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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, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO _________ .
COMMISSION FILE NUMBER 0-26146
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HNC SOFTWARE INC.
(Exact name of registrant as specified in its charter)
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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, 2000 THERE WERE 26,913,593 SHARES OF REGISTRANT'S COMMON STOCK,
$0.001 PAR VALUE, OUTSTANDING.
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TABLE OF CONTENTS
HNC Retek
--- -----
PART I. FINANCIAL INFORMATION Page
----
ITEM 1: FINANCIAL STATEMENTS
Consolidated Balance Sheets as of March 31, 2000 (unaudited)
and December 31, 1999............................................ 3 23
Consolidated Statements of Operations (unaudited) for the three
months ended March 31, 2000 and 1999............................. 4 24
Consolidated Statements of Cash Flows (unaudited) for
the three months ended March 31, 2000 and 1999................... 5 25
Consolidated Statement of Changes in Stockholders' Equity
and Comprehensive Income (unaudited) for the three
months ended March 31, 2000...................................... 6 26
Notes to Consolidated Financial Statements (unaudited).............. 7 27
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS................................. 13 30
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.......... 43 --
PART II. OTHER INFORMATION
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K.................................... 44 --
Signatures ......................................................................... 45 --
Exhibit Index ...................................................................... 46 --
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HNC SOFTWARE INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
ASSETS
MARCH 31, DECEMBER 31,
2000 1999
--------- ---------
(unaudited)
Current assets:
Cash and cash equivalents $ 128,389 $ 136,340
Short-term investments available for sale - debt 50,212 22,368
Short-term investments available for sale - equity 5,156 6,810
Trade accounts receivable, net 58,624 64,189
Current portion of deferred income taxes 2,700 20,384
Other current assets 14,193 11,144
--------- ---------
Total current assets 259,274 261,235
--------- ---------
Long-term investments available for sale-debt 72,858 68,563
Equity investments 11,469 14,219
Property and equipment, net 27,557 22,219
Intangible assets, net 104,051 29,068
Deferred income taxes, less current portion 49,147 18,085
Other assets 2,986 3,032
--------- ---------
$ 527,342 $ 416,421
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 37,414 $ 30,049
Deferred revenue 25,430 15,274
--------- ---------
Total current liabilities 62,844 45,323
--------- ---------
Non-current liabilities 4,529 4,111
--------- ---------
Convertible Subordinated Notes 100,000 100,000
--------- ---------
Commitments and contingencies (Note 8)
Minority interest in consolidated subsidiaries 14,303 17,414
--------- ---------
Stockholders' equity:
Preferred stock, $0.001 par value -- 4,000 shares authorized;
no shares issued or outstanding - -
Common stock, $0.001 par value -- 50,000 shares authorized;
27,068 and 25,704 shares issued and outstanding, respectively 27 26
Common stock in treasury, at cost -- 25 and 882 shares, respectively
(560) (19,613)
Paid-in capital 364,127 275,955
Retained earnings (deficit) (6) 12,209
Accumulated other comprehensive income 327 1,507
Unearned stock-based compensation (18,249) (20,511)
--------- ---------
Total stockholders' equity 345,666 249,573
--------- ---------
$ 527,342 $ 416,421
========= =========
See accompanying notes to consolidated financial statements.
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HNC SOFTWARE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
THREE MONTHS ENDED
MARCH 31,
------------------------
2000 1999
-------- --------
Revenues:
License and maintenance $ 31,791 $ 36,471
Services and other 22,773 12,718
-------- --------
Total revenues 54,564 49,189
-------- --------
Operating expenses:
License and maintenance (excluding non-cash stock-based
compensation expense of $126 in 2000) 12,620 10,717
Services and other (excluding non-cash stock-based
compensation expense of $394 in 2000) 15,048 8,657
Research and development (excluding non-cash stock-based
compensation expense of $1,205 in 2000) 16,222 9,520
Sales and marketing (excluding non-cash stock-based
compensation expense of $581 in 2000) 16,578 9,778
General and administrative (excluding non-cash stock-based
compensation income of $390 in 2000 and acquisition-
related amortization of $3,965 in 2000 and $2,252 in 1999) 7,784 4,580
Stock-based compensation 1,917 --
Acquisition-related amortization 3,965 2,252
In-process research and development 1,422 --
-------- --------
Total operating expenses 75,556 45,504
Operating income (loss) (20,992) 3,685
Other income (expense):
Interest and other income, net 3,371 1,684
Interest expense (1,372) (1,381)
-------- --------
Income (loss) before minority interest in losses of
consolidated subsidiary and income tax provision (benefit) (18,993) 3,988
Minority interest in losses of consolidated subsidiary 2,391 --
Income tax provision (benefit) (4,387) 1,864
-------- --------
Net income (loss) $(12,215) $ 2,124
======== ========
Earnings per share:
Basic net income (loss) per common share $ (0.47) $ 0.08
======== ========
Diluted net income (loss) per common share $ (0.47) $ 0.08
======== ========
Shares used in computing basic net income (loss) per common share 26,120 25,766
======== ========
Shares used in computing diluted net income (loss) per common share 26,120 26,483
======== ========
See accompanying notes to consolidated financial statements.
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HNC SOFTWARE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
THREE MONTHS ENDED MARCH 31,
--------------------------
2000 1999
--------- ---------
Cash flows from operating activities:
Net income (loss) $ (12,215) $ 2,124
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Provision for doubtful accounts 722 697
Depreciation and amortization 5,658 4,314
Acquired in-process research and development 1,422 --
(Gain) loss on disposals of property and equipment (2) 179
Stock-based compensation expense 1,917 --
Deferred income tax benefit (4,387) --
Tax benefit from stock option transactions 19,022 257
Minority interest in losses of consolidated subsidiary (2,391) --
Changes in assets and liabilities:
Trade accounts receivable 386 1,442
Deferred income taxes (19,022) 1,448
Other assets (2,228) 485
Accounts payable and accrued liabilities 5,794 (3,634)
Deferred revenue 10,332 1,472
--------- ---------
Net cash provided by operating activities 5,008 8,784
--------- ---------
Cash flows from investing activities:
Net sales (purchases) of investments available for sale (32,125) 1,410
Equity investments (1,500) (2,750)
Acquisitions of property and equipment (7,134) (5,781)
Cash acquired in business acquisitions, net of cash paid 2,263 --
--------- ---------
Net cash used in investing activities (38,496) (7,121)
--------- ---------
Cash flows from financing activities:
Net proceeds from issuance of HNC common stock 20,349 2,047
Costs incurred related to issuance of Retek common stock (243) --
Repurchase of HNC common stock for treasury -- (18,779)
Net proceeds from sales of receivables 5,618 --
Repayment of capital lease obligations -- (56)
--------- ---------
Net cash provided by (used in) financing activities 25,724 (16,788)
--------- ---------
Effect of exchange rate changes on cash (187) (242)
--------- ---------
Net decrease in cash and cash equivalents (7,951) (15,367)
Cash and cash equivalents at beginning of the period 136,340 54,267
--------- ---------
Cash and cash equivalents at end of the period $ 128,389 $ 38,900
========= =========
See accompanying notes to consolidated financial statements.
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HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
(in thousands)
(unaudited)
COMMON STOCK TREASURY STOCK PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
--------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1999 ................. 25,704 $ 26 882 $ (19,613) $ 275,955
Common stock options exercised ............... 791 1 (791) 17,579 1,064
Common stock issued under .................... (66) 1,474 231
Employee Stock Purchase Plan ............... 66
Tax benefit from stock option ................
transactions ............................... 19,022
Unearned stock-based
compensation expense .......................
Stock-based compensation expense ............. (259)
Retek initial public offering costs .......... (243)
Common stock issued in business .............. -
acquisitions ............................... 507 68,357
Unrealized loss on investments, net of tax ...
Foreign currency translation
adjustment, net of tax .....................
Net loss .....................................
--------- --------- --------- --------- ---------
BALANCE AT MARCH 31, 2000 .................... 27,068 $ 27 25 $ (560) $ 364,127
========= ========= ========= ========= =========
ACCUMULATED
OTHER UNEARNED TOTAL
RETAINED COMPREHENSIVE STOCK-BASED STOCKHOLDERS' COMPREHENSIVE
EARNINGS INCOME (LOSS) COMPENSATION EQUITY INCOME (LOSS)
--------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1999 .................. $ 12,209 $ 1,507 $ (20,511) $ 249,573
Common stock options exercised ................ 18,644
Common stock issued under ..................... 1,705
Employee Stock Purchase Plan ................
Tax benefit from stock option ................. 19,022
transactions ................................
Unearned stock-based
compensation expense ........................ 86 86
Stock-based compensation expense .............. 2,176 1,917
Retek initial public offering costs ........... (243)
Common stock issued in business ...............
acquisitions ................................ 68,357
Unrealized loss on investments, net of tax ... (987) (987) (987)
Foreign currency translation
adjustment, net of tax ...................... (193) (193) (193)
Net loss ...................................... (12,215) (12,215) (12,215)
--------- --------- --------- --------- ---------
BALANCE AT MARCH 31, 2000 ..................... $ (6) $ 327 $ (18,249) $ 345,666 $ (13,395)
========= ========= ========= ========= =========
See accompanying notes to consolidated financial statements.
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HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 1--GENERAL
HNC Software Inc.
Headquartered in San Diego, California, we develop, market, and support
predictive software solutions for leading service industries. These predictive
software solutions employ proprietary neural-network predictive decision
engines, profiles, traditional statistical modeling, business models, expert
rules and context vector technology to convert existing data and business
experiences into meaningful recommendations and actions. We provide innovative
predictive software systems in the insurance, financial services,
telecommunications, e-business, and retail markets. In this Report, HNC Software
Inc. is referred to as "we," "our," and "HNC". Our subsidiary, Retek Inc., is
referred to as "Retek".
Basis of Presentation
We have prepared the accompanying interim consolidated financial statements,
without audit, in accordance with the instructions to Form 10-Q and, therefore,
have not necessarily included all information and footnotes required for audited
financial statements.
In our opinion, the accompanying unaudited interim consolidated financial
information presented reflects all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of our financial
position and results of operations. These consolidated financial statements and
notes thereto should be read in conjunction with our audited financial
statements and notes thereto presented in our Annual Report on Form 10-K/A for
the fiscal year ended December 31, 1999. The interim financial information
contained in this Report is not necessarily indicative of the results to be
expected for any other interim period or for an entire fiscal year.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
effect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Certain prior year balances
have been reclassified to conform to the current presentation.
Sales of Receivables
From time to time, we enter into agreements to sell an undivided interest in
specifically identified trade accounts receivable. We generally sell these trade
accounts receivables at a discount to a bank, based upon defined short-term
market rates. Uncollected receivables that have been sold are not included in
our trade accounts receivables balance on our consolidated balance sheet. In the
quarter ended March 31, 2000, we sold $5,618 of receivables, representing
approximately 8% of our total cash collected from customers during the quarter.
We did not sell any receivables during the first quarter of 1999. Expenses
related to receivables sold were $30 during the first quarter of 2000 and are
included in interest expense in our consolidated statement of operations.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities", or FAS 133. This statement establishes a new model for
accounting for derivatives and hedging activities. Under FAS 133, all
derivatives must be recognized as assets and liabilities and measured at fair
value. In July 1999, the FASB issued Statement of Accounting Standards No. 137
"Accounting for Derivative Instruments and Hedging Activities- Deferral of the
Effective Date of FASB Statement No. 133" which defers the adoption requirement
to the first quarter of 2001. We have not yet determined the impact of the
adoption of this new accounting standard on our consolidated financial position,
results of operations or disclosures.
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HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements", or SAB 101,
which provides additional guidance in applying generally accepted accounting
principles for the recognition and reporting of revenue for certain transactions
that existing accounting rules do not specifically address. An amendment in
March 2000 delayed SAB 101's effective date until the second quarter of 2000. We
are currently evaluating the impact, if any, that SAB 101 may have on our
consolidated financial statements.
In January 2000, the Financial Accounting Standards Board's Emerging Issues Task
Force published Issue No. 00-2 "Accounting for Web Site Development Costs", or
EITF 00-2. EITF 00-2 applies the guidance given in the American Institute of
Certified Public Accountants's Statement of Position 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use", or SOP 98-1,
to Web site development costs. Under SOP 98-1, software development costs,
consisting of internally developed software and Web site development costs,
include internal and external costs incurred to develop internal-use computer
software during the application development stage are capitalized. Application
development stage costs generally include software configuration, coding,
installation to hardware and testing. Costs of significant upgrades and
enhancements that result in additional functionality are also capitalized. Costs
incurred for maintenance and minor upgrades and enhancements are expensed as
incurred. The estimated useful lives are based on planned or expected
significant modification or replacement of software applications, in response to
the rapid rate of change in the internet industry and technology in general.
Adoption of EITF 00-2 is required for the third quarter of 2000. We have not yet
determined the impact of the adoption of this new accounting standard on our
consolidated financial position, results of operations or disclosures.
NOTE 2--INITIAL PUBLIC OFFERING OF RETEK INC.
On September 10, 1999, Retek filed a registration statement with the Securities
and Exchange Commission relating to an initial public offering of Retek's common
stock. The offering was consummated in November 1999. The number of shares sold
in the offering were 6,325 shares of Retek's common stock, all of which were
sold by Retek. Prior to the offering, we transferred to Retek all of the shares
of our wholly owned subsidiary, Retek Information Systems, Inc. We now own
approximately 86% of the outstanding shares of Retek common stock. We informed
Retek that, after the completion of Retek's initial public offering, it is our
current intention to distribute pro rata to our stockholders, as a dividend,
shares of Retek common stock, subject to the satisfaction and fulfillment of
several conditions, including but not limited to the approval of our board of
directors and receipt of a written ruling from the Internal Revenue Service that
the distribution qualifies for tax-free treatment under Section 355 of the
Internal Revenue Code. However, we have no obligation to carry out, declare, or
pay such distribution and dividend of shares of Retek stock; and, if the
distribution is carried out, we will determine the timing, structure and terms
of the distribution.
NOTE 3--ACQUISITIONS
In March 2000, we acquired all of the outstanding stock and other securities of
Onyx Technologies Inc., or Onyx, in exchange for approximately 383 shares of our
common stock, including shares subject to options we assumed, and $1,500 in
cash. We applied the purchase method of accounting for the acquisition of Onyx,
which resulted in a purchase price of $49,555, including $3,500 which represents
our initial 1999 investment in Onyx.
In March 2000, we acquired all of the outstanding stock and other securities of
the Center for Adaptive Systems Applications, Inc., or CASA, in exchange for 142
shares of our common stock, 38 of which are in escrow, including shares subject
to options and warrants we assumed. These shares are in escrow to secure
indemnification obligations of the former CASA stockholders. We applied the
purchase method of accounting for the acquisition of CASA, which resulted in a
purchase price of $23,756.
In-process research and development expense was $1,400 for the three months
ended March 31, 2000. This write-off was related to the acquisition of CASA.
CASA is an advanced analytics solutions company that provides account
optimization and precision marketing solutions through an ASP delivery platform.
The classification of the technology as complete or under development was made
in accordance with the guidelines of Statement of Financial Accounting Standards
No. 86, Statement of Financial Accounting Standards No. 2 and Financial
Accounting Standards Board Interpretation No. 4. Prior to 2000, CASA
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HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
primarily sold its Adaptive Dynamic Marketing ("ADM") ASP solution to businesses
to improve revenue and customer retention. At the time of acquisition, CASA had
a number of new technologies under development related to account management
algorithms and pricing algorithms.
In March 2000, we acquired all of the outstanding stock and other securities of
AIM Solutions, Inc., or AIM, in exchange for 9 shares of our common stock,
including shares subject to options we assumed. We applied the purchase method
of accounting for the acquisition of AIM, which resulted in a purchase price of
$1,656, including $750 which represents our initial 1999 investment in AIM.
The unaudited pro forma results of operations below present the impact on our
results of operations as if the Onyx, CASA and AIM acquisitions had occurred on
January 1, 1999, instead of on their respective later acquisition dates:
THREE MONTHS ENDED MARCH 31,
----------------------------------------------------------------
2000 1999
---------------------------- ----------------------------
PRO FORMA PRO FORMA
HISTORICAL COMBINED HISTORICAL COMBINED
---------- --------- ---------- ---------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
Total revenues $ 54,564 $ 56,298 $ 49,189 $ 51,218
Net income (loss) (12,215) (12,381) 2,124 1,965
Basic net income (loss)
per share $ (0.47) $ (0.47) $ 0.08 $ 0.08
Diluted net income (loss)
per share $ (0.47) $ (0.47) $ 0.08 $ 0.07
NOTE 4--EQUITY INVESTMENTS
In March 2000, Open Solutions Inc., or OSI, completed a private placement of its
common stock. We participated in this financing by purchasing 2,146 shares of
OSI Series F preferred stock for $9.32 per share in order to maintain our
approximately 6% ownership of OSI.
NOTE 5--PER SHARE DATA
THREE MONTHS ENDED
MARCH 31,
------------------------
2000 1999
-------- --------
(in thousands)
Net income (loss) $(12,215) $ 2,124
======== ========
Shares used in computing basic net income
(loss) per common share 26,120 25,766
Weighted average options to purchase common
stock as determined by application of the
treasury stock method -- 695
Employee Stock Purchase Plan common stock equivalents -- 22
-------- --------
Shares used in computing diluted net income
(loss) per common share 26,120 26,483
======== ========
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HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The conversion of 2,230 shares of our common stock now issuable upon the
conversion of our 4.75% convertible subordinated notes were not used to
calculate diluted net income (loss) per common share for the three month periods
ended March 31, 2000 and 1999, as their effect would be anti-dilutive.
For the three month period ended March 31, 2000, weighted average options to
purchase 2,934 shares of common stock and Employee Stock Purchase Plan common
stock equivalents of 24 shares were not included in the computation of diluted
net loss per common share, as their effect in the period would be anti-dilutive.
NOTE 6--SEGMENT DATA
Our reportable segments are based upon our method of internal reporting to
management, whom view our business by functional market. Our operating segments
reflect the way our management team organizes and evaluates internal financial
information, in order to make operating decisions and assess performance. Each
segment represents a strategic business unit that offers unique products and
services to its functional market. Our segments are as follows: the Service
Industries Group, which includes our HNC Insurance Solutions segment, or IS, our
HNC Financial Solutions segment, or FS, and HNC Telecom Solutions, or TS; eHNC
Inc., or eHNC; and Retek Inc., or Retek. IS provides users with the ability to
reduce fraud losses and streamline operations in the containment of the medical
costs of workers' compensation and automobile accident insurance claims,
workers' compensation loss reserving, workers' compensation fraud, managed care
effectiveness and provider effectiveness. FS provides transaction-based,
real-time fraud detection, authorization and action decisions for applications
such as credit card charge authorization and the loan approval decision process.
TS provides our telecommunications users with the ability to reduce fraud losses
and determine customer profitability. eHNC serves e-businesses by providing
products that allow online merchants to maximize customer service capabilities
and point-of-sale transactions. Retek offers predictive software solutions that
allow retailers to build forecasting and marketing models. For presentation
purposes in this Report, our former Aptex entity's historical financial
information has been combined with eHNC's. Reflected in our "Other" category are
our TS, Advanced Technology Solutions group which primarily provides research
and development for the United States government, and any corporate activity.
The table below presents segment data for certain statement of operations line
items for the quarters ended March 31, 2000 and 1999.
Segment revenue and operating income (loss), which excludes all non-cash
expenses such as stock-based compensation expense, acquisition related
amortization, and in-process research and development expenses are as follows:
THREE MONTHS ENDED
MARCH 31,
---------------------
2000 1999
------- -------
Segment revenue:
IS $19,422 $13,649
FS 18,604 14,199
Other 1,222 2,778
------- -------
Service Industries Group 39,248 30,626
eHNC 1,352 1,917
Retek 13,964 16,646
------- -------
Total consolidated revenue $54,564 $49,189
======= =======
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HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED
MARCH 31,
------------------------
2000 1999
-------- --------
Segment operating income (loss):
IS $ 3,069 $ 705
FS 3,684 2,152
Other (1,950) (200)
-------- --------
Service Industries Group 4,803 2,657
eHNC (3,796) 204
Retek (14,695) 3,076
-------- --------
Total segment operating income (loss) (13,688) 5,937
Stock-based compensation (1,917) --
Acquisition related amortization (3,965) (2,252)
In-process research and development (1,422) --
-------- --------
Consolidated operating income (loss) (20,992) 3,685
Interest and other income, net 3,371 1,684
Interest expense (1,372) (1,381)
Minority interest in losses of consolidated subsidiary 2,391 --
-------- --------
Income (loss) before income tax provision (benefit) $(16,602) $ 3,988
======== ========
Corporate assets are primarily comprised of cash, short-term and long-term
investments available for sale, deferred tax assets and inter-segment
receivables. All tax related assets and liabilities are included within the
Corporate line item. Eliminations primarily relate to intercompany payables and
investments in subsidiaries.
Total assets:
THREE MONTHS ENDED
MARCH 31,
--------------------------
2000 1999
--------- ---------
Total segment assets:
IS $ 42,980 $ 25,435
FS 101,770 36,231
Other 56,075 5,854
--------- ---------
Service Industries Group 200,825 67,520
eHNC 3,259 8,367
Retek 133,323 31,513
--------- ---------
Total segment assets 337,407 107,400
Corporate 331,708 184,562
Eliminations (141,773) (24,409)
--------- ---------
Total consolidated assets $ 527,342 $ 267,553
========= =========
NOTE 7--STOCK-BASED COMPENSATION
Net compensation expense related to stock-based awards totaled $1,917 for the
first quarter of 2000. This net compensation expense included net compensation
income related to stock-based awards of $713, and stock-based compensation
expense related to Retek of $2,630.
The compensation income was related to reversals of compensation expense
recorded in the fourth quarter of 1999 due to a decrease in the estimated fair
values of the options during the quarter. The stock-based awards were granted to
non-employees, and were estimated at their fair values using the Black-Scholes
option pricing model with the following weighted average assumptions: dividend
yield of 0.0%, risk-free interest rate of 6.44%, volatility of 100.0%, and an
expected life of 7 months according to the vesting date and subsequent exercise
period of each option grant, and our stock prices on the various grant dates as
well as on March 31, 2000. The unearned stock-based compensation was related to
options granted to eHNC employees in the third quarter of 1999. The expense was
generated as the
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HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
options were granted at an exercise price less than deemed fair value. This
expense will be amortized over the option lives.
Retek recorded unearned stock-based compensation amortization expense of $2,630
in the first quarter of 2000. This expense was related to the stock options
Retek granted in connection with their initial public offering in the fourth
quarter of 1999. The expense was generated as these options were granted at an
exercise price less than the deemed fair value.
NOTE 8--CONTINGENCIES
Various claims arising in the course of business, seeking monetary damages and
other relief, are pending. The amount of the liability, if any, cannot be
determined with certainty; however, in the opinion of management, the ultimate
liability will not have a material adverse effect on our consolidated financial
position, results of operations or cash flows.
In November 1998, Nestor filed a complaint against us in the United States
District Court for the District of Rhode Island (C.A. No. 98 569). In the
complaint, Nestor alleged that we violated the federal Sherman Antitrust Act and
the Rhode Island Antitrust Act and tortuously interfered with prospective
contractual business relationships of Nestor in connection with our marketing of
our Falcon credit card fraud detection product. The complaint also alleged that
we infringed United States patents Nos. 4,326,259 and 4,760,604 held by Nestor.
Nestor seeks to recover unspecified compensatory damages, treble damages and
punitive damages and to obtain injunctive relief arising from these claims. The
complaint also sought a declaratory judgment that a United States patent we hold
relating to technology used in our Falcon products is invalid and unenforceable
due to our alleged inequitable conduct in obtaining this patent, and that
Nestor's products do not infringe this patent.
In January 2000, Nestor dropped its claim of patent infringement against us. Our
counter-claim that Nestor infringes our patent is still before the court in
Rhode Island. The other Nestor claims for antitrust and unfair competition were
severed by the court in an earlier ruling and will not be considered until after
the trial on the issue of the validity of our patent. We also have claims for
patent infringement and unfair competition pending in the United States District
Court venued in San Diego against Nestor's distributors Transaction Systems
Architects, Inc., or TSAI and ACI Worldwide, Inc., or ACI. In April 2000 we
agreed with TSAI and ACI to dismiss our lawsuit against them in order to enable
us to commence discussions with them regarding a possible future business
relationship. However, no agreements have been reached to date with TSAI or ACI.
We believe that these legal proceedings will not result in a material negative
impact on our results of operations, liquidity or financial condition.
NOTE 9--SUBSEQUENT EVENTS
In April 2000, we acquired Celerity Technologies Inc., or Celerity. We acquired
all of the outstanding stock of Celerity in exchange for 220 shares of our
common stock and $2,400 in cash. We are using the purchase method of accounting
for our acquisition of Celerity, and anticipate a significant portion of the
purchase price will be allocated to goodwill and other intangible assets. We
also anticipate taking a charge related to in-process research and development
costs related to the acquisition in the quarter ended June 30, 2000.
During April 2000, we repurchased 250 shares of our outstanding common stock for
our treasury at an aggregate purchase price of $18,616.
On May 10, 2000, Retek completed its acquisition of HighTouch Technologies,
Inc., or HighTouch, a provider of real-time transaction management and customer
service solutions that support multi-channel customer interactions. HighTouch
owns certain direct consumer management technologies that Retek has incorporated
into its Retek Retail CRM, an enterprise-level customer interaction system. In
connection with the purchase of HighTouch, Retek paid $18,000 in cash and issued
approximately 389,057 shares of its common stock to the former sole shareholder
of HighTouch. This transaction will be accounted for under the purchase method
of accounting. Accordingly, the purchase price will be allocated
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HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
to the estimated fair value of assets acquired, liabilities assumed and
purchased in-process research and development.
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Report (including without limitation the following section regarding
Management's Discussion and Analysis of Financial Condition and Results of
Operations) contains forward-looking statements regarding HNC and its business,
financial condition, results of operations and prospects. Words like "expects,"
"anticipates," "intends," "plans," "believes," "seeks," "estimates" and similar
expressions or variations of these words are intended to identify
forward-looking statements, but are not the exclusive means of identifying
forward-looking statements in this Report. Additionally, statements concerning
future matters, for example the development of new products, enhancements or
technologies, possible changes in legislation, and other statements regarding
matters that are not historical are forward-looking statements. In this Report,
HNC Software Inc. is referred to as "we," "our," and "HNC".
Although forward-looking statements in this Report reflect the good faith
judgment of our management, these statements can only be based on facts and
factors currently known to us and might change if future factual circumstances
change. Consequently, all forward-looking statements have inherent risks and
uncertainties and actual results and outcomes may differ materially from the
results and outcomes discussed in or anticipated by the forward-looking
statements. Factors that could cause or contribute to differences in results and
outcomes include without limitation whether we are successful in integrating new
businesses we have recently acquired, decisions we make regarding future
strategic directions of our business units, whether we are successful in
transitioning many of our products to solutions based on the application service
provider, or ASP, business model, whether we distribute our stock holdings in
Retek to our stockholders, as well as those factors discussed in our Annual
Report on Form 10-K/A for the fiscal year ended December 31, 1999, or 1999
Annual Report, and this Report should be read in conjunction with our 1999
Annual Report. Readers are urged not to place undue reliance on these
forward-looking statements, which speak only as of the date of this Report. We
undertake no obligation to revise or update any forward-looking statements in
order to reflect any event or circumstance that may arise after the date of this
Report. Readers are urged to carefully review and consider the various
disclosures made in this Report, which attempt to advise interested parties of
the risks and factors that may affect our business, financial condition, results
of operations and prospects.
OVERVIEW
We are a business-to-business software company that develops, markets, licenses
and supports predictive software solutions for various service industries,
including companies in the insurance, financial services, telecommunications,
e-commerce, and retail industries. Our predictive software solutions help
service industry companies manage and optimize their customer relationships. By
analyzing high volumes of customer transactions in real-time, our predictive
solutions help companies shift the decision-making process from a retrospective
to prospective basis. The increasing conduct of e-business over the Internet
increases the demand for analysis of large volumes of real-time information,
which our products provide. Electronic customer interaction is necessary to
manage and respond to customer activity and expectations in all markets.
Our business is currently organized as follows: the Service Industries Group,
which includes the HNC Insurance Solutions segment, or IS, the HNC Financial
Solutions segment, or FS, and the HNC Telecom Solutions, or TS; eHNC Inc., or
eHNC; and Retek Inc., or Retek.
- - SERVICE INDUSTRIES
Group Our Service Industries Group delivers predictive solutions and
services that automate key decision functions for customers in the
insurance, financial services and telecommunications markets. Most of
our predictive solutions address customer relationship management, or
CRM, issues to optimize interactions with customers over the life-cycle
of the customer relationship, including customer acquisition, account
management, customer service, marketing and risk management.
INSURANCE SOLUTIONS
IS develops software solutions for the insurance industry that are
designed to add value to its customers' businesses through cost
reduction and improved management of risks. Customers in this segment
include insurance carriers, third-party administrators, managed care
organizations, preferred provider organizations, insurance industry
trade groups, brokers, and other service organizations. Our current
product offerings are targeted to the workers' compensation and
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
automobile segments of the property and casualty insurance market, as
well as the group health segment of the insurance market.
FINANCIAL SOLUTIONS
FS provides a suite of Predictive CRM products that addresses the
customer-lifecycle management needs of banks and other financial
institutions.
TELECOM SOLUTIONS
TS provides solutions designed to help telecommunications carriers
acquire more customers and enhance relationships with existing
customers in order to retain customers for longer periods.
- - eHNC
eHNC helps online merchants and merchant service providers increase
sales and minimize risks through an Applications Service Provider, or
ASP, product delivery model. eHNC's solutions analyze electronic
interactions with consumers, and help online merchants manage risk and
understand, forecast and recommend critical next steps in each consumer
relationship. For presentation purposes in this Report, our former Aptex
subsidiary's historical financial information has been combined with
eHNC's.
- - RETEK
Retek completed its initial public offering in November of 1999 and, as
of March 31, 2000, we owned approximately 86% of Retek's outstanding
common stock. Retek provides Internet-based, business-to-business
software solutions for retailers and their trading partners, including
retail.com, an electronic commerce network that connects retailers to
members of their supply chain. Retek also provides a suite of software
solutions that address the particular needs of retailers.
Our revenues and operating results have varied significantly in the past and may
do so in the future. Factors affecting our revenues and operating results
include: the degree of market acceptance of our products; the relatively large
size and small number of customer orders that may be received during a given
period; customer cancellation of long-term contracts yielding recurring revenues
or customers' ceasing their use of our products for which our fees are based on
customer useage; the length of our products' sales cycle; our ability to
successfully develop, introduce and market new products and product
enhancements; the timing of new product announcements and introductions by us
and our competitors; changes in the mix of our distribution channels; changes in
the level of our operating expenses; our ability to achieve progress on
percentage-of-completion contracts; our success in completing pilot product
installations for contracted fees; competitive conditions in the industry;
domestic and international economic conditions; and market conditions in our
targeted markets. In addition, license agreements we enter into during a given
quarter may not meet our revenue recognition criteria, and thus may not produce
revenue in that quarter. Therefore, even if we meet or exceed our forecast of
aggregate licensing and other contracting activity, it is possible that our
revenues would not meet our expectations or those of securities analysts.
Furthermore, our operating results may be affected by other factors unique to
our product lines. For example, in the past we have, through our Retek
subsidiary, derived a substantial portion of our revenues from our retail
products, which generally have been priced as "perpetual" license transactions
in which we receive a one-time license fee, most of which is typically
recognized as revenue upon signing and delivery. Thus, failure to sign a
significant perpetual license in the quarter it was anticipated to be signed
could result in a material shortfall of revenue for that quarter.
Beginning in the fourth quarter of 1999, Retek began to enter into their
software licensing agreements with revised terms for the majority of their
software sold, and this is expected to continue going forward. Revenue from the
sale of software licenses and technical advisory services under these agreements
will be recognized as the services are performed over the contract period, which
we generally expect to be 12 to 24 months, as determined by the customers'
objectives. As Retek begins to recognize license and service revenues over a
period of time, rather than upon delivery of their products, they will recognize
significantly less revenue and their associated margins will be lower for
several quarters as compared to their prior quarters, and they will incur
operating losses during these periods. In the past, we recognized many of these
perpetual license agreements as revenue according to the revenue recognition
criteria set
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
forth in the Statement of Position 97-2 "Software Revenue Recognition", and
related pronouncements. Failure to complete a perpetual license transaction
during a fiscal quarter would preclude us from recognizing revenue from that
transaction in that quarter, and thus would harm our operating results for that
quarter.
We expect fluctuations in our operating results to continue for the foreseeable
future. Consequently, we believe that period-to-period comparisons of our
financial results should not be relied upon as an indication of our future
performance. Because our expense levels are based in part on our expectations
regarding future revenues and in the short term are fixed to a large extent, we
may be unable to adjust our spending in time to compensate for any unexpected
revenue shortfall. We may not be able to maintain profitability on a quarterly
or annual basis in the future. Due to the foregoing factors, it is possible that
in some future quarter our operating results will be below the expectations of
public market analysts and investors. In that event, the price of our Common
Stock and, in turn, the price of our 4.75% Convertible Subordinated Notes due
2003, would likely be harmed.
RESULTS OF OPERATIONS
REVENUES
Our revenues are comprised of license and maintenance revenues and services and
other revenues. Our revenues for the three months ended March 31, 2000 were
$54.6 million, an increase of 11.0% over revenues of $49.2 million for the same
period in the prior year.
LICENSE AND MAINTENANCE REVENUES. We recognize license and maintenance revenues
in several different ways, depending on the terms on which the software and
maintenance are provided. Revenue from periodic software license and maintenance
agreements is generally recognized ratably over the respective license periods.
Revenue from short-term periodic software license and maintenance agreements,
with guaranteed minimum license fees, is recognized as related services are
performed. Transaction-based fees are recognized as revenue based on system
usage or when fees based on system usage exceed the monthly minimum license
fees. Revenue from perpetual licenses of our software for which there are no
significant continuing obligations and collection of the related receivables is
probable is recognized on delivery of the software and acceptance by the
customer. Amounts received under contracts in advance of performance are
recorded as deferred revenue and are generally recognized within one year from
receipt.
License and maintenance revenues were $31.8 million for the first quarter in
2000, a decrease of 12.9% from $36.5 million for the first quarter in 1999. This
$4.7 million decrease from the prior year quarter was driven by a $5.2 million
decrease at Retek, and offset by an increase of $0.8 million at our Service
Industries Group. The decrease in our Retek segment's license and maintenance
revenues from the first quarter in 1999 to the first quarter in 2000 as Retek's
contracts generally include revised terms, resulting in revenue being recognized
over a number of quarters rather than upon delivery. For further discussion of
the decrease in Retek's license and maintenance revenues, see page 33. Our
recurring license and maintenance revenues, as a percentage of total license and
maintenance revenues, increased to 82.6% in the first quarter of 2000, up from
65.5% for the same period in 1999.
Within our Service Industries Group, our IS segment license and maintenance
revenues decreased 3.3% from the first quarter in 1999 to the first quarter in
2000, offset primarily by a 26.1% increase at our FS segment. The decrease in
the first quarter of 2000 at our IS segment resulted in part from IS's transfer
of customer contracts for the CompCompare and ProviderCompare products to a
third party under a master license agreement signed in the third quarter of
1999, under which we no longer receive license and maintenance fees from the
transferred contracts and instead receive royalty fees which are classified as
services and other. Contributing to the decrease was a decrease in PPO revenues
as a result of industry consolidations and increasing price competition. These
were offset in part by the addition of new customers. The increase at our FS
segment is primarily due to increases in sales of our Falcon and ProfitMax
products.
SERVICES AND OTHER REVENUES. Services and other revenues are comprised of
installation and implementation revenues, service bureau operations revenues and
revenues which are derived from
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
consulting contracts, new product development contracts with commercial
customers and, to a lesser extent, research and development contracts with the
United States Government. Revenue from software installation and implementation
and from contract services is generally recognized as the services are performed
using the percentage of completion method based on costs incurred to date
compared to total estimated costs at completion. Amounts received under
contracts in advance of performance are recorded as deferred revenue and are
generally recognized within one year from receipt. Contract losses are recorded
as a charge to income in the period any losses are first identified. Unbilled
accounts receivable are stated at estimated realizable value.
Service bureau fees are derived from review of and re-pricing of customers'
medical bills and are assessed to customers on the basis of volume of bills
processed. Service bureau customers typically subscribe for services under
month-to-month agreements and service bureau fees are recognized as revenue when
the processing services are performed.
Services and other revenues increased 79.5% from the first quarter in 1999 to
the first quarter in 2000, from $12.7 million to $22.8 million. This $10.1
million increase from the prior year quarter was driven primarily by a $7.8
million increase at our Service Industries Group and a $2.5 million increase at
Retek.
Within our Service Industries Group, our IS segment services and other revenues
increased $6.2 million, or 350.6%, from the first quarter in 1999 to the first
quarter in 2000. Of this increase, $4.2 million is related to the ramp-up to
full scale service bureau operations for a primary customer. The remaining
increase of $2.0 million is primarily due to growth in our service bureau
customer base at IS. Our FS segment services and other revenues increased $1.9
million, or 41.7%, from the first quarter in 1999 to the first quarter in 2000.
The increase at FS was primarily related to a higher volume of Capstone
implementations.
For discussion of the increase in Retek's services and other revenues, see page
33.
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 gross margins on license and
maintenance revenues decreased 10.3% from the first quarter in 1999 to the first
quarter in 2000, from 70.6% to 60.3%, respectively. This decrease was driven by
a 50.0% decrease at Retek, and was offset by an increase of 5.7% at our Service
Industries Group.
Within our Service Industries Group from the first quarter of 1999 to the first
quarter of 2000, license and maintenance gross margin from our IS segment
increased 10.0%, while gross margin from our FS segment remained flat. IS gross
margins increased quarter over quarter due to reductions in PPO access fees and
the re-alignment of resources.
For discussion of Retek's license and maintenance cost of revenues, see page 33.
SERVICES AND OTHER GROSS MARGIN. Services and other expenses consist of
personnel and other expenses associated with providing installation and
implementation services and performing development, consulting, and research and
development contracts, and the costs associated with service bureau operations.
Our gross margin on services and other revenues increased by 2.0%, to 33.9% for
the first quarter of 2000 from 31.9% for the first quarter of 1999. The increase
in our services and other gross margin was driven by a 15.4% increase for our
Service Industries Group, and was offset by a 17.7% decrease at Retek.
Within our Service Industries Group, services and other gross margin from our IS
segment improved 44.0% from the first quarter of 1999 to the first quarter of
2000, while gross margin from our FS segment remained flat. Our IS segment's
gross margins increased quarter over quarter primarily because of improved
efficiencies in their service bureau operations.
For discussion of Retek's services and other cost of revenues, see page 34.
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
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 expenses increased
$6.7 million or 70.5%, to $16.2 million in the first quarter of 2000 from $9.5
million in the first quarter of 1999.
Research and development expenses from the Service Industries Group increased to
$6.8 million in the first quarter of 2000 from $4.9 million in the first quarter
of 1999. Research and development expenses from our Insurance Solutions segment
increased to $2.5 million in the first quarter of 2000 from $1.8 million in the
first quarter of 1999. Research and development expenses from our Financial
Solutions segment increased to $3.2 million in the first quarter of 2000 from
$2.5 million in the first quarter of 1999. The increases in absolute dollars
quarter over quarter were attributable to increases in staffing and related
costs to support new product development activities primarily for our
CompAdvisor, Capstone, Falcon, and ASP product-delivery products. We anticipate
that research and development expenses will increase in dollar amount and could
increase as a percentage of total revenues for the foreseeable future.
For a discussion of Retek's research and development expense see page 34.
SALES AND MARKETING EXPENSE
Sales and marketing expenses consist primarily of salaries and benefits,
commissions, travel, entertainment and promotional expenses. Sales and marketing
expenses increased 69.4% to $16.6 million in the first quarter of 2000, from
$9.8 million in the first quarter of 1999. This increase was primarily driven by
a 127.2% increase at Retek, and by a 10.9% increase from the Service Industries
Group.
Within our Service Industries Group, sales and marketing expense increased,
99.8% at our IS segment, and decreased by 6.4% at our FS segment. The increases
in IS sales and marketing expenses were due primarily to increases in staffing
related to the expansion of IS's direct sales and marketing staff. Contributing
to the increases were increased expenses for trade shows, advertising, corporate
marketing programs and other expenses to support recently acquired businesses.
The decrease FS experienced during the first quarter in 2000, was related to the
timing of various marketing efforts. We expect sales and marketing expenses to
continue to increase in absolute dollars for the foreseeable future. These
expenses could also increase as a percentage of total revenues as we continue to
develop a direct sales force in Europe and other international markets, expand
our domestic sales and marketing organization and increase the breadth of our
product lines.
For a discussion of Retek's sales and marketing expenses see page 34.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expenses consist primarily of personnel costs for
finance, contract administration, human resources and general management, as
well as acquisition, insurance and professional services expenses. General and
administrative expenses increased 69.6%, to $7.8 million in the first quarter of
2000, from $4.6 million in the first quarter of 1999. This increase was
primarily driven by Retek, and related to increased staffing and related
expenses, including recruiting costs, to support higher levels of sales and
development activity, resulting in part from our recent acquisitions and to
support Retek's status as a public company. Our Service Industries Group's
general and administrative expense remained essentially flat quarter over
quarter.
For a discussion of Retek's general and administrative expenses see page 34.
STOCK-BASED COMPENSATION EXPENSE
We recognized $1.9 million of stock-based compensation expense related to
stock-based compensation agreements, calculated at fair value. This net expense
consisted of approximately $2.6 million of stock-based compensation expense for
Retek, offset by approximately $0.7 million of stock-based
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
compensation income for our Service Industries Group and eHNC in the first
quarter of 2000. Stock-based awards issued to non-employees are accounted for
using a fair value method and are marked to fair value at each period end until
the earlier of the date the performance by the non-employee is complete or the
awards are fully vested.
See Note 7 to the financial statements in this Report for further discussion.
For a discussion of Retek's stock-based compensation expense see page 35.
ACQUISITION-RELATED AMORTIZATION EXPENSE
Acquisition-related amortization expense was $4.0 million in the first quarter
of 2000, compared to $2.3 million in the first quarter of 1999. These expenses
represent the amortization of intangible assets purchased in conjunction with
our acquisitions of AIM, CASA and Onyx in the first quarter of 2000, WebTrak in
1999, and our acquisitions of Practical Control Systems Technologies, Inc. or
PCS, FTI (now HNC Financials Solutions, Inc.) and the Advanced
Telecommunications Abuse Control System, or ATACS product line assets during
1998. The average amortization period and useful life for these intangible
assets is approximately 3.5 years.
For a discussion of Retek's acquisition related amortization expense see page
35.
IN-PROCESS RESEARCH AND DEVELOPMENT EXPENSE
In-process research and development expense was $1.4 million for the three
months ended March 31, 2000. This write-off was related to the acquisition of
CASA.
CASA is an advanced analytics solutions company that provides account
optimization and precision marketing solutions through an ASP delivery platform.
The classification of the technology as complete or under development was made
in accordance with the guidelines of Statement of Financial Accounting Standards
No. 86, Statement of Financial Accounting Standards No. 2 and Financial
Accounting Standards Board Interpretation No. 4. Prior to 2000, CASA primarily
sold its Adaptive Dynamic Marketing ("ADM") ASP solution to businesses to
improve revenue and customer retention. At the time of acquisition, CASA had a
number of new technologies under development related to account management
algorithms and pricing algorithms. These in-process R&D projects were estimated
to achieve technological feasibility in the second quarter of 2000.
We used an independent appraisal firm to assist us with our valuation of the
fair market value of the purchased assets of CASA. Fair market value is defined
as the estimated amount at which an asset might be expected to be exchanged
between a willing buyer and willing seller assuming the buyer continues to use
the assets in its current operations. The in-process R&D projects were valued
through the use of a discounted cash flow analysis, taking into account
projected future cash flows associated with these projects once they achieve
technological feasibility, their stage of completion as of the acquisition date,
and the expected return requirements (i.e. discount rate) for present valuing of
the projected cash flows. Stage of completion was estimated by considering time,
cost, and complexity of tasks completed prior to the acquisition as a percentage
of total time, cost and effort required for the total project up to achieving
technological feasibility.
With respect to the projected financial information provided to the appraiser,
CASA prepared a detailed set of projections forecasting revenue from the new
algorithms as well as gross profit and operating profit margins. These
projections were made based on an assessment of customer needs and the expected
pricing and cost structure.
With respect to the discount rates used in the valuation approach, the
incomplete technology represents a mix of near and mid-term prospects for the
business and imparts a level of uncertainty to its prospects. A reasonable
expectation of return on the incomplete technology would be higher than that of
completed technology due to these inherent risks. As a result, the earnings
associated with incomplete technology were discounted at a rate of 27% based
upon the following methodology:
The Capital Asset Pricing Model was used to determine the cost of equity. It
combines a risk free rate of return with an equity risk premium multiplied by a
factor, referred to as Beta, which is based on the
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
performance of common stock prices of similar publicly traded companies.
Employing these data, the discount rate attributable to the business was 22%,
which was used for valuing completed technology. Since incomplete technology
would require a higher return than completed technology, the valuation report
prepared by the Company's appraiser used a rate of 27% to present value cash
flows (in excess of a return on other assets of the business) attributable to
in-process research and development projects.
The CASA in-process research and development projects continue to progress, in
all material respects, consistently with our original assumptions that were
provided to the independent appraiser and used to value the in-process research
and development.
These statements regarding revenues and expenses are forward-looking statements,
which are subject to risks and uncertainties. Actual results may differ
materially from those anticipated. Our inability to complete the in-process
technologies within the expected timeframes could materially impact future
revenues and earnings, which could have a material adverse effect on our
business, financial condition and results of operations.
OPERATING INCOME (LOSS)
The above factors resulted in operating loss of $21.0 million in the first
quarter of 2000, constituting 38.5% of total revenues in the same period, and
operating income of $3.7 million in the first quarter of 1999, constituting 7.5%
of total revenues in the same period.
OTHER INCOME (EXPENSE)
Other income for the first quarter of 2000 was $2.0 million, compared to other
income of $0.3 million in the first quarter of 1999. Other income is comprised
primarily of interest income earned on cash and investment balances, net of
interest expense related to the 4.75% Convertible Subordinated Notes due 2003.
This increase in other income was attributable primarily to an increase in
interest income as a result of higher cash and investment balances. The higher
cash and investment balances are related to cash proceeds from: $18.6 million in
stock options exercised, $5.6 million from the sale of receivables, and $2.3
million of net cash acquired in conjunction with the acquisitions of AIM, CASA,
and Onyx.
INCOME TAXES
The income tax benefit was $4.4 million in the first quarter of 2000, compared
to an income tax expense of $1.9 million in the first quarter of 1999. The
income tax benefit for the first quarter of 2000 includes the effects of:
non-deductible, one-time write-offs of in-process research and development
related to the purchases of AIM, CASA and Onyx; Retek minority interest;
stock-based compensation expense; and non-deductible acquisition related
amortization expense. The income tax expense for the first quarter of 1999
includes non-deductible acquisition related amortization expense. These
provisions are based on our estimates of the effective tax rates during those
respective full fiscal years.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $5.0 million in the first quarter
of 2000, compared to $8.8 million in the first quarter of 1999. Net cash
provided by operating activities in 2000 was primarily attributable to $9.7
million of net cash flow provided by operations, offset by $4.7 million of net
working capital requirements. The change in cash flows from operations primarily
reflects the increase in net income before non-cash items. The net working
capital requirements primarily reflect increases of $19.0 million deferred
income taxes that were primarily offset by an increase of $10.3 million deferred
revenue.
Net cash used in investing activities was $38.5 million in the first quarter of
2000, compared to $7.1 million in the first quarter of 1999. Net cash used for
purchases, sales and maturities of investments during the first quarter in 2000
was $32.1 million. Contributing to net cash used in investing activities was
$7.1 million expended for the purchase of property and equipment. We received
$4.2 million in cash, offset by $1.9 million in cash paid, as a result of our
acquisitions of AIM, CASA and ONYX.
Net cash provided by financing activities was $25.7 million in the first quarter
of 2000, compared to $16.8 million of cash used in financing activities in the
first quarter of 1999. In 2000, the net proceeds from the
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
issuance of HNC and Retek common stock provided $20.1 million, and the sales of
receivables provided $5.6 million.
As of March 31, 2000, we had $256.6 million in cash, cash equivalents and
investments available for sale. We believe that our current cash, cash
equivalents and investments available for sale balances, borrowings under our
credit facility and net cash provided by operating activities, will be
sufficient to meet our working capital and capital expenditure requirements for
at least the next 12 months. We expect to continue making significant
investments in capital assets, including computer equipment and building
improvements, during 2000. We intend to invest our cash in excess of current
operating requirements in short-term, interest-bearing, investment-grade
securities. A portion of our cash could also be used to acquire or invest in
complementary businesses or products or otherwise to obtain the right to use
complementary technologies or data. The proceeds from the Notes will continue to
be used for general corporate purposes, including working capital and possibly
to acquire complementary businesses, products or technologies. From time to
time, in the ordinary course of business, we evaluate potential acquisitions of
businesses, products, technologies or data.
During April 2000, we repurchased 250 shares of our outstanding common stock for
our treasury at an aggregate purchase price of $18,616.
During March 1998, we completed an offering of $100,000 of 4.75% Convertible
Subordinated Notes, or the Notes, due on March 1, 2003. We fully and
unconditionally guarantee the Notes. The Notes are convertible into our common
stock at any time prior to the close of business on the maturity date at a
conversion rate of 22.30 shares per $1,000 principal amount of the Notes
(equivalent to a conversion price of $44.85 per share). We have the right to
redeem the Notes, in whole or in part, on or after March 6, 2001, at redemption
prices (plus accrued interest), as follows: a premium of 101.9 after one year,
100.95 after two years, and at par as of the third year. As a result of the
Retek spin-off that we intend to complete during 2000, and pursuant to a
resolution by our Board of Directors, our Notes conversion price may be
significantly reduced based upon a formula that calculates a revised conversion
rate using the relative per common share values of HNC and Retek as of the date
of the spin. The Retek spin-off is subject to a favorable revenue ruling from
the Internal Revenue Service and other conditions, including approval of our
Board of Directors.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities", or FAS 133. This statement establishes a new model for
accounting for derivatives and hedging activities. Under FAS 133, all
derivatives must be recognized as assets and liabilities and measured at fair
value. In July 1999, the FASB issued Statement of Accounting Standards No. 137
"Accounting for Derivative Instruments and Hedging Activities- Deferral of the
Effective Date of FASB Statement No. 133" which defers the adoption requirement
to the first quarter of 2001. We have not yet determined the impact of the
adoption of this new accounting standard on our consolidated financial position,
results of operations or disclosures.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements", or SAB 101,
which provides additional guidance in applying generally accepted accounting
principles for the recognition and reporting of revenue for certain transactions
that existing accounting rules do not specifically address. An amendment in
March 2000 delayed SAB 101's effective date until the second quarter of 2000. We
are currently evaluating the impact, if any, that SAB 101 may have on our
consolidated financial statements.
In January 200, the Financial Accounting Standards Board's Emerging Issues Task
Force published Issue No. 00-2 "Accounting for Web Site Development Costs", or
EITF 00-2. EITF 00-2 applies the guidance given in the American Institute of
Certified Public Accountants's Statement of Position 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use", or SOP 98-1,
to Web site development costs. Under SOP 98-1, software development costs,
consisting of internally developed
21
22
HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
software and Web site development costs, include internal and external costs
incurred to develop internal-use computer software during the application
development stage are capitalized. Application development stage costs generally
include software configuration, coding, installation to hardware and testing.
Costs of significant upgrades and enhancements that result in additional
functionality are also capitalized. Costs incurred for maintenance and minor
upgrades and enhancements are expensed as incurred. The estimated useful lives
are based on planned or expected significant modification or replacement of
software applications, in response to the rapid rate of change in the internet
industry and technology in general. Adoption of EITF 00-2 is required for the
third quarter of 2000. We have not yet determined the impact of the adoption of
this new accounting standard on our consolidated financial position, results of
operations or disclosures.
22
23
RETEK INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS
MARCH 31, DECEMBER 31,
2000 1999
--------- ---------
(unaudited)
Current assets:
Cash and cash equivalents $ 61,891 $ 83,680
Short-term investments available for sale - debt 2,000 --
Trade accounts receivable, net 22,505 24,383
Current portion of deferred income taxes 1,589 11,177
Other current assets 6,606 5,560
--------- ---------
Total current assets 94,591 124,800
--------- ---------
Property and equipment, net 12,133 8,291
Intangible assets, net 8,233 8,958
Deferred income taxes, less current portion 30,668 12,151
Other assets 41 33
--------- ---------
$ 145,666 $ 154,233
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,998 $ 5,946
Accrued liabilities 7,932 3,030
Deferred revenue 14,233 5,883
Payable to HNC Software Inc. 80 15,399
--------- ---------
Total current liabilities 27,243 30,258
--------- ---------
Deferred revenue, net of current portion 381 --
--------- ---------
Total liabilities 27,624 30,258
--------- ---------
Stockholders' equity:
Preferred stock, $0.01 par value -- 5,000 shares
authorized; no shares issued and outstanding; -- --
Common stock, $0.01 par value -- 150,000 and 1
share authorized; 46,503 shares and 1 share issued 465
465
Paid-in capital 142,998 140,089
Unearned stock-based compensation (17,348) (19,978)
Accumulated other comprehensive loss (768)
(582)
Retained earnings (deficit) (7,305) 3,981
--------- ---------
Total stockholders' equity 118,042 123,975
--------- ---------
$ 145,666 $ 154,233
========= =========
See accompanying notes to consolidated financial statements.
23
24
RETEK INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except share and per share data)
(unaudited)
THREE MONTHS ENDED
MARCH 31,
------------------------
2000 1999
-------- --------
Revenues:
License and maintenance $ 6,430 $ 11,658
Services and other 7,534 4,989
-------- --------
Total revenues 13,964 16,647
-------- --------
Operating expenses:
License and maintenance (net of non-cash stock-based
compensation expense of $122 in 2000) 4,168 1,404
Services and other (net of non-cash stock-based
compensation expense of $394 in 2000) 5,509 2,885
-------- --------
Total cost of revenues 9,677 4,289
-------- --------
Gross profit 4,287 12,358
Research and development (net of non-cash stock-based
compensation expense of $1,291 in 2000) 8,008 4,277
Sales and marketing (net of non-cash stock-based
compensation expense of $575 in 2000) 8,671 3,818
General and administrative (net of non-cash stock-based
compensation income of $248 in 2000 and acquisition-
related amortization of $779 in 2000 and $258 in 1999) 2,303 1,188
Amortization of stock-based compensation 2,630 --
Acquisition-related amortization of intangibles 779 258
-------- --------
Total operating expenses 22,391 9,541
Operating (loss) income (18,104) 2,817
Other income, net 1,042 16
-------- --------
Income (loss) before income tax provision (benefit) (17,062) 2,833
Income tax provision (benefit) (5,776) 1,145
-------- --------
Net income (loss) $(11,286) $ 1,688
======== ========
Earnings per share:
Basic net income (loss) per common share $ (0.24)
========
Diluted net income (loss) per common share $ (0.24)
========
Pro forma unaudited basic net income per common share $ 0.04
========
Shares used in computing basic net income (loss) per common share 46,503
========
Shares used in computing diluted net income (loss) per common share 46,503
========
Shares used in computing pro forma unaudited basic net income per
common share 40,000
========
See accompanying notes to consolidated financial statements.
24
25
RETEK INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
THREE MONTHS ENDED
MARCH 31,
2000 1999
-------- --------
Cash flows from operating activities:
Net (loss) income $(11,286) $ 1,688
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Provision for doubtful accounts 149 270
Depreciation and amortization expense 1,587 873
Amortization of stock-based compensation 2,630 --
Deferred income tax benefit (8,929) (43)
Tax benefit from stock option transactions 3,153 --
Changes in assets and liabilities:
Accounts receivable 1,729 (2,396)
Other assets (1,047) 2,223
Accounts payable (948) (1,124)
Accrued liabilities 4,903 (1,020)
Deferred revenue 8,732 617
-------- --------
Net cash provided by operating activities 673 1,088
-------- --------
Cash flows from investing activities:
Net purchases of investments available for sale (2,000) --
Acquisitions of property and equipment (4,714) (1,916)
-------- --------
Net cash used in investing Activities (6,714) (1,916)
-------- --------
Cash flows from financing activities:
Costs incurred related to issuance of common stock
(243) --
Borrowings from HNC Software Inc 80 14,440
Repayments to HNC Software Inc (15,399) (12,269)
-------- --------
Net cash provided by (used in) financing activities (15,562) 2,171
-------- --------
Effect of exchange rate changes on cash (186) (223)
-------- --------
Net increase (decrease) in cash and cash equivalents (21,789) 1,120
Cash and cash equivalents at beginning of period 83,680 415
-------- --------
Cash and cash equivalents at end of period $ 61,891 $ 1,535
======== ========
See accompanying notes to consolidated financial statements.
25
26
RETEK INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
(in thousands)
(unaudited)
ACCUMULATED
UNEARNED OTHER
COMMON STOCK PAID-IN STOCK-BASED COMPREHENSIVE
SHARES AMOUNT CAPITAL COMPENSATION INCOME (LOSS)
--------- --------- --------- ------------ -------------
BALANCE AT DECEMBER 31, 1999 ...... 46,503 $ 465 $ 140,089 $ (19,978) $ (582)
Tax benefit from HNC Software
Inc. stock options .............. 3,152
Common stock issuance costs ....... (243)
Amortization of stock-based
compensation .................... 2,630
Foreign currency translation
Adjustment ...................... (186)
Net loss ..........................
--------- --------- --------- --------- ---------
BALANCE AT MARCH 31, 2000 ......... 46,503 $ 465 $ 142,998 $ (17,348) $ (768)
========= ========= ========= ========= =========
TOTAL
RETAINED STOCKHOLDERS' COMPREHENSIVE
EARNINGS EQUITY INCOME (LOSS)
--------- ------------- --------------
BALANCE AT DECEMBER 31, 1999 ...... $ 3,981 $ 123,975
Tax benefit from HNC Software
Inc. stock options .............. 3,152
Common stock issuance costs ....... (243)
Amortization of stock-based
compensation .................... 2,630
Foreign currency translation
Adjustment ...................... (186) $ (186)
Net loss .......................... (11,286) (11,286) (11,286)
--------- --------- ---------
BALANCE AT MARCH 31, 2000 ......... $ (7,305) $ 118,042 $ (11,472)
========= ========= =========
See accompanying notes to consolidated financial statements.
26
27
RETEK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 1 -- THE COMPANY AND BASIS OF PRESENTATION
The Company
Retek Inc. and its wholly owned subsidiaries, Retek Information Systems, Inc.
and WebTrak Limited ("Retek" or the "Company") develop Internet based
business-to-business commerce networks, warehouse management software solutions,
and market and support management decision software products for retailers and
their trading partners. The Internet based business-to-business commerce
networks provide retailers a single point of access for all members of the
retail supply chain. Additional solutions offered through the retail.com portal
provide a collaborative approach to traditional retail challenges. These
solutions are designed to increase efficiencies by sharing data among retailers
and their trading partners, effectively shortening their supply chains. The
predictive software solutions employ proprietary neural-network predictive
decision engines, profiles, traditional statistical modeling, business models,
expert rules and context vectors to convert existing data and business
experiences into meaningful recommendations and actions. The Company is
headquartered in Minneapolis, Minnesota.
Basis of Presentation
We have prepared the accompanying interim condensed consolidated financial
statements, without audit, in accordance with the instructions to Form 10-Q and,
therefore, do not necessarily include all information and footnotes necessary
for a fair presentation of our financial position, results of operations and
cash flows in accordance with generally accepted accounting principles.
In our opinion, the accompanying unaudited financial information for interim
periods presented reflects all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation. These condensed consolidated
financial statements and notes thereto should be read in conjunction with our
audited financial statements and notes thereto presented in our Annual Report on
Form 10-K for the fiscal year ended December 31, 1999. The interim financial
information contained in this Report is not necessarily indicative of the
results to be expected for any other interim period or for an entire fiscal
year.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
effect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Certain prior year balances
have been reclassified to conform to the current presentation.
Revenue Recognition
The Company recognizes software license revenue upon meeting each of the
following criteria: execution of a license agreement or contract; delivery of
software; the license fee is fixed and determinable; collectibility of the
proceeds is assessed as being probable; and vendor specific objective evidence
exists to allocate the total fee to elements of the arrangement. Vendor-specific
objective evidence is based on the price charged when an element is sold
separately, or if not yet sold separately, is established by authorized
management. Starting in the fourth quarter of 1999, we revised the terms of the
software licensing agreements for the majority of our software products sold.
Under these terms, we will provide technical advisory services after the
delivery of our products to help our customers exploit the full value and
functionality of our products. Revenue from the sale of software licenses under
these agreements is recognized over the period that the technical advisory
services are performed. For sales made through distributors, resellers and
original equipment manufacturers, we recognize revenue at the time these
partners report to us that they have sold the software to the end user and all
revenue recognition criteria have been met. Service revenue includes maintenance
revenue, which is deferred and recognized ratably over the maintenance period,
and revenue from consulting and training services, which is recognized as
services are performed. Consulting services are customarily billed at a fixed
daily rate plus out-of-pocket expenses.
27
28
RETEK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Revenue from contract development 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.
Deferred revenue consists primarily of deferred maintenance revenue.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Accounting Standards No. 133 ("FAS 133"), "Accounting for Derivative
Instruments and Hedging Activities" which is effective for all fiscal quarters
of fiscal years beginning after June 15, 1999. This statement establishes a new
model for accounting for derivatives and hedging activities. Under FAS 133, all
derivatives must be recognized as assets and liabilities and measured at fair
value. In July 1999, the FASB issued Statement of Accounting Standards No. 137
"Accounting for Derivative Instruments and Hedging Activities -- Deferral of the
Effective Date of FASB Statement No. 133" which defers the effective date to all
fiscal quarters of fiscal years beginning after June 15, 2000. The adoption of
FAS 133 is not expected to have a significant impact on our consolidated
financial position or results of operations.
In January 200, the Financial Accounting Standards Board's Emerging Issues Task
Force published Issue No. 00-2 "Accounting for Web Site Development Costs", or
EITF 00-2. EITF 00-2 applies the guidance given in the American Institute of
Certified Public Accountants's Statement of Position 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use", or SOP 98-1,
to Web site development costs. Under SOP 98-1, software development costs,
consisting of internally developed software and Web site development costs,
include internal and external costs incurred to develop internal-use computer
software during the application development stage are capitalized. Application
development stage costs generally include software configuration, coding,
installation to hardware and testing. Costs of significant upgrades and
enhancements that result in additional functionality are also capitalized. Costs
incurred for maintenance and minor upgrades and enhancements are expensed as
incurred. The estimated useful lives are based on planned or expected
significant modification or replacement of software applications, in response to
the rapid rate of change in the internet industry and technology in general.
Adoption of EITF 00-2 is required for the third quarter of 2000. We have not yet
determined the impact of the adoption of this new accounting standard on our
consolidated financial position, results of operations or disclosures.
NOTE 2 -- PER SHARE DATA
Basic net loss per share is calculated by dividing net loss by the weighted
average of common shares outstanding during the period. Net income per share,
assuming dilution is calculated by dividing net income by the weighted average
number of common and common equivalent shares outstanding during each period.
Our only common stock equivalents are those that result from dilutive common
stock options. The calculation of dilutive earnings per share for the three
months March 31, 2000 and 1999 is applicable as a net loss was realized. Share
used in the computations for the three months ended March 31, 2000 and 1999 are
as follows:
Three Months Ended
March 31,
--------------------
2000 1999
------ ------
(in thousands)
Shares used in computing basic and diluted net
loss per common share 46,503
Shares used in computing proforma unaudited
basic and diluted net income per common share 40,000
28
29
RETEK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 3 -- SUBSEQUENT EVENTS
On May 10, 2000, Retek completed its acquisition of HighTouch Technologies,
Inc., or HighTouch, a provider of real-time transaction management and customer
service solutions that support multi-channel customer interactions. HighTouch
owns certain direct consumer management technologies that Retek has incorporated
into its Retek Retail CRM, an enterprise-level customer interaction system. In
connection with the purchase of HighTouch, Retek paid $18,000 in cash and issued
approximately 389,057 shares of its common stock to the former sole shareholder
of HighTouch. This transaction will be accounted for under the purchase method
of accounting. Accordingly, the purchase price will be allocated to the
estimated fair value of assets acquired, liabilities assumed and purchased
in-process research and development.
29
30
RETEK INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of Retek's, financial condition and results of
operations should be read in conjunction with Retek's consolidated financial
statements and the related notes, and the other financial information included
in Retek's Quarterly Report on Form 10-Q. This discussion and analysis contains
forward-looking statements that involve risks and uncertainties. Retek's actual
results may differ materially from those anticipated in these forward-looking
statements as a result of specified factors, including those set forth in the
section below entitled "Factors That May Impact Future Results of Operations"
and elsewhere in this Quarterly Report on Form 10-Q. Retek is a subsidiary of
HNC Software Inc., and in this Report, HNC Software Inc. is referred to as "we,"
"our," and "HNC".
OVERVIEW
Retek completed its initial public offering on November 23, 1999. Prior to the
completion of Retek's initial public offering, they were our wholly owned
subsidiary. As of March 31, 2000, we owned approximately 86.0% of Retek's
outstanding common stock. We have informed Retek that it is our current
intention to distribute pro rata to our stockholders, as a dividend, all of the
shares of Retek's common stock that we own, subject to the satisfaction and
fulfillment of several conditions, including the receipt of a written ruling
from the Internal Revenue Service that the distribution qualifies for tax-free
treatment under Section 355 of the Internal Revenue Code. However, we have the
sole discretion to determine whether we will carry out the distribution, and if
the distribution is carried out, the timing, structure and terms of the
distribution.
Retek's business combines the business activities of Retek Information Systems,
Inc. and Retek Inc., formerly Retek Logistics, Inc. Founded in 1995, Retek
Information Systems, a developer and marketer of Internet-based,
business-to-business software solutions for retailers, was acquired by HNC in
1996. Neil Thall Associates, Inc., a developer of predictive software solutions
for retailers and a wholly owned subsidiary of HNC since 1991, was merged into
Retek Information Systems in April 1997. Financial results of Neil Thall
Associates are included in all periods presented. Founded in 1985 as Practical
Control Solutions, Inc. Retek Logistics, a developer of warehouse management
software solutions, was acquired by HNC in 1998. On September 9, 1999, Retek
Logistics was reincorporated as a Delaware corporation and renamed "Retek Inc."
Immediately prior to the completion of our initial public offering on November
23, 1999, in connection with the separation of our business from HNC, HNC
contributed all of the outstanding capital stock of Retek Information Systems to
Retek Inc. Retek Information Systems currently operates as a wholly owned
subsidiary.
Our acquisition of Retek Information Systems allowed for the integration of
HNC's patented predictive technology into Retek's software solutions for
retailers. Retek formalized a marketing relationship with Oracle in September
1998, providing Retek with an effective partnership with a world leader in
electronic commerce, an international channel to the largest retailers and the
support of Oracle's worldwide sales force.
Total revenue decreased from $16.6 million in the first quarter of 1999 to $14.0
million in the first quarter of 2000. Retek generates revenue from the sale of
software licenses, maintenance and support contracts, and professional
consulting and contract development services. Until the fourth quarter of 1999,
Retek generally licensed products to customers on a perpetual basis and
recognized revenue upon delivery of the products. Starting in the fourth quarter
of 1999, Retek revised the terms of our software licensing agreements for the
majority of our software products sold. Under the revised terms, Retek provides
technical advisory services after the delivery of its products to help customers
exploit their full value and functionality. Revenue from the sale of software
licenses under these agreements will be recognized as the technical advisory
services are performed. Retek expects the periods of technical advisory services
will generally be from 12 to 24 months, as determined by the customers'
objectives. As Retek begins to recognize license and service revenue over a
period of time, rather than upon delivery of the product, it will recognize
significantly less revenue, have lower associated margins for several quarters,
as compared to previous quarters, have higher operating expenses as a percentage
of total revenues and incur operating losses for several quarters. Deferred
revenue consists principally of the unrecognized portion of revenue received
under license and maintenance service agreements. Deferred license revenue is
recognized ratably or as a percentage of completion based on the contract terms.
Deferred maintenance revenue is recognized ratably over the term of the service
agreement.
30
31
RETEK INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
Customers who license Retek's software generally purchase maintenance contracts,
typically covering renewable annual periods. In addition, customers may purchase
consulting services, which are customarily billed at a fixed daily rate plus
out-of-pocket expenses. Contract development services, including new product
development services, are typically performed for a fixed fee. Retek also offers
training services that are billed on a per student or per class session basis.
The growth in Retek's customer base has resulted from a combination of increased
market penetration and an expanding product offering. Retek's investment in
research and development, acquisitions and alliances have helped bring new
software solutions to market. These investments produced a suite of decision
support solutions in 1997; the re-tooling of its applications for the Web in
1998; and the delivery of Internet-based, business-to-business collaborative
planning, critical path and product design solutions in 1999; and several
additional collaborative offerings on the retail.com network through the first
quarter of 2000. To support Retek's growth during these periods, it also
continued to invest in internal infrastructure by hiring employees throughout
various departments of the organization.
Retek markets its software solutions worldwide through direct and indirect sales
channels. Revenue generated from direct sales channel accounted for
approximately 2.6% and 14.4% of its total revenue in the first quarter of 2000
and the first quarter of 1999, respectively. Indirect sales channel revenue
arises from our relationship with Oracle.
On October 29, 1999, Retek completed the purchase of all the outstanding capital
stock of WebTrak Limited. WebTrak owns the WebTrack Critical Path and Portfolio
Private Label products that Retek currently distributes. In connection with the
purchase of WebTrak, Retek issued to former WebTrak shareholders notes, which
were due on November 26, 1999, in the principal amount of $5.33 million and a
convertible note, which was due on November 26, 1999, in the principal amount of
$2.67 million. The convertible note was at the option of the holder convertible
at the time of payment into the number of shares of Retek's common stock equal
to the principal amount of the note divided by the initial offering price of
$15.00. On November 29, 1999 Retek issued 177,778 shares of its common stock to
the holder of the convertible note in full satisfaction of its obligations. The
remaining notes were paid in full on their due date.
On May 10, 2000, Retek completed its purchase of all of the outstanding capital
stock of HighTouch Technologies, Inc., or HighTouch, a provider of real-time
transaction management and customer service solutions, which support
multi-channel customer interactions. HighTouch owns certain direct consumer
management technologies that Retek has incorporated into its Retek Retail CRM,
an enterprise-level customer interaction system. In connection with the purchase
of HighTouch, Retek paid $18.0 million in cash and issued approximately 389,057
shares of its common stock to the former sole shareholder of HighTouch.
Revenue attributable to customers outside of North America accounted for
approximately 31.2% and 58.0% of Retek's total revenue in the first quarter of
2000 and the first quarter of 1999, respectively. Approximately 11.2% and 41.4%
of Retek's sales were denominated in currencies other than the U.S. dollar for
the first quarter of 2000 and the first quarter of 1999, respectively.
Retek primarily sells perpetual licenses for which it recognizes revenue in
accordance with generally accepted accounting principles, upon meeting each of
the following criteria:
- execution of a written purchase order, license agreement or
contract;
- delivery of software authorization keys;
- the license fee is fixed and determinable;
- collectibility of the proceeds is assessed as being probable; and
- vendor-specific objective evidence exists to allocate the total fee
to elements of the arrangement.
31
32
RETEK INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
Vendor-specific objective evidence is based on the price charged when an element
is sold separately, or if not yet sold separately, is established by authorized
management. All elements of each order are valued at the time of revenue
recognition. Retek recognizes revenue:
- for sales made through our distributors, resellers and original
equipment manufacturers, at the time these partners report to us
that they have sold the software to the end-user and after all
revenue recognition criteria have been met;
- from maintenance agreements related to our software, over the
respective maintenance periods;
- from customer modifications, as the services are performed using the
percentage of completion method; and
- from services, using the percentage of completion method, based on
costs incurred to date compared to total estimated costs at
completion.
Retek records amounts received under contracts in advance of performance as
deferred revenue and generally recognize these amounts within one year from
receipt. Any amount not to be recognized within one year of receipt recorded in
non-current deferred revenue.
32
33
RETEK INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
RESULTS OF OPERATIONS
The following table presents selected financial data for the periods indicated
as a percentage of our total revenue. Our historical reporting results are not
necessarily indicative of the results to be expected for any future period.
AS A PERCENTAGE OF
TOTAL REVENUE
THREE MONTHS ENDED
MARCH 31,
2000 1999
---- ----
Revenue:
License and maintenance ................................ 46.0% 70.0%
Services and other ..................................... 54.0 30.0
Total revenue .................................. 100.0 100.0
Cost of revenue:
License and maintenance ................................ 29.8 8.4
Services and other ..................................... 39.5 17.4
Total cost of revenue .......................... 69.3 25.8
Gross margin ............................................. 30.7 74.2
Operating expenses:
Research and development ............................... 57.3 25.7
Sales and marketing .................................... 62.1 22.9
General and administrative ............................. 16.5 7.2
Amortization of stock-based compensation ............... 18.8 -
Acquisition related amortization of intangibles ........ 5.6 1.5
Total operating expenses ....................... 160.3 57.3
Operating (loss) income .................................. (129.6) 16.9
Other income, net ........................................ 7.5 0.1
(Loss) income before income tax (benefit) provision ...... (122.1) 17.0
(Loss) income tax (benefit) provision .................... 41.4 6.9
Net (loss) income ........................................ (80.7) 10.1
Cost of license and maintenance revenue, as a
percentage of license and maintenance revenue ............ 64.8 12.0
Cost of services and other revenue, as a percentage of
services and other revenue ............................... 73.1 57.8
REVENUES
TOTAL REVENUES. Total revenue decreased 16.1% to $14.0 million in the first
quarter of 2000 from $16.6 million in the first quarter of 1999.
LICENSE AND MAINTENANCE REVENUES. License and maintenance revenue decreased
44.8% to $6.4 million in the first quarter of 2000 from $11.7 million in the
first quarter of 1999. The decrease in license revenue in the first quarter of
2000 was primarily due to the revised terms used in writing Retek's license
contracts. As noted above in the section entitled "Overview", Retek recently
revised the terms of its software license agreements so that revenue is
recognized over a number of quarters rather than upon delivery. As a result,
year over year quarter revenue decreased in the first quarter of 2000 compared
to the first quarter of 1999. However, the average dollar contract value per
customer increased for the same time period; the decrease in revenue was due to
the revised terms of Retek's software license agreements. Maintenance revenue
increased $2.5 million in the first quarter of 2000 due to a growing base of
customers that have installed Retek's software solutions.
SERVICES AND OTHER REVENUES. Services and other revenues increased 51.0% to $7.5
million in the first quarter of 2000 from $5.0 million in the first quarter of
1999. The increase was due to $2.5 million increase in consulting services and
custom development projects. The number of billable employees increased to 81 as
of March 31, 2000 from 60 as of March 31, 1999. Services and other revenue
balances fluctuate
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RETEK INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
based on Retek's use of third party consultants. Third party consultants are
used on an as needed basis depending upon Retek's allocation of internal
resources.
COST OF REVENUES
COST OF LICENSE AND MAINTENANCE REVENUES. Cost of license and maintenance
revenue consists primarily of fees for third party software products that are
integrated into Retek's products; salaries and related expenses of its customer
support organization; and an allocation of its facilities and depreciation
expense. Cost of license and maintenance revenue increased 196.9% to $4.2
million in the first quarter of 2000 from $1.4 million in the first quarter of
1999. In the first quarter of 2000, start-up expenses were incurred to support
the implementation of the network for retail.com sales. In addition, as license
and maintenance revenue increases, Retek expects to experience increased costs
resulting from increased royalty fees and an increase in the number of support
personnel required to service its growing customer base. Retek expects the cost
of license and maintenance revenue to continue to increase in absolute dollars
as license and maintenance revenue increases.
COST OF SERVICES AND OTHER REVENUES. Cost of services and other revenues
includes salaries and related expenses of Retek's consulting organization; cost
of third parties contracted to provide consulting services to its customers; and
an allocation of facilities and depreciation expense. Cost of services and other
revenues increased 91.0% to $5.5 million in the first quarter of 2000 from $2.9
million in the first quarter of 1999. As a percentage of services and other
revenue, cost of services and other revenue was 73.1% in the first quarter of
2000 and 57.8% in the first quarter of 1999. The increase in costs as a
percentage of revenues in the first quarter are due to additional fixed fees
billed in the first quarter of 1999 that did not require additional costs to
complete. During the first quarter of 2000 Retek continued to expand its
consulting services business by increasing the number of personnel to 81 from 60
in the first quarter of 1999.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expense, which is expensed as incurred, consists
primarily of salaries and related costs within Retek's engineering organization;
fees paid to third-party consultants; and an allocation of facilities and
depreciation expenses. Retek has increased its investment in research and
development in absolute dollars each year since 1995. Research and development
expense increased 87.2% to $8.0 million in the first quarter of 2000 from $4.3
million in the first quarter of 1999. The absolute dollar increase in research
and development expense was due to significant increases in labor costs, which
included hired personnel and third party consultants. In the first quarter of
2000, research and development personnel increased to 265 from 120 in the first
quarter of 1999. Retek also invested heavily in the development of new
retail.com solutions during the first quarter of 2000. Retek expects the
absolute dollar increase in research and development to continue as it invests
in the development of other new solutions.
SALES AND MARKETING EXPENSE
Sales and marketing expense consists primarily of salaries and related costs of
the sales and marketing organization; sales commissions; costs of marketing
programs, including public relations, advertising, trade shows, collateral sales
materials, and the customer user reference group program; rent and facilities
costs associated with our regional and international sales offices; and an
allocation of facilities and depreciation expense. Sales and marketing expense
increased 127.1% to $8.7 million in the first quarter of 2000 from $3.8 million
in the first quarter of 1999. The increase was due to increases of $1.5 million
in personnel and related costs, $1.5 million in marketing expense and $0.07
million in travel expenses. In the first quarter of 2000 personnel and related
costs increased due to an increase in the number of sales and marketing
employees to 118 from 61 in the first quarter of 1999. The increase in personnel
and related costs was due to the continued build up of Retek's sales force and
marketing operations for the new product offering of retail.com during the first
quarter of 2000.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expense consists primarily of costs from Retek's
finance and human resources organizations; third party legal and other
professional services fees; and an allocation of facilities costs and
depreciation expenses. General and administrative expense increased 93.9% to
$2.3 million in the
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RETEK INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
first quarter of 2000 from $1.2 million in the first quarter of 1999. The
increase in absolute dollars in general and administrative expense in the first
quarter of 2000 was attributable to the growth of the administrative
organization to support Retek's overall growth. The increase in the first
quarter of 2000 was also due to additional compliance expenses associated with
being an independent public company. In the first quarter of 2000 total general
and administrative employees increased to 51 from 31 in the first quarter of
1999. Retek expects general and administrative expense to increase in absolute
dollars in the foreseeable future to support infrastructure growth.
STOCK-BASED COMPENSATION EXPENSE
Deferred stock-based compensation represents the difference between the exercise
price and the fair value of Retek's common stock for accounting purposes on the
date that certain stock options were granted. This amount is included as a
component of stockholders' equity and is being amortized on an accelerated basis
by charges to operations over the vesting period of the options, consistent with
the method described in Financial Accounting Standards Board Interpretation No.
28. Retek granted stock options to its employees under the 1999 Equity Incentive
Plan and to members of its board of directors through both the 1999 Equity
Incentive Plan and the 1999 Directors Stock Option Plan. Through March 31, 2000,
Retek had stock options granted to employees to purchase 7,514,250 shares and to
members of its board of directors to purchase 100,000 shares of its common stock
at an exercise price of $10 per share. Amortization of stock-based compensation
was $2.6 million for the first quarter in 2000.
ACQUISITION-RELATED AMORTIZATION EXPENSE
Acquisition-related amortization expense increased to $0.8 million for the
quarter ended March, 31, 2000 from $0.3 million for the quarter ended March 31,
1999. In connection with the purchase of WebTrak in the fourth quarter of 1999,
the application of the purchase method for the acquisition resulted in an excess
of cost over net assets acquired of $8.1 million, of which $6.6 million was
allocated to intangibles and $1.5 million was allocated to in-process research
and development. In conjunction with the purchase, Retek recorded various
intangible assets, which are being amortized over estimated useful lives ranging
from three to five years. In connection with the purchase of Retek Logistics in
1998, the application of the purchase method for the acquisition resulted in an
excess of cost over net assets acquired of approximately $5.8 million, of which
$4.0 million was allocated to intangibles and $1.8 million was allocated to
in-process research and development. In conjunction with the purchase, Retek
recorded various intangible assets, which are being amortized over estimated
useful lives ranging from three to five years.
OTHER INCOME (EXPENSE)
Other income, net increased to $1.0 million in the first quarter of 2000 from
$0.02 million in the first quarter of 1999. The increase was due to interest
income earned on investments.
INCOME TAXES
The income tax benefit was $5.8 million in the first quarter of 2000, compared
to an income tax provision of $2.0 million in the first quarter of 1999. The
income tax benefit and provision are based on Retek's estimates of the effective
tax rates to be incurred during those respective full fiscal years.
LIQUIDITY AND CAPITAL RESOURCES
Prior to its initial public offering, Retek funded operations primarily through
funding from HNC in the form of intercompany advances. Since the initial public
offering, Retek has not obtained any additional funding from HNC. At March 31,
2000, our cash and cash equivalent balance was $61.9 million. In addition, we
had investments in short-term securities of $2.0 million at March 31, 2000.
Net cash provided by operating activities was $0.7 million in the first quarter
of 2000 and $1.1 million in the first quarter of 1999. Sources of cash for the
first quarter of 2000, which offset Retek's net loss and increase in certain
assets, were depreciation and amortization and amortization of stock-based
compensation, increases in accrued liabilities and deferred revenue and
decreases in accounts receivable. Uses of cash in the first quarter of 2000 were
due to increases in non-current deferred income taxes and other assets and a
decrease in accounts payable.
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RETEK INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
Net cash used in investing activities was $6.7 million in the first quarter of
2000 and $1.9 million in the first quarter of 1999. In the first quarter of
2000, uses of cash included $4.7 million for the acquisition of capital
equipment, primarily computer equipment and software, as well as purchases of
investments.
Net cash used by financing activities was $15.6 million in the first quarter of
2000. Net cash provided by financing activities was $2.2 million in the first
quarter of 1999. Net cash used in the first quarter 2000 included $0.08 million
in borrowings from HNC and $15.4 million in payments to HNC. Beginning in 1997,
HNC implemented a cash management policy that all cash balances were transferred
daily from all of HNC's subsidiaries, including Retek, into a centralized cash
management account at HNC. The financing activities with HNC include borrowings
and payment from these cash management activities in 1999. Starting in November
1999 these daily transfers to HNC ceased.
Retek believes that the net proceeds of its initial public offering, together
with its current cash and cash equivalents and net cash provided by operating
activities, will be sufficient to meet its working capital and capital
expenditure requirements for at least the next 12 months. Retek's management
intends to invest the excess of current operating requirements in short-term,
interest-bearing, investment-grade securities.
A portion of Retek's cash could also be used to acquire or invest in
complementary businesses or products or otherwise to obtain the right to use
complementary technologies or data. Retek regularly evaluates, in the ordinary
course of business, potential acquisitions of such businesses, products,
technologies or data.
In addition, Retek's ability to enter into any acquisition of a business or
assets may be limited if HNC completes the distribution. Specifically, pursuant
to the terms of a corporate rights agreement between HNC, and Retek until two
years, and possibly longer, after the distribution of HNC's remaining shares of
Retek's common stock, Retek's ability to issue common stock in connection with
acquisitions, offerings or otherwise will be limited.
FACTORS THAT MAY IMPACT FUTURE RESULTS OF OPERATIONS
An investment in Retek's common stock involves a high degree of risk. Investors
evaluating Retek and its business should carefully consider the factors
described below and all other information contained in this Quarterly Report on
Form 10-Q before purchasing Retek common stock. Any of the following factors
could materially harm Retek's business, operating results and financial
condition. Additional factors and uncertainties not currently known to Retek or
that it currently considers immaterial could also harm its business, operating
results and financial condition. Investors could lose all or part of their
investment as a result of these factors.
While Retek's management is optimistic about our long-term prospects, the
following factors, among others, could materially harm its business, operating
results and financial condition and should be considered in evaluating Retek.
Industry's rapid pace of change. If Retek is unable to develop new software
solutions or enhancements to its existing products on a timely and
cost-effective basis, or if new products or enhancements do not achieve market
acceptance, its sales may decline. The life cycles of its products are difficult
to predict because the business-to-business electronic commerce market for
Retek's products is new and emerging and is characterized by rapid technological
change and changing customer needs. The introduction of products employing new
technologies could render its existing products or services obsolete and
unmarketable.
In developing new products and services, Retek may:
- fail to respond to technological changes in a timely or cost-effective
manner;
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RETEK INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
- encounter products, capabilities or technologies developed by others
that render our products and services obsolete or noncompetitive or that
shorten the life cycles of its existing products and services;
- experience difficulties that could delay or prevent the successful
development, introduction and marketing of these new products and
services; or
- fail to achieve market acceptance of its products and services.
Fluctuations in quarterly operating results. Retek's quarterly operating results
have fluctuated in the past and are expected to continue to fluctuate in the
future. If its quarterly operating results fail to meet analysts' expectations,
the trading price of Retek common stock could decline. In addition, significant
fluctuations in its quarterly operating results may harm business operations by
making it difficult to implement its budget and business plan. Factors, many of
which are outside of Retek's control, which could cause its operating results to
fluctuate include:
- the size and timing of customer orders, which can be affected by
customer budgeting and purchasing cycles;
- the demand for and market acceptance of its software solutions;
- competitors' announcements or introductions of new software solutions,
services or technological innovations;
- its ability to develop, introduce and market new products on a timely
basis;
- customer deferral of material orders in anticipation of new releases or
new product introductions;
- its success in expanding our sales and marketing programs;
- increased sales of Oracle Retail(TM) during its second fiscal quarter
due to seasonally greater sales by Oracle near its fiscal year-end in
May;
- technological changes or problems in computer systems; and
- general economic conditions which may affect its customers' capital
investment levels.
In addition, Retek has incurred, and will continue to incur, compensation
expense in connection with its grant of options under the 1999 Equity Incentive
Plan and the 1999 Directors Stock Option Plan. This expense will be amortized
over the vesting period of these granted options, which is generally four years,
resulting in lower quarterly income.
Quarterly expense levels are relatively fixed and are based, in part, on
expectations as to future revenue. As a result, if revenue levels fall below
Retek's expectations, net income will decrease because only a small portion of
its expenses vary with revenue.
New type of license agreement. Until recently, Retek generally licensed its
products to customers on a perpetual basis, and recognized revenue upon delivery
of the products. In the fourth quarter of 1999, Retek entered into software
licensing agreements with revised terms for the majority of new sales of
software products. Under these agreements, it will provide technical advisory
services after the delivery of the product to help customers exploit the full
value and functionality of its products. Revenue from the sale of software
licenses and technical advisory services under these agreements will be
recognized as the services are performed over the contract period, which Retek
expects will generally be 12 to 24 months, as determined by its customers'
objectives. As Retek begins to recognize license and service revenues over a
period of time, rather than upon the delivery of our products, it will recognize
significantly less revenue, have lower associated margins for several quarters,
as compared to previous quarters, have
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RETEK INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
higher operating expenses as a percentage of total revenues and will incur
operating losses for several quarters.
Early stage of development of the retail.com network. Retek began operation of
the retail.com network on September 26, 1999. Retek incurred, and will continue
to incur, significant infrastructure costs in establishing this network. During
the first quarter of 2000 it invested approximately $10.4 million in retail.com.
Retek will continue to invest in new products and services to be offered over
the retail.com network in the foreseeable future. Broad and timely acceptance of
the retail.com network is subject to a number of significant risks. These risks
include:
- its need to provide value-enhancing software solutions and services on
the retail.com network to achieve widespread commercial acceptance of
this network;
- whether its network will be able to support large numbers of retailers
and the members of their supply chains; and
- its need to significantly expand internal resources and incur associated
expenses to support planned growth of the retail.com network.
Retek has established a subscription pricing model for the software solutions
provided on its retail.com network, whereby members pay an annual fee based on
the number of the member's employees who will have access to the network. As
additional services are added to the retail.com network, Retek will need to
establish pricing models for these new services. If the pricing models for the
retail.com network fail to be competitive and profitable or if they are not
acceptable to customers, its network will not be commercially successful, which
could harm Retek's revenue and business.
Increased operating expenses. Retek intends to significantly increase operating
expenses as it:
- increases research and development activities;
- increases services activities;
- develops and build the retail.com network;
- expands its distribution channels;
- increases sales and marketing activities, including expanding our direct
sales force;
- builds its internal information technology system; and
- operates as an independent public company.
Retek will incur expenses before it generates any revenue from this increase in
spending. If it does not significantly increase revenue from these efforts, its
business and operating results could be seriously harmed.
Competitive pressures. The market for Retek's software solutions is highly
competitive and subject to rapidly changing technology. Competition could
seriously impede its ability to sell additional products and services on terms
favorable Retek. Competitive pressures could reduce its market share or require
it to reduce prices, which would reduce its revenues and/or operating margins.
Many of Retek's competitors have substantially greater financial, marketing or
other resources, and greater name recognition. In addition, these companies may
adopt aggressive pricing policies that could compel Retek to reduce the prices
of its products and services in response. Retek's competitors may also be able
to respond more quickly than Retek can to new or emerging technologies and
changes in customer requirements. Retek's current and potential competitors may:
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RETEK INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
- develop and market new technologies that render its existing or future
products obsolete, unmarketable or less competitive;
- make strategic acquisitions or establish cooperative relationships among
themselves or with other solution providers, which would increase the
ability of their products to address the needs of its customers; and
- establish or strengthen cooperative relationships with its current or
future strategic partners, which would limit its ability to sell
products through these channels.
As a result, Retek may not be able to maintain a competitive position against
current or future competitors.
Loss of key personnel. Retek believes that its future success will depend upon
its ability to attract and retain highly skilled personnel, including John
Buchanan, its chairman and chief executive officer; Gordon Masson, its
president, core applications; John L. Goedert, its senior vice president,
research and development; Gregory A. Effertz, its vice president, finance and
administration and chief financial officer and Jeremy Thomas, its president,
retail.com. Retek currently does not have any key-man life insurance relating to
key personnel, who are employees at-will and are not subject to employment
contracts except for Jeremy Thomas who has a two year employment contract. The
loss of the services of any one or more of these key persons could harm Retek's
ability to grow the business.
Retek also must attract, integrate and retain skilled sales, research and
development, marketing and management personnel. Competition for these types of
employees is intense, particularly in Retek's industry. Failure to hire and
retain qualified personnel would harm its ability to grow the business.
Relationships with third parties who implement Retek's products. Retek relies,
and expects to continue to rely, on a number of third parties to implement its
software solutions at customer sites. If Retek is unable to establish and
maintain effective, long-term relationships with these implementation providers,
or if these providers do not meet the needs or expectations of its customers,
its revenue will be reduced and its customer relationships will be harmed.
Retek's current implementation partners are not contractually required to
continue to help implement its software solutions. If the number of product
implementations continues to increase, Retek will need to develop new
relationships with additional third-party implementation providers to provide
these services.
Retek may be unable to establish or maintain relationships with third parties
having sufficient qualified personnel resources to provide the necessary
implementation services to support its needs. If third-party services are
unavailable, Retek will be required to provide these services internally, which
would significantly limit our ability to meet customers' implementation needs
and would increase its operating expenses and could reduce gross margins. A
number of Retek's competitors, including IBM and SAP, have significantly more
established relationships with these third parties and, as a result, these third
parties may be more likely to recommend competitors' products and services
rather than Retek's. In addition, it cannot control the level and quality of
service provided by its current and future implementation partners.
Intellectual property of third parties. Retek must now, and may in the future
have to, license or otherwise obtain access to the intellectual property of
third parties and related parties, including HNC, Lucent, MicroStrategy and
Oracle. Retek's business would be seriously harmed if the providers from whom it
licenses such software cease to deliver and support reliable products or enhance
their current products. In addition, the third-party software may not continue
to be available to Retek on commercially reasonable terms or prices or at all.
Retek's inability to maintain or obtain this software could result in shipment
delays or reduced sales of its products. Furthermore, it might be forced to
limit the features available in its current or future product offerings. Either
alternative could seriously harm business and operating results.
Confidentiality of intellectual property. Retek depends on its ability to
develop and maintain the proprietary aspects of its technology. To protect
proprietary technology, Retek relies primarily on a combination of contractual
provisions, confidentiality procedures, trade secrets, and copyright and
trademark laws.
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RETEK INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
Retek seeks to protect its software, documentation and other written materials
under trade secret and copyright laws, which afford only limited protection. In
addition, Retek cannot assure investors that any of its proprietary rights with
respect to the retail.com network will be viable or of value in the future
because the validity, enforceability and type of protection of proprietary
rights in Internet-related industries are uncertain and still evolving.
Despite Retek's efforts to protect its proprietary rights, unauthorized parties
may attempt to copy aspects of its products or obtain and use information that
it regards as proprietary. Policing unauthorized use of Retek's products is
difficult and expensive, and while it is unable to determine the extent to which
piracy of its software products exists, software piracy may be a problem. In
addition, the laws of some foreign countries do not protect our proprietary
rights to the same extent, as do the laws of the United States. Retek intends to
vigorously protect intellectual property rights through litigation and other
means. However, such litigation can be costly to prosecute and it cannot be
certain that it will be able to enforce its rights or prevent other parties from
developing similar technology, duplicating its products or designing around its
intellectual property.
Potential third party claims that Retek's products infringe on their
intellectual property. There has been a substantial amount of litigation in the
software industry and the Internet industry regarding intellectual property
rights. It is possible that in the future third parties may claim that Retek's
current or potential future products infringe their intellectual property. Retek
expects that software product developers and providers of electronic commerce
solutions will increasingly be subject to infringement claims as the number of
products and competitors in its industry segment grow and the functionality of
products in different industry segments overlap. Any claims, with or without
merit, could be time-consuming, result in costly litigation, cause product
shipment delays or require Retek to enter into royalty or licensing agreements.
Royalty or licensing agreements, if required, may not be available on terms
acceptable to Retek or at all, which could seriously harm its business.
International sales. Since Retek sells products worldwide, its business is
subject to risks associated with doing business internationally. To the extent
that its sales are denominated in foreign currencies, the revenue Retek receives
could be subject to fluctuations in currency exchange rates. If the effective
price of the products Retek sells to its customers were to increase due to
fluctuations in foreign currency exchange rates, demand for Retek's technology
could fall, which would, in turn, reduce its revenue. Retek has not historically
attempted to mitigate the effect that currency fluctuations may have on its
revenue through use of hedging instruments, and it does not currently intend to
do so in the future.
Retek anticipates that revenue from international operations will continue to
represent a substantial portion of its total revenue. Accordingly, its future
results could be harmed by a variety of factors, including:
- changes in foreign currency exchange rates;
- greater risk of uncollectible accounts;
- changes in a specific country's or region's political or economic
conditions, particularly in emerging markets;
- trade protection measures and import or export licensing requirements;
- potentially negative consequences from changes in tax laws;
- difficulty in staffing and managing widespread operations;
- international variations in technology standards;
- differing levels of protection of intellectual property; and
- unexpected changes in regulatory requirements.
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RETEK INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
Acceptance of the Internet. As Retek's software solutions are Internet-based, it
depends on the acceptance of the Internet as a communications protocol. However,
this acceptance may not continue. Rapid growth of the Internet is a recent
phenomenon. The Internet may not be accepted as a viable long-term
communications protocol for businesses for a number of reasons. These reasons
include:
- potentially inadequate development of the necessary communications and
computer network technology, particularly if rapid growth of the
Internet continues;
- delayed development of enabling technologies and performance
improvements;
- increased security risks in transmitting and storing confidential
information over public networks; and
- potentially increased governmental regulation.
Errors and defects in Retek's products. Retek's products are complex and,
accordingly, may contain undetected errors or failures when it first introduces
them or as it releases new versions. This may result in loss of, or delay in,
market acceptance of its products and could cause us to incur significant costs
to correct errors or failures or to pay damages suffered by customers as a
result of such errors or failures. In the past, Retek has discovered software
errors in new releases and new products after their introduction. Retek has
incurred costs during the period required to correct these errors, although to
date such costs, including costs incurred on specific contracts, have not been
material. Retek may in the future discover errors in new releases or new
products after the commencement of commercial shipments.
New accounting standards. Statement of Position 97-2, "Software Revenue
Recognition," was issued in October 1997 by the American Institute of Certified
Public Accountants and amended by Statement of Position 98-4. Retek adopted
Statement of Position 97-2 effective January 1, 1998 and Statement of Position
98-4 effective March 31, 1998. The American Institute of Certified Public
Accountants also issued Statement of Position 98-9, which is effective for
transactions entered into beginning January 1, 2000. Full implementation
guidelines for this standard and additional standards could be issued in the
future. These guidelines and additional standards could lead to unanticipated
changes in Retek's current revenue recognition policies, which could harm our
business, financial condition and operating results.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Accounting Standards No. 133 "Accounting for Derivative Instruments and
Hedging Activities" ("FAS 133"), which is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999. This statement establishes a new
model for accounting for derivatives and hedging activities. Under FAS 133, all
derivatives must be recognized as assets and liabilities and measured at fair
value. In July 1999, the FASB issued Statement of Accounting Standards No. 137
"Accounting for Derivative Instruments and Hedging Activities -- Deferral of the
Effective Date of FASB Statement No. 133," which defers the effective date to
all fiscal quarters of fiscal years beginning after June 15, 2000. The adoption
of FAS 133 is not expected to have a significant impact on Retek's consolidated
financial position or results of operations.
In January 200, the Financial Accounting Standards Board's Emerging Issues Task
Force published Issue No. 00-2 "Accounting for Web Site Development Costs", or
EITF 00-2. EITF 00-2 applies the guidance given in the American Institute of
Certified Public Accountants's Statement of Position 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use", or SOP 98-1,
to Web site development costs. Under SOP 98-1, software development costs,
consisting of internally developed software and Web site development costs,
include internal and external costs incurred to develop internal-use computer
software during the application development stage are capitalized. Application
development stage costs generally include software configuration, coding,
installation to hardware and testing. Costs of significant upgrades and
enhancements that result in additional functionality are also capitalized. Costs
incurred for maintenance and minor upgrades and enhancements are expensed as
incurred. The estimated useful lives are based on planned or expected
significant modification or replacement of software applications, in response to
the rapid rate of change in the internet industry and technology in
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RETEK INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
general. Adoption of EITF 00-2 is required for the third quarter of 2000. We
have not yet determined the impact of the adoption of this new accounting
standard on our consolidated financial position, results of operations or
disclosures.
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HNC SOFTWARE INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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 investments available for sale at March 31, 2000 was
$128.2 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 certain 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 three months ended March 31, 2000, approximately 4.4% of our sales were
denominated in currencies other than our functional currency, which is the U.S.
dollar. These foreign currencies are primarily those of Western Europe, Canada
and Australia.
EQUITY PRICE RISK
We have several equity investments we entered into for strategic business
purposes, and therefore are exposed to direct equity price risk. We mitigate
this risk by monitoring the financial performance of our investments. However,
many of our equity investments are in the common stock of privately held,
non-public companies and thus we may be unable to sell or achieve liquidity in
those investments prior to an adverse change in their values.
IMPACT OF EUROPEAN MONETARY CONVERSION
We are aware of the issues associated with the changes in Europe resulting from
the formation of a European economic and monetary union, or EMU. One change
resulting from this union required EMU member states to irrevocably fix their
respective currencies to a new currency, the Euro, as of January 1, 1999, at
which date the Euro became a functional legal currency of these countries.
Through December 31, 2002, business in the EMU member states will be conducted
in both the existing national currencies, such as the French franc or the
Deutsche mark, and the Euro. As a result, companies operating or conducting
business in EMU member states will need to ensure that their financial and other
software systems are capable of processing transactions and properly handling
these currencies, including the Euro. We are assessing the impact that
conversion to the Euro will have on our internal systems, the sale of our
solutions and the European and global economies. We will take appropriate
corrective actions based on the results of its assessment. We have not yet
determined the cost related to addressing this issue although it does not expect
these costs to be significant.
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PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.01 eHNC Lease Agreement
27.01 Financial Data Schedule
(b) Reports on Form 8-K
Report on Form 8-K filed dated March 27, 2000 reporting the
acquisition of Onyx Technologies, Inc. under Item 5.
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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 15, 2000 By: /s/ Kenneth J. Saunders
-------------------------------------
Kenneth J. Saunders
Chief Financial Officer and Secretary
(for Registrant as duly authorized officer
and as Principal Financial Officer)
/s/ Russell C. Clark
-------------------------------------
Russell C. Clark
Vice President, Corporate Finance and
Principal Accounting Officer
(for Registrant as Principal
Accounting Officer)
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EXHIBIT INDEX
Exhibits
--------
10.01 eHNC Lease Agreement
27.01 Financial Data Schedule
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