3,251) Paid-in capital 526,787 499,705 Accumulated deficit (120,147) (104,209) Notes receivable from stockholders (5,166) (9,049) Unearned stock-based compensation (496) (577) Accumulated other comprehensive loss (168) (77) --------- --------- Total stockholders' equity 397,594 382,574 --------- --------- $ 426,409 $ 447,741 ========= ========= See accompanying notes to consolidated financial statements.
3 4 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
QUARTER ENDED MARCH 31, 2001 2000 -------- -------- Revenues: License and maintenance $ 39,455 $ 31,791 Services and other 14,515 22,773 -------- -------- Total revenues 53,970 54,564 -------- -------- Operating expenses: License and maintenance (including stock-based compensation expense of $7 and $126 in 2001 and 2000, respectively) 11,458 12,746 Services and other (including stock-based compensation expense of $394 in 2000) 10,286 15,442 Research and development (including stock-based compensation expense of $36 and $1,205 in 2001 and 2000, respectively) 10,874 17,427 Sales and marketing (including stock-based compensation expense of $15 and $581 in 2001 and 2000, respectively) 10,621 17,159 General and administrative (including stock-based compensation expense of $128 in 2001 and stock-based compensation income of $389 in 2000) 7,227 7,395 Transaction-related amortization and costs 13,690 3,965 In-process research and development -- 1,422 -------- -------- Total operating expenses 64,156 75,556 -------- -------- Operating loss (10,186) (20,992) Interest income 2,635 3,455 Interest expense (144) (1,193) Other expense, net (20) (263) Minority interest in losses of consolidated subsidiaries -- 2,391 -------- -------- Loss before income tax provision (benefit) (7,715) (16,602) Income tax provision (benefit) 8,223 (4,387) -------- -------- Net loss $(15,938) $(12,215) ======== ======== Earnings per share: Basic and diluted net loss per common share $ (0.48) $ (0.47) ======== ======== Shares used in computing basic and diluted net loss per common share 33,084 26,120 ======== ======== See accompanying notes to consolidated financial statements.
4 5 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED AND IN THOUSANDS)
QUARTER ENDED MARCH 31, ------------------------- 2001 2000 --------- --------- Cash flows from operating activities: Net loss $ (15,938) $ (12,215) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Provision for doubtful accounts 1,214 722 Depreciation and amortization 16,146 5,656 Acquired in-process research and development -- 1,422 Non-cash stock-based compensation expense 186 1,917 Deferred income tax expense (benefit) 8,135 (4,387) Minority interest in losses of consolidated subsidiary -- (2,391) Changes in assets and liabilities: Trade accounts receivable 422 386 Other assets 1,553 (2,228) Accounts payable and accrued liabilities (11,861) 5,794 Deferred revenue (1,263) 10,332 --------- --------- Net cash provided by (used in) operating activities (1,406) 5,008 --------- --------- Cash flows from investing activities: Net purchases of marketable securities (22,412) (32,125) Cash paid for equity investments -- (1,500) Acquisitions of property and equipment (2,607) (7,134) Cash acquired in business acquisitions, net of cash paid -- 2,263 --------- --------- Net cash used in investing activities (25,019) (38,496) --------- --------- Cash flows from financing activities: Net proceeds from issuances of HNC common stock 6,947 20,349 Costs incurred related to issuance of Retek common stock -- (243) Payment of Retek spin-off costs (6,863) -- Proceeds from sales of receivables -- 5,618 Proceeds from repayments of stockholder notes 4,008 -- --------- --------- Net cash provided by financing activities 4,092 25,724 --------- --------- Effect of exchange rate changes on cash (80) (187) --------- --------- Net decrease in cash and cash equivalents (22,413) (7,951) Cash and cash equivalents at beginning of the period 69,271 136,340 --------- --------- Cash and cash equivalents at end of the period $ 46,858 $ 128,389 ========= ========= See accompanying notes to consolidated financial statements.
5 6 HNC SOFTWARE INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED AND IN THOUSANDS)
COMMON STOCK TREASURY STOCK ----------------------- ---------------------- PAID-IN ACCUMULATED SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT --------- --------- --------- --------- --------- ----------- BALANCE AT DECEMBER 31,2000 ................... 32,286 $ 32 49 $ (3,251) $ 499,705 $(104,209) Common stock options exercised ................ 433 1 -- -- 5,203 -- Common stock issued under Employee Stock Purchase Plan ......................... 231 -- -- -- 1,743 -- Interest accrued on stockholder notes ......... -- -- -- -- -- -- Repayment of stockholder notes ................ -- -- -- -- -- -- Tax benefit from stock option transactions .... -- -- -- -- 3,871 -- Stock-based compensation expense .............. -- -- -- -- 105 -- Common stock issued upon conversion of Subordinated Notes .......................... 1,639 2 -- -- 16,160 -- Unrealized loss on marketable securities, net of tax .................................. -- -- -- -- -- -- Foreign currency translation adjustment, net of tax .................................. -- -- -- -- -- -- Net loss ...................................... -- -- -- -- -- (15,938) --------- --------- --------- --------- --------- --------- BALANCE AT MARCH 31, 2001 ..................... 34,590 $ 35 49 $ (3,251) $ 526,787 $(120,147) ========= ========= ========= ========= ========= =========
ACCUMULATED STOCKHOLDER UNEARNED OTHER TOTAL NOTES STOCK-BASED COMPREHENSIVE STOCKHOLDERS' COMPREHENSIVE RECEIVABLE COMPENSATION LOSS EQUITY INCOME (LOSS) ----------- ------------ ------------- ------------- ------------- BALANCE AT DECEMBER 31,2000 ................... $ (9,049) $ (577) $ (77) $ 382,574 Common stock options exercised ................ -- -- -- 5,204 Common stock issued under Employee Stock Purchase Plan ......................... -- -- -- 1,743 Interest accrued on stockholder notes ......... (125) -- -- (125) Repayment of stockholder notes ................ 4,008 -- -- 4,008 Tax benefit from stock option transactions .... -- -- -- 3,871 Stock-based compensation expense .............. -- 81 -- 186 Common stock issued upon conversion of Subordinated Notes .......................... -- -- -- 16,162 Unrealized loss on marketable securities, net of tax .................................. -- -- (11) (11) (11) Foreign currency translation adjustment, net of tax .................................. -- -- (80) (80) (80) Net loss ...................................... -- -- -- (15,938) (15,938) --------- --------- --------- --------- --------- BALANCE AT MARCH 31, 2001 ..................... $ (5,166) $ (496) $ (168) $ 397,594 $ (16,029) ========= ========= ========= ========= ========= See accompanying notes to consolidated financial statements.
6 7 HNC SOFTWARE INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 1--GENERAL HNC Software Inc. We develop, market, and support innovative predictive software solutions for leading service industries. These intelligent decision management solutions employ proprietary neural-network predictive decision engines, profiles, traditional statistical modeling, business models, expert rules and/or context vector technology to convert existing data and business experiences into meaningful recommendations and actions. In this report, HNC Software Inc. is referred to as "we," "our," and "HNC." Our former subsidiary Retek Inc., which we spun-off to our stockholders in September 2000, is referred to as "Retek." Basis of Presentation Our consolidated financial statements include our assets, liabilities, and results of operations, as well as those of our wholly-owned subsidiaries and Retek Inc. ("Retek"), which was a majority-owned subsidiary prior to its spin-off in September 2000. The ownership of other interest holders in Retek was reflected as minority interest. All significant inter-company balances and transactions have been eliminated. We have prepared the accompanying interim consolidated financial statements, without audit, in accordance with the instructions to Form 10-Q. Consequently, we have not necessarily included in this Form 10-Q all information and footnotes required for audited financial statements. In our opinion, the accompanying unaudited interim consolidated financial statements in this Form 10-Q reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of our financial position and results of operations. These consolidated financial statements and notes thereto should be read in conjunction with our audited financial statements and notes thereto presented in our Annual Report on Form 10-K for the fiscal year ended December 31, 2000. The interim financial information contained in this Report is not necessarily indicative of the results to be expected for any other interim period or for any entire fiscal year. The preparation of financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Certain prior period balances have been reclassified to conform to the current presentation. Sales of Receivables From time to time, we enter into agreements to sell an undivided interest in specifically identified trade accounts receivable. We sell these trade accounts receivable to a financial institution for a fee, based principally upon defined short-term market rates. Once sold, these receivables are not included in our trade accounts receivable balance on our consolidated balance sheet. We did not sell any receivables during the quarter ended March 31, 2001. During the quarter ended March 31, 2000, we sold $5,618 of our receivables, representing approximately 8% of our total cash collected from customers' receivables during this period. Expenses related to receivables sold during the quarter ended March 31, 2000 totaled $30 and are included in interest expense in our consolidated statement of operations. New Accounting Pronouncements 7 8 HNC SOFTWARE INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) In September 2000, the Financial Accounting Standards Board issued Statement of Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("FAS 140"), which replaces Statement of Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." FAS 140 revises the standards for accounting and disclosures for securitizations and other transfers of financial assets and collateral. The primary provisions of this statement become effective for us in the second quarter of 2001. We do not expect that this new accounting standard will have a significant impact on our consolidated financial position or results of operations. NOTE 2--CONVERTIBLE SUBORDINATED NOTES In February 2001, we announced the call for redemption of our remaining outstanding convertible subordinated notes on March 6, 2001. In March 2001, all remaining outstanding notes were converted into 1,639 shares of our common stock at a conversion ratio of 100.2004 shares per $1,000 principal amount of convertible notes held. NOTE 3--EARNINGS PER SHARE DATA For the quarters ended March 31, 2001 and 2000, weighted average options to purchase 2,225 and 2,934 shares of common stock, respectively, and Employee Stock Purchase Plan common stock equivalents of 108 and 24 shares of common stock, respectively, were not included in the computation of diluted net loss per common share, as their effect in these periods would have been anti-dilutive. Additionally, the assumed conversion of our convertible subordinated notes outstanding during the quarters ended March 31, 2001 and 2000 into 1,147 and 2,230 shares of common stock, respectively, was excluded from the calculation of diluted net loss per common share during these periods, as the effect of such conversion would have been anti-dilutive. NOTE 4--SEGMENT DATA During the quarters ended March 31, 2001 and 2000, our reportable segments were based upon our method of internal reporting to management, who viewed our business for these periods by functional market. Our operating segments reflected the way management organized and evaluated internal financial information to make operating decisions and assess performance. Excluding Retek, which we spun-off to stockholders effective September 29, 2000, our primary operating segments during these periods included HNC Financial Solutions ("FS"), HNC Insurance Solutions ("IS") and HNC Telecommunications Solutions ("TS"). FS provides transaction-based, real-time fraud detection, authorization and action decisions for applications such as credit card charge authorization and the loan approval decision process. IS provides users with the ability to reduce fraud losses and streamline operations in the containment of the medical costs of workers' compensation and automobile accident insurance claims, workers' compensation loss reserving, workers' compensation fraud, managed care effectiveness and provider effectiveness. TS provides our telecommunications carrier customers with the ability to reduce fraud losses and determine customer profitability. TS is presented below within our "Other" segment category, which also includes activities associated with our Advanced Technology Solutions group, which primarily conducts research and development for the United States government, as well as unallocated corporate expenses. Retek, which we spun-off to stockholders effective September 29, 2000, is also presented separately below. Segment revenue and operating income (loss), which excludes certain non-cash and non-recurring expenditures that we do not allocate between segments, are as follows (unaudited): 8 9 HNC SOFTWARE INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
QUARTER ENDED MARCH 31, ----------------------- 2001 2000 -------- -------- Segment revenue: FS $ 27,302 $ 19,956 IS 18,402 19,422 Other 8,266 1,222 -------- -------- HNC, excluding Retek 53,970 40,600 Retek -- 13,964 -------- -------- Total consolidated revenue $ 53,970 $ 54,564 ======== ========
QUARTER ENDED MARCH 31, ----------------------- 2001 2000 -------- -------- Segment operating income (loss): FS $ 1,724 $ (112) IS 1,718 3,069 Other 248 (1,950) -------- -------- HNC, excluding Retek 3,690 1,007 Retek -- (14,695) -------- -------- Total segment operating income (loss) 3,690 (13,688) Stock-based compensation (186) (1,917) Acquisition-related costs and amortization (13,690) (3,965) In-process research and development -- (1,422) -------- -------- Consolidated operating loss (10,186) (20,992) Interest income 2,635 3,455 Interest expense (144) (1,193) Other expense, net (20) (263) Minority interest in losses of consolidated subsidiary -- 2,391 -------- -------- Loss before income tax provision (benefit) $ (7,715) $(16,602) ======== ========
NOTE 5--ACQUISITIONS AND PRO FORMA RESULTS OF OPERATIONS During the year ended December 31, 2000, HNC acquired the following entities in transactions that were accounted for in accordance with the purchase method of accounting: Onyx Technologies, Inc. ("Onyx"), the Center for Adaptive Systems Applications, Inc. ("CASA"), and Adaptive Systems Applications, Inc. ("AIM") were acquired in the first quarter of 2000; Celerity Technologies, Inc. ("Celerity") was acquired in the second quarter of 2000; and Systems/Link Corporation ("Systems/Link") and CardAlert Services, Inc. ("CardAlert") were acquired in the third quarter of 2000. The following table summarizes the unaudited pro forma results of operations for the quarter ending March 31, 2000, as if the above-referenced acquisitions had occurred on January 1, 2000:
QUARTER ENDED MARCH 31, 2000 (UNAUDITED) ------------------------- PRO FORMA HISTORICAL COMBINED ---------- ----------- Total revenues $ 54,564 $ 61,227 Net loss (12,215) (23,245) Basic and diluted net loss per share $ (0.47) $ (0.84)
9 10 HNC SOFTWARE INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 6--STOCK-BASED COMPENSATION Stock-based compensation expense recorded during the quarter ended March 31, 2001 totaled $186. This expense included a one-time charge associated with an employee option award modification, along with the amortization of unearned stock-based compensation during the quarter. Net stock-based compensation expense for the quarter ended March 31, 2000 totaled $1,917. This net compensation expense included $2,630 related to Retek's amortization of unearned stock-based compensation, offset by net compensation income related to stock-based awards of $713 at HNC. The net compensation income at HNC related primarily to the reversal of compensation expense recorded in 1999 on variable awards, as a result of a decline in the fair values of these awards during the first quarter of 2000, offset by the amortization of unearned stock-based compensation during the quarter. NOTE 7--CONTINGENCIES Various claims arising in the course of business, seeking monetary damages and other relief, are pending. We believe that these claims will not result in a material negative impact on our results of operations, liquidity or financial condition. However, the amount of the liability associated with these claims, if any, cannot be determined with certainty. We recently settled a suit that Nestor Inc. filed against us in November 1998 in the United States District Court for the District of Rhode Island. In this suit, Nestor had alleged antitrust violations and unfair competition claims with respect to our marketing of our Falcon credit card fraud detection product. Nestor's complaint also alleged that we infringed United States patents held by Nestor and sought a declaratory judgment that a United States patent we hold relating to technology used in our Falcon products is invalid and unenforceable. In January 2000 Nestor dropped its claim of patent infringement against us and in January 2001 the case settled and Nestor's remaining claims for antitrust and unfair competition were dismissed. NOTE 8 -- SUBSEQUENT EVENTS In April 2001, we acquired ClaimPort, Inc. ("ClaimPort") in exchange for approximately $3,200 in cash, including approximately $600 that we paid to reduce certain indebtedness and other liabilities of ClaimPort on the acquisition date. ClaimPort is a national electronic data interchange vendor providing Web-enabled workers' compensation injury reporting and proof of coverage services for insurance carriers, third party administrators, self-insured employers and state agencies that support claims processing for workers' compensation. This acquisition will be accounted for using the purchase method of accounting in the second quarter of 2001. 10 11 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Statements in the following section contain forward-looking information about our anticipated future operating expenses and our future capital requirements. Forward-looking statements are subject to risks and uncertainties. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various risk factors, including those appearing later in this report under the caption "Risk Factors." Investors are cautioned not to place undue reliance on these forward-looking statements that speak only as of the date of this report. We undertake no obligation to revise or update any forward-looking statements for any reason. This Report should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 31, 2000. OVERVIEW We provide customer insight through Intelligent Response, Decision Management and Customer Analytics software that enables companies in the financial, insurance, telecommunications and e-commerce industries to acquire, manage and retain customers. Our technology helps businesses make the right decisions about their customers in real time. It can improve a business' speed and accuracy in differentiating between customer value and risk; determining what customers want without invading their privacy; delivering personalized service and managing customers more profitably; and developing customer loyalty. Excluding Retek, which we spun-off to our stockholders on September 29, 2000, our core business segments that were in place through March 31, 2001 included HNC Financial Solutions ("FS"), HNC Insurance Solutions ("IS") and HNC Telecommunications Solutions ("TS"). Each of our segments sells products that incorporate our Intelligent Response, Decision Management and Customer Analytics solutions. FS provides a suite of products that addresses the customer-lifecycle management needs of banks and other financial institutions, providing transaction-based, real-time fraud detection, authorization and action decisions for applications such as credit card charge authorization and the loan approval decision process. IS provides a suite of product solutions for the insurance industry that are designed to add value to its customers' businesses through cost reduction and improved management of risks, providing users with the ability to reduce fraud losses and streamline operations in the containment of the medical costs of workers' compensation and automobile accident insurance claims, workers' compensation loss reserving, workers' compensation fraud, managed care effectiveness and provider effectiveness. TS provides a suite of product solutions designed to help telecommunications carriers acquire more customers, enhance relationships with existing customers and retain customers for longer periods, including solutions to reduce fraud losses and determine customer profitability. Our revenues and operating results have varied significantly in the past and in some quarters we have experienced net losses. We expect fluctuations in our operating results to continue for the foreseeable future. As a result, we believe that investors should not rely on period-to-period comparisons of our financial results as an indication of our future performance. Because our expense levels are based in part on our expectations regarding future revenues and in the short term are fixed to a large extent, we may be unable to adjust our spending in time to compensate for any unexpected revenue shortfall. We may not be able to maintain profitability on a quarterly or annual basis in the future. In addition, in the past we have acquired several companies and may continue to do so in the future. Further, in September 2000, we completed the spin-off of our former Retek subsidiary. Such transactions typically affect the comparability of our historical financial results. Acquisitions also typically generate significant continuing charges that decrease our net income, often for many fiscal periods. It is possible that in some future quarter our operating results will be below the expectations of public market analysts and investors. In that event, the price of our common stock would likely be harmed. 11 12 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) RESULTS OF OPERATIONS REVENUES Our revenues are comprised of license and maintenance revenues and services and other revenues. Our revenues for the first quarter of 2001, which excluded Retek, were $54.0 million. Revenues for the first quarter of 2000, which included Retek, were $54.6 million. LICENSE AND MAINTENANCE REVENUES We recognize license and maintenance revenues in several different ways, depending on the terms on which the software and maintenance are provided. Revenue from perpetual and short-term periodic licenses of our software is generally recognized upon delivery. Transactional fees under software license arrangements are recognized as revenue based on system usage or when fees based on system usage exceed the monthly minimum license fees. Software maintenance fees are recognized as revenue ratably over the maintenance periods. Transactional fees under network service or internal hosted software arrangements are recognized as revenue based on system usage or when fees based on system usage exceed the monthly minimum license fees. Amounts received under contracts in advance of delivery or performance are recorded as deferred revenue and are generally recognized within one year from receipt. License and maintenance revenues were $39.5 million for the first quarter of 2001, an increase of 24.1% over $31.8 million for the first quarter of 2000. Excluding Retek, whose license and maintenance revenues in the first quarter of 2000 totaled $6.4 million, HNC's license and maintenance revenues for the first quarter of 2001 increased by $14.1 million, or 55.6%, over the first quarter of 2000. Within HNC, the $14.1 million increase in license and maintenance revenues was attributable to a $7.8 million increase at our FS segment and a $6.8 million increase at our combined TS and other segments, partially offset by a $0.5 million decline at our IS segment. The increase at our FS segment was attributable primarily to increased revenues associated with our Falcon and ProfitMax products, along with the addition of network revenues resulting from our acquisition of CardAlert. The increase at our combined TS and other segments was attributable primarily to growth in the TS license and maintenance business through the acquisitions of Onyx and Systems/Link, resulting in increased revenues derived primarily through the sale of our 4SCORE and RoamEx products. The decrease at our IS segment was attributable primarily to a decline in CompAdvisor product revenues, due principally to a decline in bill review volumes, partially offset by increased decision management product revenues resulting from our acquisition of Celerity. SERVICES AND OTHER REVENUES Services and other revenues are comprised of installation and implementation revenues, remote hosted service operation revenues and revenues which are derived from consulting contracts, new product development contracts with commercial customers and, to a lesser extent, research and development contracts with the United States Government. Revenue from software installation and implementation and from contract services is generally recognized as the services are performed using the percentage of completion method based on costs incurred to date compared to total estimated costs at completion. Amounts received under contracts in advance of performance are recorded as deferred revenue and are recognized as services are performed, which is generally within one year from receipt. Contract losses are recorded as a charge to operations in the period any losses are first identified. Installation or setup fees associated with network service and internally hosted software agreements are recognized ratably over the longer of the customer contract period or estimated life of the customer relationship. Remote hosted service fees derived from the review and repricing of customers' medical bills are recognized as revenue when the processing services are performed. 12 13 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) Services and other revenues were $14.5 million for the first quarter of 2001, a decrease of 36.3% as compared to $22.8 million for the first quarter of 2000. Excluding Retek, whose services and other revenues in the first quarter of 2000 totaled $7.5 million, HNC's services and other revenues for the first quarter of 2001 decreased by $0.7 million, or 4.8%, as compared to the first quarter of 2000. Within HNC, the $0.7 million decrease in services and other revenues was attributable primarily to a $0.5 million decline at our FS segment and a $0.4 million decline at our IS segment, partially offset partially by a $0.2 million increase at our combined TS and other segments. The decline at our FS segment was attributable primarily to decreased revenues associated with Capstone implementations, partially offset by an increase in Marketing Optimization revenues. The decline at our IS segment is attributable primarily to a decline in customer bill volumes associated with our remote hosted service operations. GROSS MARGIN LICENSE AND MAINTENANCE GROSS MARGIN License and maintenance costs primarily represent our expenses for personnel engaged in customer support, travel to customer sites and documentation materials. Our license and maintenance gross margins are summarized as follows:
QUARTER ENDED MARCH 31, --------------------------------------------------- 2001 2000 ----------------------- -------------------- (IN THOUSANDS) LICENSE AND MAINTENANCE GROSS MARGINS HNC operating segments ......................... $ 28,004 71.0% $ 16,731 66.0% Retek operating segment ........................ -- -- 2,441 38.0% -------- ------- -------- ---- 28,004 71.0% 19,172 60.3% Stock-based compensation expense not allocated to segments ................... (7) (0.0%) (126) (0.4%) -------- ------- -------- ---- HNC Consolidated ......................... $ 27,997 71.0% $ 19,045 59.9% ======== ======= ======== ====
Our license and maintenance gross margin percentage in the first quarter of 2001 increased by 11.1% over the first quarter of 2000. This increase was attributable primarily to a 5.0% margin increase within HNC, coupled with the absence of Retek in the first quarter of 2001, whose license and maintenance margins were 38.0% in the first quarter of 2000. The improvement in HNC's license and maintenance gross margin percentage was attributable primarily to a 4.7% margin increase at our FS segment and a 24.0% margin increase at our combined TS and other segments, partially offset by a 9.4% margin decline at our IS segment. The margin increase at our FS segment was attributable primarily to the increase in higher-margin Falcon and ProfitMax revenues. The margin increase at our combined TS and other segments was attributable primarily to the increase of higher-margin TS product revenues in the first quarter of 2001, primarily resulting from growth in the TS license and maintenance business through acquisitions. The margin decline at our IS segment was attributable primarily to increased customer support costs associated with decision management products, partially offset by the addition of higher-margin decision management product revenues resulting from our acquisition of Celerity. SERVICES AND OTHER GROSS MARGIN Services and other expenses consist of personnel and other expenses associated with providing installation and implementation services and performing development, consulting, and research development contracts, and the costs associated with hosted service operations. Our services and other gross margins are summarized as follows:
QUARTER ENDED MARCH 31, --------------------------------------------------- 2001 2000 ----------------------- -------------------- (IN THOUSANDS) SERVICES AND OTHER GROSS MARGINS HNC operating segments ......................... $ 4,229 29.1% $ 5,879 38.6% Retek operating segment ........................ -- -- 1,846 24.5% 4,229 29.1% 7,725 33.9% Stock-based compensation expense not allocated to segments ................... -- -- (394) (1.7%) -------- ------- -------- ---- HNC Consolidated ......................... $ 4,229 29.1% $ 7,331 32.2% ======== ======= ======== ====
13 14 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) Our services and other gross margin percentage in the first quarter of 2001 decreased by 3.1% compared to the first quarter of 2000. This decline was attributable primarily to a 9.5% margin decline within HNC, offset by the absence of Retek in the first quarter of 2001, whose services and other margins were 24.5% in the first quarter of 2000. The decline in HNC's services and other gross margin percentage was attributable primarily to an 11.5% margin decline at our FS segment and a 6.4% margin decline at our IS segment. The margin decline at our FS segment was attributable primarily to the decline in higher-margin Capstone implementation revenues, partially offset by an increase in higher-margin Marketing Optimization revenues. The margin decline at our IS segment was attributable primarily to lower margins associated with contract development work performed during the first quarter of 2001. RESEARCH AND DEVELOPMENT EXPENSE Research and development expenses consist primarily of salaries and other personnel-related expenses, subcontracted development services, depreciation for development equipment and supplies. Research and development expense totaled $10.9 million in the first quarter of 2001 and $17.4 million in the first quarter of 2000. Excluding Retek, whose research and development expense totaled $9.3 million in the first quarter of 2000 (including $1.3 million in stock-based compensation charges), HNC's research and development expense increased by $2.7 million, or 33.8%, from $8.1 million in the first quarter of 2000 to $10.9 million in the first quarter of 2001. This increase was attributable primarily to a $3.2 million increase at our FS segment and a $0.6 million increase at our combined TS and other segments, partially offset by a decline of $1.1 million at our IS segment. The absolute dollar increase within HNC was attributable primarily to increases in staffing and related costs to support new product development activities, including those resulting from acquisitions in 2000, partially offset in part by a reduction in research and development personnel and third-party development costs associated with IS research and development projects. We anticipate that research and development expenses will increase in dollar amount and could increase as a percentage of total revenues for the foreseeable future. SALES AND MARKETING EXPENSE Sales and marketing expenses consist primarily of salaries and benefits, commissions, travel, entertainment, trade shows and promotional expenses. Sales and marketing expense totaled $10.6 million in the first quarter of 2001 and $17.2 million in the first quarter of 2000. Excluding Retek, whose sales and marketing expense totaled $9.2 million in the first quarter of 2000 (including $0.6 million in stock-based compensation charges), HNC's sales and marketing expense increased by $2.7 million, or 34.2%, from $7.9 million in the first quarter of 2000 to $10.6 million in the first quarter of 2001. This increase was attributable primarily to a $0.9 million increase at our FS segment and a $1.8 million increase at our combined TS and other segments, while research and development expenditures within our IS segment remained relatively flat quarter over quarter. The absolute dollar increase within HNC was attributable primarily to increases in staffing related to the expansion of direct sales and marketing staff, including that resulting from our acquisitions in 2000. Also contributing to the increase were additional expenses associated with advertising and trade shows and other expenses to support our acquired businesses. We expect sales and marketing expenses to continue to increase in absolute dollars for the foreseeable future. These expenses could also increase as a percentage of total revenues as we continue to develop a direct sales force in international markets and expand our domestic sales and marketing organization and increase the breadth of our product lines. GENERAL AND ADMINISTRATIVE EXPENSE General and administrative expenses consist primarily of personnel costs for finance, contract administration, human resources and general management, as well as insurance and professional services expenses. General and administrative expenses totaled $7.2 million in the first quarter of 2001 and $7.4 million in the first quarter of 2000. Excluding Retek, whose general and administrative expense totaled $2.6 million in the first quarter of 2000 (including $0.2 million in stock-based compensation charges), HNC's general and administrative expense increased by $2.4 million, or 49.2%, from $4.8 million in the first quarter of 2000 to $7.2 million in the first quarter of 2001. This increase was attributable primarily to a $0.6 million increase at our FS segment, a $0.5 million increase at our IS segment and a $0.6 million increase at our combined TS and other segments. Also contributing to the increase within HNC was $0.8 million in additional HNC net stock-based compensation charges as compared to the first quarter of 2000 (for a further discussion regarding stock-based compensation charges, refer to the section entitled "Stock-Based Compensation Expense" appearing later in this Report). Excluding stock-based compensation charges, the absolute dollar increase at HNC are 14 15 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) attributable primarily to additional staffing and related expenses to support a higher volume of business, including that resulting from our acquisitions in 2000. TRANSACTION-RELATED AMORTIZATION AND COSTS Transaction-related amortization and costs primarily include acquisition-related amortization during the first quarters of 2001 and 2000. Transaction-related amortization and costs increased from $4.0 million in the first quarter of 2000 to $13.7 million in the first quarter of 2001. This increase is attributable primarily to incremental intangible asset amortization charges as a result of our business acquisitions during 2000. The average amortization period and useful life for these intangible assets is approximately 3.5 years. IN-PROCESS RESEARCH AND DEVELOPMENT EXPENSE In-process research and development expense was $1.4 million in the first quarter of 2000, related to a one-time charge recorded in connection with our acquisition of CASA. No such charges were recorded during the first quarter of 2001, as we did not consummate any acquisitions in this quarter. INTEREST INCOME Interest income totaled $2.6 million in the first quarter of 2001 and $3.5 million in the first quarter of 2000. The quarter over quarter decline in interest income is attributable primarily to lower average cash and investment balances during the first quarter of 2001 as compared to the first quarter of 2000. INTEREST EXPENSE Interest expense totaled $0.1 million in the first quarter of 2001 and $1.2 million in the first quarter of 2000. The majority of our interest expense during each of these periods relates to our convertible subordinated notes. The decline in interest expense in the first quarter of 2001 as compared to the first quarter of 2000 is attributable primarily to the conversion of $83.6 million of our convertible subordinated notes into common stock during the third quarter of 2000, and to a lesser degree the conversion of the remaining $16.4 million of such notes in the first quarter of 2001, whereas the outstanding convertible note balance during the full first quarter of 2000 was $100.0 million. INCOME TAXES The provision (benefit) for income taxes was $8.2 million for the first quarter of 2001 and $(4.4) million for the first quarter of 2000. The provision for the first quarter of 2001, as compared to the benefit for the first quarter of 2000, is attributable primarily to the significant increase in non-deductible acquisition-related amortization expense in the first quarter of 2001, resulting from our acquisitions during 2000. The provision (benefit) for income taxes is based on our estimates of the effective tax rates for the respective full fiscal years. STOCK-BASED COMPENSATION EXPENSE Within our statement of operations, stock-based compensation charges (income) have been classified as follows for the first quarters in 2001 and 2000:
QUARTERS ENDED MARCH 31, -------------------- 2001 2000 ------- ------- (IN THOUSANDS) License and maintenance ....................... $ 7 $ 126 Services and other ............................ -- 394 Research and development ...................... 36 1,205 Sales and marketing ........................... 15 581 General and administrative .................... 128 (389) ------- ------- $ 186 $ 1,917 ======= =======
15 16 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) Stock-based compensation expense recorded during the first quarter of 2001 totaled $186. This expense included a one-time charge associated with an employee option award modification, along with the amortization of unearned stock-based compensation during the quarter. Net stock-based compensation expense for the first quarter in 2000 totaled $1,917. This net compensation expense included $2,630 related to Retek's amortization of unearned stock-based compensation, offset by net compensation income related to stock-based awards of $713 at HNC. The net compensation income at HNC related primarily to the reversal of compensation expense recorded in 1999 on variable awards, as a result of a decline in the fair values of these awards during the first quarter of 2000, offset by the amortization of unearned stock-based compensation during the quarter. LIQUIDITY AND CAPITAL RESOURCES Net cash used in operating activities totaled $1.4 million during the first quarter of 2001, compared to net cash provided by operating activities of $5.0 million during the first quarter of 2000. Cash used in operations during the first quarter of 2001 reflects our net loss of $15.9 million, reduced by non-cash aspects of our net loss totaling $14.5 million. Net cash used in investing activities totaled $25.0 million during the first quarter of 2000, compared to net cash used in investing activities of $38.5 million in the first quarter of 1999. Cash used in investing activities during the first quarter of 2001 consisted of $22.4 million in net purchases of marketable securities and $2.6 used to purchase property and equipment. Net cash provided by financing activities totaled $4.1 million during the first quarter of 2001, compared to net cash provided by financing activities of $25.7 million during the first quarter of 2000. Cash provided by financing activities during the first quarter of 2001 included $11.0 million in proceeds resulting from stock option exercises and employee stock purchase plan stock purchases under HNC plans, inclusive of the repayment of stockholder notes, offset by the payment of $6.9 million in investment banking fees during the first quarter of 2001 related to the Retek spin-off. As of March 31, 2001, we had $162.8 million in cash, cash equivalents and marketable securities. We believe that these balances, including interest to be earned thereon, and borrowings available under our credit facility will be sufficient to fund our working and other capital requirements, including potential investments in other companies and other assets to support the strategic growth of our business, over the next twelve months. In the event additional needs for cash arise, we may raise additional funds from a combination of sources including the potential issuance of debt or equity securities in public markets. Additional financing might not be available on terms favorable to us, or at all, particularly in light of the recent decline in the capital markets. If adequate funds were not available or were not available on acceptable terms, our ability to take advantage of unanticipated opportunities or respond to competitive pressures could be limited. In February 2001, we announced the call for redemption of our remaining outstanding convertible subordinated notes on March 6, 2001. In March 2001, all remaining outstanding notes were converted into 1,639 shares of our common stock. In April 2001, we acquired ClaimPort in exchange for approximately $3.2 million in cash, including approximately $0.6 million that we paid to reduce certain indebtedness and other liabilities of ClaimPort on the acquisition date. NEW ACCOUNTING PRONOUNCEMENTS In September 2000, the Financial Accounting Standards Board issued Statement of Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("FAS 140"), which replaces Statement of Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." FAS 140 revises the standards for accounting and disclosures for securitizations and other transfers of financial assets and collateral. The primary provisions of this statement become effective for us in the second quarter of 2001. We do not expect that this new accounting standard will have a significant impact on our consolidated financial position or results of operations. 16 17 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) RISK FACTORS Fluctuations in our revenues and operating results might lead to reduced prices for our stock. Our revenues and operating results have varied significantly in the past and in some quarters we have experienced net losses. We expect fluctuations in our operating results to continue for the foreseeable future. As a result, we believe that you should not rely on period-to-period comparisons of our financial results as an indication of our future performance. It is possible that in some future periods our operating results may fall below the expectations of market analysts and investors. In this event the market price of our common stock would likely fall. Factors that are likely to cause our revenues and operating results to fluctuate include the following: - changes in the volume of our sales; - a decrease in recurring revenues or the loss of key customers; - the timing or deferral, or the reduction or cancellation, of customer orders or purchases; - the timing of our new product announcements and introductions in comparison to our competitors; - delays in the release of final commercial versions of our products; - changes in the mix of our distribution channels; - the amount and timing of our operating expenses; - our ability to fulfill our obligations under percentage-of-completion contracts; - our success in completing pilot installations within contracted fee budgets; - competitive conditions in the industries we serve; - economic conditions in our targeted markets; - domestic and international economic conditions; - changes in prevailing technologies; - expenses and charges related to our acquisition of other businesses; - increased operating expenses related to the development of new products, including products for the Internet; - our ability to recognize revenues in accordance with generally accepted accounting principles in the quarter in which we expect to recognize those revenues. The lengthy sales cycle of our products makes it difficult for us to determine when sales will occur, and we may not be able to compensate for unanticipated revenue shortfalls. We cannot predict the timing of the recognition of our revenues accurately because of the length of our sales cycles. As a result, if sales forecasted from specific customers are not realized, we may be unable to compensate for the resulting revenue shortfall and our operating results would be harmed. The sales cycle to license our products can typically range from 60 days to 18 months. Customers are often cautious in making decisions to acquire our products, because purchasing our products typically involves a significant commitment of capital, and may involve shifts by the customer to a new software and/or hardware platform or changes in the customers operational procedures. Delays in completing sales can arise while customers complete their internal procedures to approve large capital expenditures and test and accept our applications. We may incur substantial sales and marketing expenses and expend significant management effort while potential customers are evaluating our products and before 17 18 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) they place an order with us. Consequently, if orders for our products are not received as anticipated, our operating results could be harmed. The challenges associated with effectively integrating acquired businesses could prevent us from realizing the intended benefits of these acquisitions. During 2000, we completed the acquisition of seven businesses (one of which was divested in connection with the spin-off of our former subsidiary Retek), and to date in 2001 we have acquired one additional business. Integrating and organizing the acquired businesses creates challenges for our operational, financial and management information systems and can pose difficulties in maintaining our corporate culture. If we do not adequately address issues presented by growth through acquisitions, we may not fully realize the intended benefits, including any financial benefits, of these acquisitions and may incur increased costs and expenses. We expect to continue to make strategic acquisitions, which could put a strain on our resources, cause dilution to our stockholders and adversely affect our financial results. We believe that our future growth may depend, in part, upon our ability to successfully complete future acquisitions of businesses and technologies. Integrating newly acquired organizations and technologies into our business could put a strain on our resources and be expensive and time consuming. In addition, we may not succeed in integrating acquired businesses or technologies and may not achieve anticipated revenue and cost benefits. Further, our acquisition strategy and future acquisitions could result in any of the following risks: - increased competition for acquisition opportunities could inhibit our growth and our ability to complete suitable acquisitions, and could also increase the price we would have to pay to complete acquisitions, which might result in dilution to the equity interests of our stockholders; - if we are unable to complete acquisitions successfully, we might not be able to successfully develop and market products for new industries or for markets with which we may not be familiar; - we might not be able to coordinate the diverse operating structures, policies and practices of companies we acquire or to successfully integrate the employees of the acquired companies into our organization and culture, which could impair employee morale and productivity; - despite due diligence reviews, acquired businesses may bring with them unanticipated liabilities, risks or operating costs that could harm our results of operations or business or require unbudgeted expenses; - if we fail to retain the services of key employees of acquired companies for significant time periods after the acquisition of their companies, we may experience difficulty in managing the acquired company's business and not realize the anticipated benefits of the acquisition; - the accounting treatment of acquisitions can result in significant acquisition-related accounting charges and expenses that can reduce our reported results of operations both at the time of the acquisition and in future periods; and - additional acquisitions may require us to issue shares of our stock and stock options to owners of the acquired businesses, resulting in dilution to our stockholders. If we fail to effectively respond to changes in our business then our corporate organization will be disrupted and we will be diverted from our business plan. In recent years, we have experienced changes in our operations that have placed significant demands on our administrative, operational and financial resources. These demands, which are expected to continue to challenge our management and operations, include the following: - growth and diversification of our customer base; - expansion of our product functionality and the number of products we market and support; - expansion of our product lines into new markets, industries and technology mediums; - increase in the number of our employees; and 18 19 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) - geographic dispersion of our operations and personnel. These changes require us to manage an increasing number of relationships with customers and other third parties, as well as a larger workforce. In addition, we will need to adapt our operational and financial control systems, if necessary, to respond to changes in the size and diversification of our business. If we fail to manage changes effectively, our employee-related costs and employee turnover could increase and we could face disruptions that compromise our ability to execute on our business plan. If our software products do not achieve widespread market acceptance, our business reputation and financial performance would suffer. The rate at which businesses have adopted our products has varied significantly by market and by product within each market, and we expect to continue to experience variations to the degree to which our products are accepted in our target markets in the future. In particular, the acceptance of our products may be limited by factors such as: - the failure of prospective customers to perceive value in predictive software solutions; - the reluctance of our prospective customers to replace their existing solutions with our products; and - the emergence of new technologies that could cause our products to be less competitive or obsolete. In addition, because the market for customer insight solutions is still in a relatively early stage of development, we cannot accurately assess the size of the market, and we have limited insight into trends that may emerge and affect our business. For example, we may have difficulty in predicting customer needs and new technologies, developing products that could address those needs and technologies, and establishing a distribution strategy for these products. We may also have difficulties in predicting the competitive environment that will develop. If we fail to keep up with rapidly changing technologies, our products could become less competitive or obsolete. In our markets, technology changes rapidly, and there are continuous improvements in computer hardware, network operating systems, programming tools, programming languages, operating systems, database technology and the use of the Internet. If we fail to enhance our current products and develop new products in response to changes in technology or industry standards, our products could rapidly become less competitive or obsolete. For example, the rapid growth of the Internet environment creates new opportunities, risks and uncertainties for businesses, such as ours, which develop software solutions that must also be designed to operate in Internet, intranet and other online environments. Our future success will depend, in part, upon our ability to: - internally develop new and competitive technologies; - use leading third-party technologies effectively; - continue to develop our technical expertise; - anticipate and effectively respond to changing customer needs; - time new product introductions in a way that minimizes the impact of customers delaying purchases of existing products in anticipation of new product releases; and - Influence and respond to emerging industry standards and other technological changes. Delays in the development of new products or product enhancements could harm our operating results and our competitive position. The development of new, technologically advanced products is a complex and uncertain process that requires innovation, highly skilled personnel and accurate anticipation of technological and market trends. We have previously experienced significant delays in the development and introduction of new products and product enhancements, primarily due to difficulties with model development, which has in the past required multiple iterations, as well as difficulties with acquiring data and adapting to particular operating environments. The length of these delays has varied depending upon the size and scope of the project and the nature of the problems encountered. If we are unable to meet the introduction schedules for our new products or product enhancements, customers may switch their allegiance to 19 20 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) competitive products or refuse to purchase our solutions, which would harm our competitive position and our operating results. We derive a substantial portion of our revenues from our compadvisor and falcon products, and our revenue will decline if the market does not continue to accept these products. We expect these products will continue to account for a substantial portion of our total revenues for the foreseeable future. Our revenue will decline if the market does not continue to accept these products. Factors that might affect the market acceptance of CompAdvisor include the following: - simplification of state workers' compensation fee schedules; - changes in the overall payment system or regulatory structure for workers' compensation claims; - technological change; - our inability to obtain or use state fee schedule or claims data; - saturation of market demand; - loss of key customers; and - industry consolidation. Demand for, or use of, Falcon, could decline as a result of factors that reduce the effectiveness of Falcon's fraud detection capabilities. For example, patterns of credit card fraud might change in a manner that the Falcon product line would not detect. In addition, other methods of credit card fraud prevention such as smart cards may reduce customers' need for the Falcon product line. Because many Falcon customers are banks and related financial institutions, sales of our Falcon products are subject to changes in the financial services industry such as fluctuations in interest rates and the general economic health of financial services companies, which affect their capital expenditure budgets. In addition, the financial services industry tends to be cyclical, which may result in variations in demand for our Falcon products. There is a continuing trend toward consolidation in the financial services industry, which has reduced our customer base and may lead to lost or delayed sales and reduced demand for our Falcon products. Industry consolidation also could affect our base of recurring revenues derived from contracts in which we are paid on a per-transaction basis, when consolidated customers combine their operations under one contract with us which, in some cases, could result in lower payments to us than those previously paid by our customers separately. We depend on data to update our statistical models, and failure to timely obtain this data could harm the performance of our products. The development, installation and support of our credit card fraud control and profitability management, loan underwriting and insurance products require periodic updates of our statistical models. To develop these updates, we must develop or obtain a reliable source of sufficient amounts of current and statistically relevant data to analyze transactions and update our models. In most cases, these data must be periodically updated and refreshed to enable our predictive products to continue to work effectively in a changing environment. We do not own or control much of the data that we require, most of which are collected privately and maintained in proprietary databases. Generally, our customers agree to provide us the data we require to analyze transactions, report results and build new predictive models. If we fail to maintain good relationships with these customers, we could lose access to required data and our products might become less effective. In addition, our CompAdvisor product uses data from state workers' compensation fee schedules adopted by state regulatory agencies. Third parties have previously asserted copyright interests in this data. These assertions, if successful, could prevent us from using the data. We may not be able to continue to obtain adequate amounts of statistically relevant data on time, in the required formats or on reasonable terms and conditions, whether from customers or commercial suppliers. If we are unable to compete effectively with existing or new competitors, our resulting loss of competitive position could result in price reductions for our products, fewer customer orders and loss of market share. The market for predictive software solutions is intensely competitive and is constantly changing. Some of our competitors or potential competitors have substantially greater financial, technical and marketing resources than we do. These competitors may be able to respond more rapidly than we can to new or emerging technologies or changes in customer requirements. They may also 20 21 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) devote greater resources to the development, promotion and sale of their products than we do. In addition, they may have the ability to sell products competitive to ours at lower prices as part of integrated suites of several related products that are vital to the customer's computing infrastructure. This may cause customers to purchase products of our competitors that directly compete with our products in order to acquire other products of the competitor. Our competitors vary in size and in the scope of the products and services they offer. We encounter competition from a number of sources, including: - other application software companies, including enterprise software vendors; - management information systems departments of customers and potential customers, including financial institutions, insurance companies, telecommunications carriers and retailers; - third-party professional services organizations, including consulting divisions of public accounting firms; - Internet companies; - hardware suppliers that bundle or develop complementary software; - network and telecommunications switch manufacturers, and service providers that seek to enhance their value-added services; - neural-network tool suppliers; and - managed care organizations. We expect to experience additional competition from other established and emerging companies, as well as from other technologies. For example, our Falcon and eFalcon products compete against other methods of preventing credit card fraud, such as credit card activation programs, credit cards that contain the cardholder's photograph, smart cards and other card authorization techniques. Increased competition, whether from other products or new technologies, could result in price reductions, fewer customer orders, loss of customers, reduced gross margins and loss of market share, any of which could negatively impact our business. We expect to face increasing pricing pressures from our current competitors and new market entrants. Price reductions could negatively impact our margins and results of operations. Price competition could also harm our ability to obtain new long-term contracts and renewals of existing long-term contracts on favorable terms. Furthermore, a number of our current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of our prospective customers. As a result, new competitors or alliances among competitors may emerge and rapidly gain significant market share. We may not be able to compete effectively against current and potential competitors, especially those with significantly greater resources and market leverage. If we lose key personnel, we might not be able to manage our business successfully. Our future success depends to a significant degree upon the continued service of members of our senior management and other key research, development, sales and marketing personnel. We generally do not have employment agreements with our employees, and the few employment agreements we do have with a small number of our employees may not result in the retention of these employees. As a result, we could experience the untimely loss of a member of the management team on little or no advance notice. We could also lose the services of a key employee of a business we acquire before we have had adequate time to familiarize ourselves with the operating details of that business and obtain a suitably experienced replacement. Our future performance will also depend, in part, upon the ability of our officers to work together effectively. Our management personnel may not be successful in carrying out their duties or running our company. Any dissent among members of management could impair our ability to make strategic decisions quickly in a rapidly changing market. If we do not recruit and retain qualified personnel, our ability to execute our business plan would be compromised. Our future success depends upon our ability to attract, retain and motivate highly skilled employees. Competition for 21 22 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) employees in our industry is intense. We have historically experienced difficulty in recruiting a sufficient number of qualified sales and technical employees. In addition, competitors and other businesses may be successful in attempts to recruit our key employees, particularly if they can offer more attractive stock options or other equity compensation packages. Many of our technical employees possess unique skills and are not easily replaceable, and loss of technical personnel could harm our product development efforts. We expect to continue to experience difficulty in hiring and retaining highly skilled employees with appropriate qualifications. Our future results could be harmed by economic, political, regulatory and other risks associated with international sales. We intend to continue to expand our operations outside the United States and to enter additional international markets, which will require significant management attention and financial resources. For more mature products, like Falcon, we may need to increase our international sales in order to continue to expand our customer base. We have committed and continue to commit significant time and development resources to customizing and adapting our products for selected international markets, and to developing international sales and support channels. These international marketing efforts require us to incur increased sales, marketing, development and support expenses. If our efforts do not generate additional international sales on a timely basis, our margins and earnings would be harmed. To the extent that our revenues from international operations represent an increasing portion of our total revenues, we will be subject to increased exposure to international risks. As a result, our future results could be affected by a variety of factors, including: - changes in foreign currency exchange rates; - changes in the political or economic conditions of a country or region, particularly in emerging markets; - trade protection measures, such as tariffs, EEU software directives and import or export licensing requirements; - potentially negative consequences from changes in tax laws; - potentially reduced protection for intellectual property rights; - difficulty in managing widespread sales operations; and - slower payment cycles from international customers. If our products do not comply with government regulations that apply to us or to our customers, we could be exposed to liability or our products could become obsolete. Many of our customers must comply with a number of government regulations and other industry standards, and as a result, many of our key products must also be compliant. For example, our financial services products are affected by the Fair Credit Reporting Act, by Regulation B under the Equal Credit Opportunity Act, by regulations governing the extension of credit to consumers and by Regulation E under the Electronic Fund Transfers Act, as well as non-governmental VISA and MasterCard electronic payment standards. Fannie Mae and Freddie Mac regulations, among others, for conforming loans, affect our mortgage services products. Insurance-related regulations may in the future apply to our insurance products. If our products fail to comply with existing or future regulations and standards, our customers or we could be subject to legal action by regulatory authorities or by third parties, including actions seeking civil or criminal penalties, injunctions against our use of data or preventing use of our products or civil damages. In addition, we may also be liable to our customers for failure of our products to comply with regulatory requirements. If state-mandated workers' compensation laws or regulations or state workers' compensation fee schedules are simplified, these changes would diminish the need for, and the benefit provided by, CompAdvisor. In many states, including California, there have been periodic legislative efforts to reform workers' compensation laws in order to reduce the cost of workers' compensation insurance and to curb abuses of the workers' compensation system. Changes in workers compensation laws or regulations could adversely affect our insurance products by making them obsolete, or by requiring extensive changes in these products to reflect new workers' compensation rules. To the extent that we sell new products targeted to markets that include regulated industries and businesses, our products will need to comply with these additional regulations. If we fail to protect and preserve our intellectual property we could lose an important competitive advantage. Our success and ability to compete substantially depend upon our internally developed proprietary technologies, which we protect through a combination of patent, copyright, trademark and trade secret laws and confidentiality procedures. We also seek to protect our software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. Despite the measures we take to protect our intellectual property, it may be possible for a third 22 23 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) party to copy or otherwise to obtain and use our products or technology without authorization, or to develop similar technology independently. In addition, patents may not be issued with respect to our pending or future patent applications, and our patents may not be upheld as valid or may not prevent the development of competitive products. To ensure that customers will not be harmed by an interruption in our business, we often place software source code for our products into escrow, which may increase the likelihood of misappropriation or other misuse of our intellectual property. Any disclosure, loss, invalidity of, or failure to protect, our intellectual property could negatively impact our competitive position, and ultimately, our business. We have developed technologies under research projects conducted under agreements with various United States Government agencies or subcontractors. Although we have acquired commercial rights to these technologies, the United States Government typically retains ownership of intellectual property rights and licenses in the technologies developed by us under these contracts, and in some cases can terminate our rights in these technologies if we fail to commercialize them on a timely basis. Under our contracts with the United States Government, the results of our research may be made public by the government, which could limit our competitive advantage with respect to future products based on our research. We could be subject to claims of infringement of third-party intellectual property rights, which could result in significant expense and loss of intellectual property rights. In the past, we have received communications from third parties asserting that our trademarks infringe upon their trademarks, or that data we use is copyrighted by them, none of which has resulted in litigation or material losses. We have also been involved in patent litigation. Given our ongoing efforts to develop and market new technologies and products, we may from time to time be served with other claims from third parties asserting that our products or technologies infringe their intellectual property rights. Any litigation to determine the validity of these claims, including claims arising through our contractual indemnification of our customers and other business partners against infringement, regardless of their merit or resolution, would likely be costly and time consuming and divert the efforts and attention of our management and technical personnel. We cannot be certain we would prevail in this litigation given the complex technical issues and inherent uncertainties in intellectual property litigation. If this litigation resulted in an adverse ruling, we could be required to: - pay substantial damages; - cease the use or sale of infringing products; - expend significant resources to develop non-infringing technology; - discontinue the use of certain technology; or - obtain a license under the intellectual property rights of the third party claiming infringement, which license may not be available on reasonable terms, or at all. A license, if obtained, might require that we pay substantial royalties or license fees that would reduce our margins. Our products may have defects, which could damage our reputation, decrease market acceptance of our products, cause us to lose customers and revenue and result in liability to us. Products as sophisticated as ours are likely to contain errors or failures when first introduced or as new versions are released. To the extent that we develop new products that operate in new environments, such as the Internet, the possibility for program errors and failures may increase due to factors including the use of new technologies or the need for more rapid product development that is characteristic of the Internet market. In the future, we may experience delays in releasing new products or product enhancements as problems are corrected. Errors or defects in our products that are significant, or are perceived to be significant, could result in the rejection of our products, damage to our reputation, lost revenues, diverted development resources and increased service and support costs and warranty claims. In addition, because our products are used in business-critical applications, any product errors or failures may give rise to substantial product liability claims. Our common stock price fluctuates and has been volatile. The market price of our common stock has been, and will likely continue to be, subject to wide fluctuations. Many factors could cause the price of our common stock to rise and fall, including: - variations in our quarterly results; - announcements of new products by us or our competitors 23 24 HNC SOFTWARE INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (CONTINUED) - acquisitions of businesses or products by us or our competitors; - recruitment or departure of key personnel; - the gain or loss of significant orders; - the gain or loss of significant customers; - changes in the estimates of our operating performance or changes in recommendations by any securities analysts that follow our stock; and - market conditions in our industry, the industries of our customers and the economy as a whole. In addition, stocks of technology companies have experienced extreme price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of these companies. Public announcements by companies in our industry about, among other things, their performance, accounting practices or legal problems could cause the market price of our common stock to decline regardless of our actual operating performance. In the past, securities class action litigation has often been brought against a company following a period of volatility in the market price of its securities. We may in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management's attention and resources. Our certificate of incorporation and Delaware law contain provisions that could discourage or prevent a takeover, even if an acquisition would benefit our stockholders. Under our certificate of incorporation, our board of directors is authorized to issue up to 4,000,000 shares of preferred stock without any further vote or action by our stockholders. The rights of the holders of our common stock will be subject to the rights of the holders of any preferred stock that we may issue in the future. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. We have no current plans to issue shares of preferred stock. In addition, Section 203 of the Delaware General Corporation Law restricts business combinations with any "interested stockholder" as defined by the statute. The statute could make it more difficult for a third party to acquire us, even if an acquisition would benefit our stockholders. 24 25 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The following discusses our exposure to market risk related to changes in interest rates, foreign currency exchange rates and equity prices. INTEREST RATE RISK The fair value of our marketable security investments at March 31, 2001 was $116.0 million. The objectives of our investment policy are the safety and preservation of invested funds, and liquidity of investments that is sufficient to meet cash flow requirements. Our policy is to place our cash, cash equivalents, and investments available for sale with high credit quality financial institutions, commercial companies, and government agencies in order to limit the amount of credit exposure. Except for certain strategic equity investments, it is also our policy to maintain concentration limits and to invest only in allowable securities as determined by our management. Our investment policy also provides that our investment portfolio must not have an average portfolio maturity of beyond one year and that we must maintain liquidity positions. Investments are prohibited in industries and speculative activities. Investments must be denominated in U.S. dollars. FOREIGN CURRENCY EXCHANGE RATE RISK We mitigate our foreign currency risks principally by contracting primarily in U.S. dollars and maintaining only nominal foreign currency cash balances. Working funds necessary to facilitate the short term operations of our subsidiaries are kept in the local currencies in which they do business, with excess funds transferred to our offices in the United States for investment. For the quarter ended March 31, 2001, less than 1.0% of our sales were denominated in currencies other than our functional currency, which is the U.S. dollar. EQUITY PRICE RISK We have several equity investments we entered into for strategic business purposes, and therefore are exposed to direct equity price risk. We mitigate this risk by monitoring the financial performance of our investments. However, many of our equity investments are in the common stock of privately held, non-public companies and thus we may be unable to sell or achieve liquidity in those investments prior to an adverse change in their values. In addition, the current funding environment for high technology companies may expose our investments in such companies to increased risks. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In November 1998, Nestor filed a complaint against us in the United States District Court for the District of Rhode Island (C.A. No. 98 569). In the complaint, Nestor alleged antitrust violations and unfair competition in connection with our marketing of our Falcon credit card fraud detection product. The complaint also alleged that we infringed United States patents held by Nestor. Nestor sought to recover unspecified compensatory damages, treble damages and punitive damages and to obtain injunctive relief arising from these claims. The complaint also sought a declaratory judgment that a United States patent we hold relating to technology used in our Falcon products is invalid and unenforceable. We counterclaimed for patent infringement. In January 2000, Nestor dropped its claim of patent infringement against us. In January 2001, the Court granted our motion to dismiss our counterclaim that Nestor infringes our patent, and Nestor's claims that our patent is invalid or unenforceable. After that motion was granted, the case settled and Nestor's remaining claims for antitrust and unfair competition were dismissed. 25 26 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS Not applicable (b) REPORTS FILED ON FORM 8-K Not applicable. 26 27 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized. HNC SOFTWARE INC. Date: May 14, 2001 By: /s/ Kenneth J. Saunders ---------------------------------- Kenneth J. Saunders Chief Financial Officer and Secretary (for Registrant as duly authorized officer and as Principal Financial Officer) /s/ Russell C. Clark --------------------------------- Russell C. Clark Vice President, Corporate Finance and Assistant Secretary (for Registrant as Principal Accounting Officer) 27 -----END PRIVACY-ENHANCED MESSAGE-----