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