<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 17, 1998
REGISTRATION NO. 333-
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
HNC SOFTWARE INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 0-26146 33-0248788
(STATE OR OTHER JURISDICTION OF (COMMISSION FILE NUMBER) (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION)
</TABLE>
------------------------
5930 CORNERSTONE COURT WEST
SAN DIEGO, CALIFORNIA 92121
(619) 546-8877
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
ROBERT L. NORTH
PRESIDENT AND CHIEF EXECUTIVE OFFICER
HNC SOFTWARE INC.
5930 CORNERSTONE COURT WEST
SAN DIEGO, CALIFORNIA 92121
(619) 546-8877
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
------------------------
COPIES TO:
<TABLE>
<S> <C>
LAIRD H. SIMONS, III, ESQ. JOHN A. FORE, ESQ.
KENNETH A. LINHARES, ESQ. KATHLEEN B. BLOCH, ESQ.
KATHERINE TALLMAN SCHUDA, ESQ. STEPHEN KIM, ESQ.
FENWICK & WEST LLP WILSON SONSINI GOODRICH & ROSATI
TWO PALO ALTO SQUARE PROFESSIONAL CORPORATION
PALO ALTO, CALIFORNIA 94306 650 PAGE MILL ROAD
(650) 494-0600 PALO ALTO, CALIFORNIA 94304
(650) 493-9300
</TABLE>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [ ]
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ] _________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] _________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<S> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------
TITLE OF EACH CLASS PROPOSED MAXIMUM PROPOSED MAXIMUM
OF SECURITIES AMOUNT TO BE OFFERING PRICE AGGREGATE OFFERING AMOUNT OF
TO BE REGISTERED REGISTERED PER SHARE PRICE REGISTRATION FEE
- ------------------------------------------------------------------------------------------------------------------------
% Convertible Subordinated
Notes due 2003......................... $86,250,000(1) 100%(2) $86,250,000(2) $25,443.75
- ------------------------------------------------------------------------------------------------------------------------
Common Stock, par value $0.001......... (3) N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------
Common Stock, par value $0.001......... 1,725,000(4) $34.3375(5) $59,232,187(5) $17,473.50
- ------------------------------------------------------------------------------------------------------------------------
Total Registration
Fee $42,917.25
---------------------------------------
</TABLE>
(1) Includes $11,250,000 in principal amount of Notes that the Underwriters have
the option to purchase to cover over-allotments, if any.
(2) Estimated solely for the purposes of calculating the amount of the
registration fee, pursuant to Rule 457 under the Securities Act.
(3) Such indeterminate number of shares of Common Stock as are issuable upon
conversion of the Notes.
(4) Includes 225,000 shares of Common Stock that the Underwriters have the
option to purchase to cover over-allotments, if any.
(5) Estimated solely for the purpose of calculating the amount of the
registration fee, pursuant to Rule 457(c) under the Securities Act, based on
the average of the high and low prices of the Common Stock on the Nasdaq
National Market on February 9, 1998.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
================================================================================
<PAGE> 2
EXPLANATORY NOTE
This Registration Statement consists of two separate prospectuses. There is
a prospectus relating to Convertible Subordinated Notes to be issued and sold by
the Registrant. There is also a prospectus relating to Common Stock to be sold
by the Registrant and certain stockholders of the Registrant.
<PAGE> 3
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any jurisdiction in which such offer, solicitation or sale would be unlawful
prior to registration or qualification under the securities laws of any such
jurisdiction.
SUBJECT TO COMPLETION, DATED FEBRUARY 17, 1998
[LOGO]
- --------------------------------------------------------------------------------
U.S. $75,000,000
% CONVERTIBLE SUBORDINATED NOTES DUE 2003
- --------------------------------------------------------------------------------
Interest on the Notes is payable on March 1 and September 1 of each year,
commencing September 1, 1998. The Notes will mature on March 1, 2003.
The Notes will be convertible into Common Stock, par value $.001 per share (the
"Common Stock"), of HNC Software Inc., a Delaware corporation ("HNC" or the
"Company"), at any time prior to the close of business on the maturity date,
unless previously redeemed or repurchased, at a conversion price of $ share
(equivalent to a conversion rate of approximately shares per $1,000
principal amount of Notes), subject to adjustment in certain circumstances. See
"Description of Notes -- Conversion."
The Common Stock is listed on the Nasdaq National Market under the symbol
"HNCS." The last reported sale price of the Common Stock on the Nasdaq National
Market on February 13, 1998 was $36.00 per share. See "Price Range of Common
Stock."
The Notes are not redeemable prior to March 6, 2001. On or after March 6, 2001,
the Notes may be redeemed at the option of the Company, in whole or from time to
time in part, at the redemption prices set forth herein plus accrued interest.
See "Description of Notes -- Optional Redemption." In the event of a Fundamental
Change (as defined), each Holder of Notes may require the Company to repurchase
its Notes, in whole or in part, for cash, at the repurchase prices set forth
herein plus accrued interest. See "Description of Notes -- Repurchase at Option
of Holders Upon a Fundamental Change."
The Notes are general unsecured obligations of the Company and are subordinated
in right of payment to all existing and future Senior Indebtedness (as defined)
of the Company and effectively subordinated to all indebtedness and other
liabilities of the Company's subsidiaries. As of December 31, 1997, the Company
had no indebtedness outstanding that would have constituted Senior Indebtedness,
and the Company's subsidiaries had indebtedness and other liabilities
outstanding aggregating approximately $254,000 (excluding intercompany
liabilities and liabilities of a type not required to be reflected as
liabilities on the balance sheets of such subsidiaries in accordance with
generally accepted accounting principles). The Indenture will not restrict the
incurrence of additional Senior Indebtedness by the Company or the incurrence of
other indebtedness and liabilities by the Company or its subsidiaries.
FOR INFORMATION CONCERNING CERTAIN RISK FACTORS THAT SHOULD BE CONSIDERED BY
PROSPECTIVE INVESTORS, SEE "RISK FACTORS" COMMENCING ON PAGE 5.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC(1) DISCOUNT(2) COMPANY(3)
<S> <C> <C> <C>
Per Note 100% $ $
Total(3) $75,000,000 $ $
</TABLE>
(1) Plus accrued interest, if any, from , 1998.
(2) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."
(3) Before deducting expenses estimated at $50,000, payable by the Company.
(4) The Company has granted to the Underwriters an option for 30 days to
purchase up to an additional $11,250,000 aggregate principal amount of Notes
solely to cover over-allotments, if any. If such option is exercised in
full, the total Price to Public, Underwriting Discount and Proceeds to
Company will be $ , $ and $ , respectively. See
"Underwriting."
The Notes offered hereby are offered by the Underwriters subject to prior sale,
when, as and if delivered to and accepted by them, and subject to approval of
certain legal matters by counsel and certain other conditions. The Underwriters
reserve the right to withdraw, cancel or modify such offer and to reject orders
in whole or in part. Delivery of the Notes offered hereby to the Underwriters is
expected to be made in New York, New York on or about , 1998.
DEUTSCHE MORGAN GRENFELL
BANCAMERICA ROBERTSON STEPHENS
SALOMON SMITH BARNEY
The date of this Prospectus is , 1998.
<PAGE> 4
AVAILABLE INFORMATION
HNC is subject to the reporting requirements of the Securities Exchange Act
of 1934, as amended (the "Exchange Act"), and, in accordance therewith, files
reports, proxy statements and other information with the Securities and Exchange
Commission (the "Commission"). Such reports, proxy statements and other
information can be inspected and copied at the public reference facilities
maintained by the Commission at Room 1024, 450 Fifth Street, N.W., Judiciary
Plaza, Washington, D.C. 20549, and at the Commission's following Regional
Offices: 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and Seven
World Trade Center, 13th Floor, New York, New York 10048. Copies of such
material can be obtained at prescribed rates from the Public Reference Section
of the Commission at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C.
20549. The Commission maintains a World Wide Web site that contains reports,
proxy statements and other information regarding registrants that file
electronically with the Commission. The address of the site is
http://www.sec.gov. The Company's Common Stock is quoted on the Nasdaq National
Market and reports, proxy statements and other information concerning the
Company also may be inspected at the offices of Nasdaq Operations, 1735 K
Street, N.W., Washington, D.C. 20006.
The Company has filed with the Commission a Registration Statement on Form
S-3 (the "Registration Statement") under the Securities Act of 1933, as amended
(the "Securities Act"), with respect to the securities offered by this
Prospectus. This Prospectus, which forms a part of the Registration Statement,
does not contain all of the information set forth in the Registration Statement,
certain parts of which have been omitted in accordance with the rules and
regulations of the Commission. For further information with respect to the
Company and the securities offered hereby, reference is made to the Registration
Statement, including the exhibits filed or incorporated by reference in the
Registration Statement. Statements made in this Prospectus about any contract or
other document are not necessarily complete and in each instance in which a copy
of such contract is filed with, or incorporated by reference in, the
Registration Statement as an exhibit, reference is made to such copy, and each
such statement shall be deemed qualified in all respects by such reference.
Copies of the Registration Statement may be inspected, without charge, at the
offices of the Commission, or obtained at prescribed rates from the Public
Reference Section of the Commission at the address set forth above.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents that HNC has previously filed with the Commission
are hereby incorporated herein by reference:
(a) The Company's Annual Report on Form 10-K for the year ended
December 31, 1997; and
(b) The description of the Company's Common Stock contained in the
Company's registration statement on Form 8-A filed with the Commission on
May 26, 1995.
All documents filed by the Company pursuant to Sections 13(a), 13(c), 14 or
15(d) of the Exchange Act after the date of this Prospectus and prior to the
termination of the offering covered by this Prospectus shall be deemed to be
incorporated by reference in this Prospectus and to be a part hereof from the
date of filing of such documents. Any statement contained in any document
incorporated by reference herein shall be deemed to be modified or superseded
for purposes of this Prospectus to the extent that a statement contained herein
or in any other subsequently filed document that also is or is deemed to be
incorporated by reference herein, modifies or supersedes such statement. Any
statement so modified or superseded shall not be deemed, except as so modified
or superseded, to constitute a part of this Prospectus.
The Company will provide without charge, upon written or oral request of
any person to whom this Prospectus is delivered, a copy of any or all of the
documents that have been or may be incorporated by reference in this Prospectus
(other than exhibits to such documents that are not specifically incorporated by
reference into such documents). Requests for such copies should be directed to
HNC at 5930 Cornerstone Court West, San Diego, California 92121-3728, Attention:
Raymond V. Thomas (telephone number (619) 546-8877).
------------------------
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE NOTES OR COMMON
STOCK, INCLUDING BY ENTERING STABILIZING BIDS, IMPOSING PENALTY BIDS OR
OTHERWISE. SUCH ACTIVITIES, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. FOR A
DISCUSSION OF THESE ACTIVITIES, SEE "UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS (AND SELLING GROUP
MEMBERS, IF ANY) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON
STOCK ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M.
SEE "UNDERWRITING."
2
<PAGE> 5
PROSPECTUS SUMMARY
The following summary should be read in conjunction with and is qualified in
its entirety by the more detailed information, including "Risk Factors" and the
consolidated financial statements and notes thereto, appearing elsewhere in this
Prospectus or incorporated by reference in this Prospectus.
THE COMPANY
HNC develops, markets and supports predictive software solutions for leading
service industries. These predictive software solutions employ proprietary
neural-network predictive decision engines, profiles, traditional statistical
modeling, business models, expert rules and context vectors to convert existing
data and business experiences into meaningful recommendations and actions. Just
as manufacturing organizations have implemented manufacturing resource planning
software to automate routine transactions, leading service industries such as
the healthcare/insurance, financial services and retail industries are using
predictive software solutions to improve profitability, competitiveness and
customer satisfaction.
The Company's objective is to be the leading supplier of predictive software
solutions by leveraging its core computational intelligence technology across a
series of product lines targeted at specific service industries. In the
healthcare/insurance industry, the Company's products are used to automate
workers' compensation bill review and loss reserving, detect and prevent
workers' compensation fraud and increase workers' compensation payor and
provider effectiveness. In the financial services industry, the Company's
products are used to detect and prevent credit card fraud, manage the
profitability of credit card portfolios and automate lending decisions and
residential property valuations. In the retail industry, the Company's products
address inventory control, merchandise management, demand forecasting and
private label credit card fraud. The Company markets most of its predictive
software solutions as an ongoing service that includes software licenses,
decision model updates, application consulting and on-line or on-site support
and maintenance. The Company's customers include many of the leading companies
in each of its target markets, including Concentra Managed Care Inc., CIGNA
Corp. and CNA Financial Corporation in the healthcare/insurance industry, First
Data Resources, Inc., Household International Inc. and MBNA Corp. in the
financial services industry, and the Computer City division of Tandy Corp.,
Caldor Corp. and Hills Department Stores Inc. in the retail industry.
The Company was founded in 1986 under the laws of California and was
reincorporated in June 1995 under the laws of Delaware. The Company's principal
executive offices are located at 5930 Cornerstone Court West, San Diego,
California 92121-3728, and its telephone number is (619) 546-8877. In this
Prospectus, the terms "HNC" and the "Company" each refer to HNC Software Inc., a
Delaware corporation, and its consolidated subsidiaries unless the context
otherwise requires.
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT RATIO AND PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:(1)
Total revenues................................................ $16,167 $29,838 $43,704 $71,439 $113,735
Operating income.............................................. 1,034 2,881 5,082 9,659 23,040
Net income.................................................... 875 3,142 6,077 11,893 17,565
Basic net income per common share(2).......................... 0.02 0.28 0.38 0.50 0.72
Diluted net income per common share(2)........................ 0.02 0.17 0.28 0.47 0.68
Pro forma net income(3)....................................... 641 2,137 4,534 9,731 15,417
Basic pro forma net income per common share(3)................ 0.64
Diluted pro forma net income per common share(3).............. 0.60
Shares used in computing basic net income per common share and
basic pro forma net income per common share................. 8,591 8,642 15,195 23,552 24,275
Shares used in computing diluted net income per common share
and diluted pro forma net income per common share........... 9,289 18,142 21,510 25,363 25,681
OTHER DATA:
Ratio of earnings to fixed charges(4)......................... 3.00x 4.87x 6.99x 12.15x 26.51x
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
---------------------------
ACTUAL AS ADJUSTED(5)
-------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and investments available for sale............................ $ 42,946 $115,646
Working capital...................................................................... 74,303 147,003
Total assets......................................................................... 119,877 192,577
Total stockholders' equity........................................................... 103,860 103,860
</TABLE>
- ---------------
(1) The summary consolidated financial information gives retroactive effect to
the acquisitions of Risk Data Corporation ("Risk Data"), Retek Distribution
Corporation, now known as Retek Information Systems("Retek") and CompReview,
Inc. ("CompReview") for all periods presented, accounted for as poolings of
interests.
(2) The computations of basic net income per common share for 1993, 1994 and
1995 include reductions of consolidated net income in the amounts of
$717,000, $717,000 and $348,000, respectively, related to the accretion of
dividends on mandatorily redeemable convertible Preferred Stock, which
converted into Common Stock upon the closing of the Company's initial public
offering on June 26, 1995. The computation of diluted net income per common
share for 1993 does not include the assumed conversion of all outstanding
shares of mandatorily redeemable convertible Preferred Stock into 7,675,000
shares of Common Stock or an increase to net income per common share related
to the elimination of dividend accretion on such Preferred Stock as the
impact would be antidilutive.
(3) Pro forma net income and net income per common share reflect a provision for
taxes on the income of CompReview, which was a subchapter S corporation
prior to its acquisition by HNC, as if CompReview had been subject to
corporate income taxes as a C corporation for all periods presented.
(4) The ratio of earnings to fixed charges has been computed by dividing
earnings available for fixed charges (earnings before income taxes plus
fixed charges less capitalized interest) by fixed charges (interest expense
plus capitalized interest and the portion of rental expense which represents
interest).
(5) Adjusted to reflect the sale of the Notes offered hereby and the receipt of
the net proceeds therefrom.
3
<PAGE> 6
THE OFFERING
Securities Offered......... $75,000,000 principal amount of % Convertible
Subordinated Notes due 2003 (the "Notes")
($86,250,000 principal amount of Notes if the
over-allotment option is exercised in full).
Interest Payment Dates..... March 1 and September 1, commencing September 1,
1998.
Conversion................. The Notes will be convertible into Common Stock at
any time prior to the close of business on the
maturity date, unless previously redeemed or
repurchased, at a conversion price of $ share
(equivalent to a conversion rate of approximately
shares per $1,000 principal amount of
Notes), subject to adjustment.
Subordination.............. The Notes are subordinated in right of payment to
all existing and future Senior Indebtedness (as
defined) of the Company and effectively
subordinated to all indebtedness and other
liabilities of the Company's subsidiaries. As of
December 31, 1997, the Company had no indebtedness
outstanding that would have constituted Senior
Indebtedness and the Company's subsidiaries had
outstanding indebtedness and other liabilities
outstanding aggregating approximately $254,000
(excluding intercompany liabilities and liabilities
of a type not required to be reflected as
liabilities on the balance sheets of such
subsidiaries in accordance with generally accepted
accounting principles). The Indenture will not
restrict the incurrence of additional Senior
Indebtedness by the Company or the incurrence of
other indebtedness and liabilities by the Company
or its subsidiaries.
Optional Redemption........ The Notes are not redeemable by the Company prior
to March 6, 2001. On or after March 6, 2001, the
Notes may be redeemed at the option of the Company,
in whole or from time to time in part, at the
redemption prices set forth herein plus accrued
interest.
Repurchase at Option of
Holders Upon a Fundamental
Change..................... In the event of a Fundamental Change (as defined),
each Holder of Notes may require the Company to
repurchase its Notes, in whole or in part, for cash
at the repurchase prices set forth herein, subject
to adjustment in certain events as described
herein, plus accrued interest.
Use of Proceeds............ The proceeds of the Notes will be used for general
corporate purposes, including working capital, and
potentially to repurchase outstanding shares of the
Company's Common Stock or to acquire complementary
businesses, products or technologies. See "Use of
Proceeds."
------------------------
ProfitMax(R) is a registered trademark of the Company. CRLink(TM),
CompCompare(TM), ProviderCompare(TM), PMA Advisor(TM), VeriComp(TM), MIRA(TM),
Falcon(TM), Falcon Export(TM), Falcon Select(TM), Falcon Debit(TM), Falcon
Retail(TM), Falcon Sentry(TM), Eagle(TM), Capstone(TM), Capstone for Payment
Cards(TM), Capstone for Consumer Lending(TM), Capstone for Mortgage Lending(TM),
ProfitMax Bankruptcy(TM), AREAS(TM), Retek Merchandising System(TM), Retek Data
Warehouse(TM), Active Retail Intelligence(TM), Retek Demand Forecasting(TM),
Falcon Retail(TM), MatchPlus(TM), SelectCast(TM), SelectResponse(TM) and
SelectResource(TM) are trademarks of the Company. All other trademarks or trade
names referred to in this Prospectus are the property of their respective
owners.
4
<PAGE> 7
RISK FACTORS
This Prospectus (including without limitation the following Risk Factors)
contains forward-looking statements (within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act) regarding the Company and
its business, financial condition, results of operations and prospects. Words
such as "expects," "anticipates," "intends," "plans," "believes," "seeks,"
"estimates" and similar expressions or variations of such words are intended to
identify forward-looking statements, but are not the exclusive means of
identifying forward-looking statements in this Prospectus. Additionally,
statements concerning future matters such as the development of new products,
enhancements or technologies, possible changes in legislation and other
statements regarding matters that are not historical are forward-looking
statements.
Although forward-looking statements in this Prospectus reflect the good
faith judgment of the Company's management, such statements can only be based on
facts and factors currently known by the Company. Consequently, forward-looking
statements are inherently subject to risks and uncertainties, and actual results
and outcomes may differ materially from the results and outcomes discussed in
the forward-looking statements. Factors that could cause or contribute to such
differences in results and outcomes include without limitation those discussed
below as well as those discussed elsewhere in this Prospectus and in any
documents that are incorporated into this Prospectus by reference. Readers are
urged not to place undue reliance on these forward-looking statements, which
speak only as of the date of this Prospectus. The Company undertakes no
obligation to revise or update any forward-looking statements in order to
reflect any event or circumstance that may arise after the date of this
Prospectus. Readers are urged to carefully review and consider the various
disclosures made by the Company in this Prospectus and in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997 filed with the
Commission, which attempts to advise interested parties of the risks and factors
that may affect the Company's business, financial condition and results of
operations and prospects.
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS. The Company's revenues and
operating results have varied significantly in the past and may do so in the
future. Because the Company's expense levels are based in part on its
expectations regarding future revenues and in the short term are fixed to a
large extent, the Company may be unable to adjust its spending in time to
compensate for any unexpected revenue shortfall. Factors affecting operating
results include market acceptance of the Company's products; the relatively
large size and small number of customer orders that may be received during a
given period; customer cancellation of long-term contracts yielding recurring
revenues or customers' ceasing their use of Company products for which the
Company's fees are usage based; the length of the Company's sales cycle; the
Company's ability to develop, introduce and market new products and product
enhancements; the timing of new product announcements and introductions by the
Company and its competitors; changes in the mix of distribution channels;
changes in the level of operating expenses; the Company's ability to achieve
progress on percentage-of-completion contracts; the Company's success in
completing certain pilot installations for contracted fees; competitive
conditions in the industry; domestic and international economic conditions; and
market conditions in the Company's targeted markets. Furthermore, the Company's
operating results may be affected by factors unique to certain of its product
lines. For example, the Company derives a substantial and increasing portion of
its revenues from its retail products, which are generally priced as "perpetual"
license transactions in which the Company receives a one-time license fee. The
Company recognizes these fees as revenue upon delivery of the software and
acceptance by the customer. Thus, failure to complete a perpetual license
transaction during a fiscal quarter would have a disproportionate adverse impact
on the Company's operating results for that quarter.
The Company expects fluctuations in its operating results to continue for
the foreseeable future. Accordingly, the Company believes that period-to-period
comparisons of its financial results should not be relied upon as an indication
of future performance. The Company may not be able to maintain profitability on
a quarterly or annual basis in the future. Due to all of the foregoing factors,
it is possible that in some future quarter the Company's operating results will
be below the
5
<PAGE> 8
expectations of public market analysts and investors. In that event, the price
of the Company's Common Stock and, in turn, the market price of the Notes, would
likely be materially adversely affected. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
LENGTHY AND UNPREDICTABLE SALES CYCLE. Due in part to the mission-critical
nature of certain of the Company's applications, potential customers perceive
high risk in connection with adoption of the Company's products. As a result,
customers have been cautious in making decisions to acquire the Company's
products. In addition, because the purchase of the Company's products typically
involves a significant commitment of capital and may involve shifts by the
customer to a new software and/or hardware platform, delays in completing sales
can arise while customers complete their internal procedures to approve large
capital expenditures and test and accept new technologies that affect key
operations. For these and other reasons, the sales cycle associated with the
purchase of the Company's products is typically lengthy, unpredictable and
subject to a number of significant risks over which the Company has little or no
control, including customers' budgetary constraints and internal acceptance
reviews. The sales cycle associated with the licensing of the Company's products
can typically range from 60 days to 18 months. As a result of the length of the
sales cycle and the typical size of customers' orders, the Company's ability to
forecast the timing and amount of specific sales is limited. A lost or delayed
sale could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and "Business -- Sales and
Marketing."
ACQUISITIONS. Between August 1996 and November 1997, the Company acquired
three businesses. In August 1996, the Company acquired Risk Data, a company that
develops, markets and supports proprietary software decision products for use in
the insurance industry. In November 1996, the Company acquired Retek, a company
that develops, markets and supports management decision software products for
retailers and their vendors. In November 1997, the Company acquired CompReview,
a company that develops, markets and supports a software product and related
services designed to assist in the management and containment of the medical
costs of workers' compensation and automobile accident medical claims. The
Company believes that its future growth depends, in part, upon the success of
these and possible future acquisitions. There can be no assurance that the
Company will successfully identify, acquire on favorable terms or integrate such
businesses, products, services or technologies. The Company may in the future
face increased competition for acquisition opportunities, which may inhibit the
Company's ability to consummate suitable acquisitions and increase the costs of
completing such acquisitions. The acquisitions of Risk Data, Retek and
CompReview, as well as other potential future acquisitions, will require the
Company to successfully manage and integrate such acquired businesses, which may
be located in diverse geographic locations. Acquiring other businesses also
requires the Company to successfully develop and market products to new
industries and markets with which the Company may not be familiar. It also
requires the Company to coordinate (and possibly change) the diverse operating
structures, policies and practices of the acquired companies and to integrate
the employees of the acquired companies into the Company's organization and
culture. Failure of the Company to successfully integrate and manage acquired
businesses, to retain their employees, and to successfully address new
industries and markets associated with such acquired businesses, would have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, although the acquisitions of Risk Data,
Retek and CompReview have been accounted for as poolings of interests, future
acquisitions may be accounted for as purchases, resulting in potential charges
that may adversely affect the Company's earnings. Additional acquisitions may
also involve the issuance of shares of the Company's stock to owners of acquired
businesses, resulting in dilution in the percentage of the Company's stock owned
by other stockholders. See "Business -- HNC's Strategy."
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RISKS ASSOCIATED WITH MANAGING GROWTH. In recent years, the Company has
experienced changes in its operations that have placed significant demands on
the Company's administrative, operational and financial resources. The growth in
the Company's customer base and expansion of its product functionality, together
with its acquisition of other businesses and their employees, have challenged
and are expected to continue to challenge the Company's management and
operations, including its sales, marketing, customer support, research and
development and finance and administrative operations. The Company's future
performance will depend in part on its ability to successfully manage change,
both in its domestic and international operations, and to adapt its operational
and financial control systems, if necessary, to respond to changes in its
business and to facilitate the integration of acquired businesses with the
Company's operations. The failure of the Company's management to effectively
respond to and manage growth could have a material adverse effect on the
Company's business, financial condition and results of operations.
DEPENDENCE ON EMERGING TECHNOLOGIES AND MARKETS. The market for predictive
software solutions is still emerging. The rate at which businesses have adopted
the Company's products has varied significantly by market and by product within
each market, and the Company expects to continue to experience such variations
with respect to its target markets and products in the future. The Company has
introduced products for the healthcare/insurance, financial services and retail
markets. The Company has recently announced several new products, including
PMAdvisor, VeriComp, SelectCast, SelectResponse and SelectResource. To date,
none of these products has achieved any significant degree of market acceptance,
and there can be no assurance that such products will ever be widely accepted.
Although businesses in the Company's target markets have recognized the
advantages of using predictive software solutions to automate the
decision-making process, many have developed decision automation systems
internally rather than licensing them from outside vendors. There can be no
assurance that the markets for the Company's products will continue to develop
or that the Company's products will be widely accepted, if at all. If the
markets for the Company's new or existing products fail to develop, or develop
more slowly than anticipated, the Company's sales would be negatively impacted,
which would have a material adverse effect on the Company's business, financial
condition and results of operations. See "Business -- Emerging Market
Opportunities."
RISKS ASSOCIATED WITH TECHNOLOGICAL CHANGE AND DELAYS IN DEVELOPING NEW
PRODUCTS. The market for the Company's predictive software solutions for service
industries is characterized by rapidly changing technology and improvements in
computer hardware, network operating systems, programming tools, programming
languages, operating systems and database technology. The Company's success will
depend upon its ability to continue to develop and maintain competitive
technologies, enhance its current products and develop, in a timely and
cost-effective manner, new products that meet changing market conditions,
including evolving customer needs, new competitive product offerings, emerging
industry standards and changing technology. For example, the rapid growth of the
Internet environment creates new opportunities, risks and uncertainties for
businesses, such as the Company, which develop software solutions that now may
have to be designed to operate in Internet, intranet and other on-line
environments. The Company may not be able to develop and market, on a timely
basis, or at all, product enhancements or new products that respond to changing
technologies. The Company has previously experienced significant delays in the
development and introduction of new products and product enhancements, primarily
due to difficulties with model development, which has in the past required
multiple iterations, as well as difficulties with acquiring data and adapting to
particular operating environments. The length of these delays has varied
depending upon the size and scope of the project and the nature of the problems
encountered. Any significant delay in the completion of new products, or the
failure of such products, if and when installed, to achieve any significant
degree of market acceptance, would have a material adverse effect on the
Company's business, financial condition and results of operations. Any failure
by the Company to anticipate or to respond adequately to changing technologies,
or any significant delays in product development or introduc-
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tion, could cause customers to delay or decide against purchases of the
Company's products and would have a material adverse effect on the Company's
business, financial condition and results of operations. See
"Business -- Technology" and "-- Research and Development."
PRODUCT CONCENTRATION. The Company currently has one product or product
line in each of its three target markets that accounts for a majority of the
Company's total revenues from that market. These products in the aggregate
accounted for 60.0%, 59.1% and 57.9% of the Company's total revenues in 1995,
1996 and 1997, respectively. In the healthcare/insurance market, the Company's
revenues from its CRLink product accounted for 29.8%, 24.6% and 23.0% of the
Company's total revenues in 1995, 1996 and 1997, respectively, and are expected
to account for a substantial portion of the Company's total revenues for the
foreseeable future. Continued market acceptance of CRLink will be affected by
future product enhancements and competition. Decline in demand for, or use of,
CRLink, whether as a result of competition, simplification of state workers'
compensation fee schedules, changes in the overall payment system or regulatory
structure for workers' compensation claims, technological change, an inability
to obtain or use state fee schedule or claims data, saturation of market demand,
industry consolidation or otherwise, could result in decreased revenues from
CRLink, which could have a material adverse effect on the Company's business,
financial condition and results of operations. Further, revenues from the Retek
Merchandising System ("RMS"), a retail management product, accounted for 2.2%,
13.6% and 18.9% of the Company's total revenues in 1995, 1996 and 1997,
respectively, and are expected to continue to account for a substantial portion
of the Company's revenues in the foreseeable future. Continued market acceptance
of RMS will be affected by the quality and timely introduction of future product
enhancements and competition. Decline in demand for, or use of, RMS as a result
of continued entry into the retail inventory management market by vendors that
may have significantly greater resources and a broader customer base than the
Company could result in decreased revenues from RMS, which could have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, decline in demand for RMS, as a result of technological
change, saturation of market demand, industry consolidation or otherwise would
have a material adverse effect on the Company's business, financial condition
and results of operations. Revenues from the Company's Falcon product line for
credit card fraud detection for financial institutions accounted for 28.0%,
20.9% and 16.0% of the Company's total revenues in 1995, 1996 and 1997,
respectively, and are expected to continue to account for a substantial portion
of the Company's total revenues in the foreseeable future. Continued market
acceptance of the Falcon product line will be affected by the quality and timely
introduction of future product enhancements and competition. In addition, it is
possible that patterns of credit card fraud may change in a manner that the
Falcon product line would not detect and that other methods of credit card fraud
prevention may reduce customers' needs for the Falcon product line. As a result
of increasing saturation of market demand for the Falcon product line, the
Company may also need to rely increasingly on international sales to maintain or
increase Falcon revenue levels. Furthermore, Falcon customers are banks and
related financial institutions. Accordingly, the Company's future success
depends upon the capital expenditure budgets of such customers and the continued
demand by such customers for Falcon products. The financial services industry
tends to be cyclical in nature, which may result in variations in demand for the
Company's products. In addition, there has been and continues to be
consolidation in the financial services industry, which in some cases has
lengthened the sales cycle and may lead to reduced demand for the Company's
products. Decline in demand for, or use of, Falcon, whether as a result of
competition, technological change, change in fraud patterns, the cyclical nature
of the financial services industry, saturation of market demand, fluctuations in
interest rates, industry consolidation, reduction in capital spending or
otherwise, could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business -- Markets and
Products."
DEPENDENCE ON DATA. The development, installation and support of the
Company's credit card fraud control and profitability management, loan
underwriting, home valuation and certain
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healthcare/insurance products require periodic model updates. The Company must
develop or obtain a reliable source of sufficient amounts of current and
statistically relevant data to analyze transactions and update its models. For
example, in the electronic payments market, the data required by the Company are
collected privately and maintained in proprietary databases. As a result, the
Company and its Falcon and ProfitMax customers enter into agreements pursuant to
and build new fraud detection and profitability models. For its AREAS home
valuation product, the Company obtains data from commercial databases on
available terms and conditions. Many of the Company's healthcare/insurance
products use historical workers' compensation claims data obtained from
customers. CRLink also uses data from state workers' compensation fee schedules
adopted by state regulatory agencies, and certain third parties have asserted
copyright interests in such data. In most cases, such data must be periodically
updated and refreshed to enable the Company's predictive software products to
continue to work effectively. In addition, the development of new and enhanced
products also depends to a significant extent on the availability of sufficient
amounts of statistically relevant data to enable the Company to develop models.
For example, to expand the geographic coverage of its AREAS product, the Company
would be required to develop or obtain data on home sales in each county for
which AREAS is marketed. There can be no assurance that the Company will be able
to continue to obtain adequate amounts of statistically relevant data on a
timely basis, in the required formats or on reasonable terms and conditions,
whether from customers or commercial suppliers. Any such failure by the Company
to obtain required data when it is needed, for a reasonable price and on
reasonable terms, could have a significant negative impact on existing product
performance, new product development and product pricing which could in turn
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Business -- Customer Service and Support."
COMPETITION. The market for predictive software solutions for service
industries is intensely competitive and subject to rapid change. Competitors,
many of which have substantially greater financial resources than the Company,
vary in size and in the scope of the products and services they offer. The
Company encounters competition from a number of sources, including (i) other
application software companies, (ii) management information systems departments
of customers and potential customers, including banks, insurance companies and
retailers, (iii) third-party professional services organizations, including
without limitation, consulting divisions of public accounting firms, (iv)
hardware suppliers that bundle or develop complementary software, (v) network
and service providers that seek to enhance their value-added services, (vi)
neural-network tool suppliers and (vii) managed care organizations. In the
healthcare/insurance market, the Company has experienced competition primarily
from National Council on Compensation Insurance ("NCCI"), Corporate Systems and
CSC Incorporated. In the workers' compensation and medical cost administration
market, the Company has experienced competition from MediCode, Inc.
("MediCode"), Medata, Inc. and Embassy Software with regard to software
licensing, and Intracorp and Corvel Corporation in the service bureau operations
market. Additionally, the Company has faced competition from Automatic Data
Processing, Inc. ("ADP") in the automobile accident medical claims market. In
the financial services market, the Company has experienced competition from
Fair, Isaac & Co., Inc., Cogensys (a subsidiary of Policy Management Systems
Corporation), Federal National Mortgage Association ("Fannie Mae"), Federal Home
Loan Mortgage Corporation ("Freddie Mac"), International Business Machines
Corporation ("IBM"), Nestor, Inc., NeuralTech Inc., Neuralware Inc., PMI
Mortgage Services Co., VISA International and others. In the retail market, the
Company has experienced competition from JDA Software Group, Inc., SAP AG,
PeopleSoft, Inc., IBM, Manugistics Group, Inc. and others. The Company expects
to experience additional competition from other established and emerging
companies, as well as other technologies. For example, the Company's Falcon
product competes against other methods of preventing credit card fraud, such as
card activation programs, credit cards that contain the cardholder's photograph,
smart cards and other card authorization techniques. Increased competition,
whether from other products or new technologies, could result in price
reductions, fewer customer orders, reduced gross margins and loss of market
share, any of
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<PAGE> 12
which could materially adversely affect the Company's business, financial
condition and results of operations.
The Company believes that most of its products are currently priced at a
premium when compared to its competitors' products. The market for the Company's
products is highly competitive, and the Company expects that it will face
increasing pricing pressures from its current competitors and new market
entrants. In particular, increased competition could reduce or eliminate such
premiums and cause further price reductions. In addition, such competition could
adversely affect the Company's ability to obtain new long-term contracts and
renewals of existing long-term contracts on terms favorable to the Company. Any
reduction in the price of the Company's products could materially adversely
affect the Company's business, financial condition and results of operations.
Some of the Company's current, and many of the Company's potential,
competitors have significantly greater financial, technical, marketing and other
resources than the Company. As a result, they may be able to respond more
quickly to new or emerging technologies and changes in customer requirements or
to devote greater resources to the development, promotion and sale of their
products than the Company. In addition, current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties to increase the ability of their products to address the needs of
the Company's prospective customers. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly gain
significant market share. Also, the Company relies upon its customers to provide
data, expertise and other support for the ongoing updating of the Company's
models. The Company's customers, most of which have significantly greater
financial and marketing resources than the Company, may compete with the Company
in the future or otherwise discontinue their relationships with or support of
the Company. There can be no assurance that the Company will be able to compete
successfully against current and future competitors or that competitive
pressures faced by the Company will not materially adversely affect its
business, financial condition and results of operations. See
"Business -- Competition."
RISKS ASSOCIATED WITH RECRUITING AND RETAINING QUALIFIED PERSONNEL. The
Company's success depends to a significant degree upon the continued service of
members of the Company's senior management and other key research, development,
sales and marketing personnel. Accordingly, the loss of any such personnel could
have a material adverse effect on the Company's business, financial condition
and results of operations. Only a small number of employees have employment
agreements with the Company, and there can be no assurance that such agreements
will result in the retention of these employees for any significant period of
time. In addition, the untimely loss of a member of the management team or a key
employee of a business acquired by the Company could have a material adverse
effect on the Company's business, financial condition and results of operations,
particularly if such loss occurred before the Company has had adequate time to
familiarize itself with the operating details of that business. In the past, the
Company has experienced difficulty in recruiting a sufficient number of
qualified sales and technical employees. In addition, competitors may attempt to
recruit the Company's key employees. There can be no assurance that the Company
will be successful in attracting, assimilating and retaining such personnel. The
failure to attract, assimilate and retain key personnel could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Business -- Employees" and "Management."
CUSTOMER CONCENTRATION. Product licenses to First Data Resources, Inc.
("First Data"), the largest provider of credit card charge receipt processing
services to banks, accounted for 8.7%, 8.6% and 7.6% of the Company's total
revenues in 1995, 1996 and 1997, respectively. The Company has licensed First
Data to provide its customers with access to the Company's ProfitMax product
pursuant to a license agreement entered into in January 1996 (the "ProfitMax
Contract"). The Company's revenues under the ProfitMax Contract represented
approximately one-quarter of the Company's revenues from First Data in 1997. In
late January 1998, First Data
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asserted that certain restrictive covenants under the ProfitMax Contract
violated certain intellectual property laws. First Data also asserted that the
existence of such restrictions made the ProfitMax Contract at least temporarily
unenforceable and that First Data is therefore not obligated to pay the Company
license fees due under the ProfitMax Contract. The Company disputed First Data's
claim, released and waived the above-mentioned restrictive covenants in the
ProfitMax Contract and gave First Data written notice that the Company intended
to terminate the ProfitMax Contract pursuant to its terms unless First Data
cured its failure to pay the delinquent license fees in a timely manner.
Currently, First Data and the Company are working to resolve their dispute
regarding the ProfitMax Contract by negotiating a new agreement; however, there
can be no assurance that such an agreement will be reached or that the terms of
such an agreement would be as favorable to HNC as its existing contractual
arrangements with First Data. If no such agreement can be reached and First Data
maintains its current position, it is possible that litigation or arbitration
could ensue, which would likely result in a loss of anticipated revenue to the
Company under the ProfitMax Agreement and possibly other agreements between the
Company and First Data, which could have a material adverse affect on the
Company's business, financial condition and results of operation. See
"Business -- Sales and Marketing."
RISKS ASSOCIATED WITH INTERNATIONAL SALES. In 1995, 1996 and 1997,
international operations and export sales (including sales in Canada)
represented 12.6%, 17.7% and 16.8% of the Company's total revenues,
respectively. The Company intends to continue to expand its operations outside
the United States and to enter additional international markets, including by
adding sales and support offices in Europe and Japan, which will require
significant management attention and financial resources. For certain more
mature products, such as Falcon, the Company may need to increase international
sales in order to continue to expand the product's customer base. The Company
has committed and continues to commit significant time and development resources
to customizing certain of its products for selected international markets and to
developing international sales and support channels. There can be no assurance
that the Company's efforts to develop products, databases and models for
targeted international markets or to develop additional international sales and
support channels will be successful. The failure of such efforts, which can
entail considerable expense, could have a material adverse effect on the
Company's business, financial condition and results of operations.
International sales are subject to additional inherent risks, including
longer payment cycles, unexpected changes in regulatory requirements, import and
export restrictions and tariffs, difficulties in staffing and managing foreign
operations, the burdens of complying with a variety of foreign laws, greater
difficulty or delay in accounts receivable collection, potentially adverse tax
consequences and political and economic instability. The Company's international
sales are currently denominated predominantly in United States dollars and a
small portion are denominated in British pounds sterling. An increase in the
value of the United States dollar relative to foreign currencies could make the
Company's products more expensive, and therefore potentially less competitive,
in foreign markets. In the future, to the extent the Company's international
sales are denominated in local currencies, foreign currency translations may
contribute to significant fluctuations in the Company's business, financial
condition and results of operations. If for any reason exchange or price
controls or other restrictions on foreign currencies are imposed, the Company's
business, financial condition and results of operations could be materially
adversely affected. See "Business -- Sales and Marketing."
RISKS ASSOCIATED WITH CHANGING REGULATORY ENVIRONMENT. The Company's
customers are subject to a number of government regulations and certain other
industry standards with which the Company's products must comply. For example,
the Company's financial services products are affected by Regulation B
promulgated under the Equal Credit Opportunity Act, by regulations governing the
extension of credit to consumers and by Regulation E promulgated under the
Electronic Fund Transfers Act governing the transfer of funds from and to
consumer deposit accounts, as well as VISA and MasterCard electronic payment
standards. In the mortgage services
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market, the Company's products are affected by regulations such as Fannie Mae
and Freddie Mac regulations for conforming loans, Uniform Standards of
Professional Appraisal Practice and appraisal standards for federally insured
institutions under the Financial Institutions Reform, Recovery and Enforcement
Act. In addition, recent regulatory initiatives have restricted the availability
of bank and credit bureau data, reflecting a consumer privacy trend that could
limit the Company's ability to obtain or use certain credit-related information.
It is also possible that insurance-related regulations may in the future apply
to the Company's healthcare/insurance products. In many states, including
California, there have been periodic legislative efforts to reform workers'
compensation laws in order to reduce the cost of workers' compensation insurance
and to curb abuses of the workers' compensation system, and such changes, if
adopted, might adversely affect the Company's healthcare/insurance business. In
addition, if state-mandated workers' compensation laws or regulations or state
workers' compensation fee schedules are simplified, such changes would diminish
the need for, and the benefit provided by, the CRLink product. Changes in
workers' compensation laws or regulations could also adversely affect the
Company's healthcare/insurance products by making them obsolete, or by requiring
extensive changes in these products to reflect new workers' compensation rules.
To the extent that the Company sells new products targeted to markets that
include regulated industries and businesses, the Company's products will need to
comply with these additional regulations. Any failure of the Company's products
to comply with existing or new regulations and standards could result in legal
action against the Company or its customers by regulatory authorities or by
third parties, including actions seeking civil or criminal penalties,
injunctions against the Company's use of data or civil damages, any of which
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company may also be liable to its
customers for failure of its products to comply with such regulatory
requirements. Furthermore, changes to these regulations and standards or the
adoption of new regulations or standards that affect the Company's products
could affect the performance of such products and have a material adverse effect
on the Company's business, financial condition and results of operations.
PROTECTION OF INTELLECTUAL PROPERTY. The Company relies on a combination of
patent, copyright, trademark and trade secret laws and confidentiality
procedures to protect its proprietary rights. The Company currently owns seven
issued United States patents and has four United States patent applications
pending. The Company has applied for additional patents for its Falcon
technology in Canada, Europe and Japan and its MIRA product in Australia, Canada
and Europe. There can be no assurance that patents will be issued with respect
to pending or future patent applications or that the Company's patents will be
upheld as valid or will prevent the development of competitive products. The
Company seeks to protect its software, documentation and other written materials
under trade secret and copyright laws, which afford only limited protection. As
part of its confidentiality procedures, the Company generally enters into
invention assignment and proprietary information agreements with its employees
and independent contractors and nondisclosure agreements with its distributors,
corporate partners and licensees, and limits access to and distribution of its
software, documentation and other proprietary information. Despite these
precautions, it may be possible for a third party to copy or otherwise to obtain
and use the Company's products or technology without authorization, or to
develop similar technology independently. In addition, to ensure that customers
will not be adversely affected by an interruption in the Company's business, the
Company places source code for certain of its products into escrow, which may
increase the likelihood of misappropriation or other misuse of the Company's
intellectual property. Moreover, effective protection of intellectual property
rights may be unavailable or limited in certain foreign countries in which the
Company has done and may do business. Also, the Company has developed
technologies under research projects conducted under agreements with various
United States Government agencies or subcontractors to such agencies. Although
the Company has acquired certain commercial rights to such technologies, the
United States Government typically retains ownership of certain intellectual
property rights and licenses in the technologies developed by the Company under
such contracts, and in some cases
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<PAGE> 15
can terminate the Company's rights in such technologies if the Company fails to
commercialize them on a timely basis. In addition, under certain United States
Government contracts, the results of the Company's research may be made public
by the government, which could limit the Company's competitive advantage with
respect to future products based on such research. See "Business -- Intellectual
Property and Other Proprietary Rights."
INFRINGEMENT OF PROPRIETARY RIGHTS. In the past, the Company has received
communications from third parties asserting that Company trademarks infringed
such other parties' trademarks, none of which have resulted in litigation or
losses to the Company. Given the Company's ongoing efforts to develop and market
new technologies and products, the Company may receive communications from third
parties asserting that the Company's products infringe, or may infringe, their
intellectual property rights. If as a result of any such claims the Company were
precluded from using certain technologies or intellectual property rights,
licenses to such disputed third-party technology or intellectual property rights
might not be available on reasonable commercial terms, if at all. Furthermore,
the Company may initiate claims or litigation against third parties for
infringement of the Company's proprietary rights or to establish the validity of
the Company's proprietary rights. Litigation, either as plaintiff or defendant,
could result in significant expense to the Company and divert the efforts of the
Company's technical and management personnel from productive tasks, whether or
not such litigation is resolved in favor of the Company. In the event of an
adverse ruling in any such litigation, the Company might be required to pay
substantial damages, discontinue the use and sale of infringing products, expend
significant resources to develop non-infringing technology or obtain licenses to
infringing technology, and the court might invalidate the Company's patents,
trademarks or other proprietary rights. In the event of a successful claim
against the Company and the failure of the Company to develop or license a
substitute technology, the Company's business, financial condition and results
of operations would be materially and adversely affected. As the number of
software products increases and the functionality of these products further
overlaps, the Company believes that software developers may become increasingly
subject to infringement claims. Any such claims, with or without merit, can be
time consuming and expensive to defend and could materially and adversely affect
the Company's business, financial condition and results of operations. See
"Business -- Intellectual Property and Other Proprietary Rights."
RISK OF PRODUCT DEFECTS AND PRODUCT LIABILITY. Software products as complex
as those offered by the Company often contain undetected errors or failures when
first introduced or as new versions are released. In addition, to the extent
that the Company may have to develop new products that operate in new
environments, such as the Internet, the possibility for program errors and
failures may increase due to factors such as the use of new technologies or the
need for more rapid product development that is characteristic of the Internet
market. Despite pre-release testing by the Company and by current and potential
customers, there still may be errors in new products, even after commencement of
commercial shipments. The occurrence of such errors could result in delay in, or
failure to achieve, market acceptance of the Company's products, which could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Although the Company's license agreements with its customers typically
contain provisions designed to limit the Company's exposure to potential product
liability claims, it is possible that such limitation of liability provisions
may not be effective as a result of existing or future laws or unfavorable
judicial decisions. Because the Company's products are used in business-critical
applications, any errors or failures in such products may give rise to
substantial product liability claims, which could have a material adverse effect
on the Company's business, financial condition and results of operations.
VOLATILITY OF PRICE OF NOTES AND COMMON STOCK. The Company's Common Stock
has experienced significant price volatility and such volatility may recur in
the future. Factors such as announcements of the introduction of new products by
the Company or its competitors, acquisitions of businesses or products by the
Company, quarter-to-quarter variations in the Company's
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operating results and the gain or loss of significant orders, as well as market
conditions in the technology and emerging growth company sectors, may have a
significant impact on the market price of the Company's Common Stock and, in
turn, the market price of the Notes. Further, the stock market has experienced
extreme volatility that has particularly affected the market prices of
securities of many technology companies and that often has been unrelated or
disproportionate to the operating performance of such companies. These market
fluctuations may adversely affect the price of the Notes and the Common Stock.
The trading prices of many technology companies' stocks, including the Company's
Common Stock, reflect price/earnings ratios substantially above historical
norms. The trading price of the Company's Common Stock may not remain at or near
its current level, which, in turn, would materially and adversely affect the
market price of the Notes. See "Price Range of Common Stock."
YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. These date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, in less
than two years, computer systems and/or software used by many companies may need
to be upgraded to comply with such "Year 2000" requirements. Significant
uncertainty exists in the software industry concerning the potential effects
associated with such compliance. The Company anticipates that it will need to
devote resources in the next two years to modify its CRLink product to properly
process dates beyond December 31, 1999. The Company expects that the cost of
making these modifications and distributing the modified product to existing
customers will be approximately $500,000. These modifications and the resources
that the Company expects to devote to such modifications may divert management
and engineering attention from, or delay the development and introduction of,
new products and enhancements to existing products. The inability of the Company
to complete such modifications successfully and on a timely basis, or the
inability of the Company to devote sufficient resources to continuing updates
and enhancements to the CRLink product, could have a material adverse effect on
the Company's business, financial condition and results of operations. In
addition, the Company believes that the purchasing patterns of customers and
potential customers may be affected by Year 2000 issues as companies expend
significant resources to correct or patch their current software systems for
Year 2000 compliance. These expenditures may result in reduced funds available
to purchase software products such as those offered by the Company, which could
result in a material adverse effect on the Company's business, financial
condition and results of operations.
FACTORS INHIBITING TAKEOVER. The Board of Directors is authorized to issue
up to 4,000,000 shares of Preferred Stock and to determine the price, rights,
preferences, privileges and restrictions, including voting rights, of those
shares without any further vote or action by the stockholders. The rights of the
holders of Common Stock will be subject to, and may be adversely affected by,
the rights of the holders of any Preferred Stock that may be issued in the
future. The issuance of Preferred Stock, while providing desirable flexibility
in connection with possible acquisitions and other corporate purposes, could
have the effect of making it more difficult for a third party to acquire a
majority of the outstanding voting stock of the Company. The Company has no
current plans to issue shares of Preferred Stock. In addition, Section 203 of
the Delaware General Corporation Law restricts certain business combinations
with any "interested stockholder" as defined by such statute. The statute may
have the effect of delaying, deferring or preventing a change in control of the
Company. The repurchase option upon a "fundamental change" feature of the Notes
may in certain circumstances make more difficult or discourage a takeover of the
Company and, thus, the removal of incumbent management. See "Description of the
Notes -- Repurchase at Option of Holders Upon a Fundamental Change."
LEVERAGE; SUBORDINATION AND ABSENCE OF FINANCIAL COVENANTS. In connection
with the sale of the Notes, the Company will incur $75.0 million in indebtedness
($86.3 million if the over-allotment option is exercised in full) which will
result in a ratio of long-term debt to total capitalization at December 31, 1997
of approximately 41.9% on an as adjusted basis (45.4% if
14
<PAGE> 17
the over-allotment option is exercised in full). As a result of this
indebtedness, the Company will have substantial principal and interest
obligations. The degree to which the Company will be leveraged could materially
and adversely affect the Company's ability to obtain financing for working
capital, acquisitions or other purposes and could make the Company more
vulnerable to industry downturns and competitive pressures. The Company's
ability to meet its debt service obligations will be dependent upon the
Company's future performance, which will be subject to financial, business and
other factors affecting the operation of the Company, many of which are beyond
its control.
The Notes will be unsecured and subordinated in right of payment in full to
all Senior Indebtedness of the Company. As a result of such subordination, in
the event of bankruptcy, liquidation or reorganization of the Company or certain
other events, the assets of the Company will be available to pay obligations on
the Notes only after all Senior Indebtedness has been paid in full in cash, and
there may not be sufficient assets remaining to pay amounts due on any or all of
the Notes then outstanding. As a significant portion of the Company's
consolidated operations is conducted through subsidiaries, the cash flow and the
consequent ability to service debt of the Company, including the Notes, is
partially dependent upon the earnings of such subsidiaries and the distribution
of those earnings, or upon loans or other payments of funds by those
subsidiaries, to the Company. Such subsidiaries are separate and distinct legal
entities, and have no obligation, contingent or otherwise, to pay any amounts
due pursuant to the Notes or to make any funds available therefor, whether by
dividends, distributions, loans or other payments. In addition, the payment of
dividends or distributions and the making of loans and advances to the Company
by any such subsidiaries may be subject to statutory or contractual
restrictions, and may be contingent upon the earnings of those subsidiaries and
subject to various business considerations. Any right of the Company to receive
assets of subsidiaries upon their liquidation or reorganization (and the
consequent right of the Holders of the Notes to participate in these assets)
would be effectively subordinated to the claims of that subsidiary's creditors
(including trade creditors), except to the extent that the Company is itself
recognized as a creditor of such subsidiary, in which case the claims of the
Company would still be subordinate to any security interests in the assets of
such subsidiary and any indebtedness of such subsidiary senior to that held by
the Company.
As of December 31, 1997, the Company had no indebtedness outstanding that
would have constituted Senior Indebtedness and the Company's subsidiaries had
indebtedness and other liabilities outstanding aggregating approximately
$254,000 (excluding intercompany liabilities and liabilities of a type not
required to be reflected as liabilities on the balance sheets of such
subsidiaries in accordance with generally accepted accounting principles) to
which the Notes would have been effectively subordinated. The Indenture will not
limit the amount of additional indebtedness, including Senior Indebtedness,
which the Company can create, incur, assume or guarantee, nor will the Indenture
limit the amount of indebtedness which any subsidiary of the Company can create,
incur, assume or guarantee. The Company anticipates that from time to time it
and its subsidiaries will incur additional indebtedness, including Senior
Indebtedness. In addition, the Indenture does not contain any financial
covenants or restrictions on the payment of dividends, by the Company or the
issuance or repurchase of securities by the Company and contains no covenants or
other provisions to afford protection to holders of the Notes in the event of a
highly leveraged transaction or a change in control of the Company except to the
extent described under "Description of Notes -- Subordination" and
"-- Repurchase at Option of Holders Upon a Fundamental Change."
DISCRETIONARY USE OF PROCEEDS OF OFFERING. The principal purpose of this
offering is to increase the Company's capital base and financial flexibility.
The Company expects to use the net proceeds principally for general corporate
purposes, including working capital, and potentially to acquire complementary
businesses, products or technologies and to repurchase outstanding shares of the
Company's stock. As a consequence, the Company's management will have the
ability to allocate the net proceeds of this offering at its discretion. There
can be no assurance that
15
<PAGE> 18
the proceeds will be utilized in a manner that the Holders of Notes deem optimal
or that the proceeds can or will be invested to yield a significant return upon
the completion of this offering. Upon completion of this offering, the Company
will have more than $115.6 million of cash, cash equivalents and short-term
investments (based on balances at December 31, 1997, and assuming no exercise of
the Underwriters' over-allotment option and after deducting the estimated
underwriting discount and estimated offering expenses payable by the Company),
substantially all of which will be invested in short-term, interest-bearing,
investment-grade obligations for an indefinite period of time. See "Use of
Proceeds."
LIMITATIONS ON REPURCHASE OF NOTES. Upon a Fundamental Change (as defined),
each Holder of Notes will have certain rights, at the Holder's option, to
require the Company to repurchase all or a portion of such Holder's Notes. If a
Fundamental Change were to occur, there can be no assurance that the Company
would have or be able to obtain sufficient funds to pay the repurchase price for
all Notes tendered by the Holders thereof. The Company's existing credit
agreement contains, and any future credit agreements or other agreements
relating to other indebtedness (including Senior Indebtedness) to which the
Company becomes a party may contain, restrictions and provisions that prohibit
the Company from repurchasing or redeeming any Notes or provide that a
Fundamental Change would constitute an event of default thereunder. In the event
that a Fundamental Change occurs at a time when the Company is prohibited from
repurchasing or redeeming Notes, the Company could seek the consent of its
lenders to the repurchase of Notes or could attempt to refinance the borrowings
that contain such prohibition. If the Company does not obtain such a consent or
repay such borrowings, the Company would remain prohibited from repurchasing or
redeeming Notes. In such case, the Company's failure to repurchase tendered
Notes would constitute an Event of Default under the Indenture, which may, in
turn, constitute a further default under the terms of other indebtedness that
the Company may enter into from time to time, including under any Senior
Indebtedness. In such circumstances, the subordination provisions in the
Indenture would likely prohibit the repurchase of the Notes. See "Description of
Notes -- Repurchase at Option of Holders upon a Fundamental Change."
ABSENCE OF PUBLIC MARKET FOR THE NOTES. The Notes are a new issue of
securities for which there is currently no public market. There can be no
assurance that an active trading market will develop or be maintained for the
Notes. If a market for the Notes does develop, the Notes may trade at a discount
from their initial offering price, depending upon prevailing interest rates, the
market for similar securities, the performance of the Company, the market price
for the Company's Common Stock and other factors.
16
<PAGE> 19
USE OF PROCEEDS
The net proceeds to the Company from the issuance and sale of the Notes
offered hereby are estimated to be $72.7 million ($83.6 million if the
Underwriters' over-allotment option is exercised in full), after deducting the
estimated underwriting discount and estimated offering expenses. The Company
expects to use the net proceeds for working capital and other general corporate
purposes. The Company has not allocated any specific portion of the net proceeds
to such purposes and management will have the ability to allocate such proceeds
at its discretion. A portion of the net proceeds may be used to repurchase
shares of the Company's Common Stock from time to time in the open market. A
portion of the net proceeds may also be used to acquire or invest in
complementary businesses or products or otherwise to obtain the right to use
complementary technologies or data. From time to time, in the ordinary course of
business, the Company evaluates potential acquisitions of such businesses,
products, technologies or data. The Company has no present understandings,
commitments or agreements with respect to any material acquisition of
businesses, products, technologies or data. Pending use of the net proceeds, the
Company intends to invest such funds in short-term, interest-bearing,
investment-grade securities. See "Risk Factors -- Discretionary Use of Proceeds
of Offering."
PRICE RANGE OF COMMON STOCK
The Company's Common Stock has been traded on the Nasdaq National Market
since June 1995 under the symbol "HNCS." The following table sets forth for the
periods indicated the high and low sales prices of the Common Stock. Prior to
June 1995, there was no established public trading market for the Common Stock.
All prices have been adjusted to give effect to a two-for-one stock split
effected in the form of a stock dividend paid in April 1996.
<TABLE>
<CAPTION>
HIGH LOW
---- ----
<S> <C> <C>
1996:
First Quarter.................................... $38 3/4 $18 1/4
Second Quarter................................... 51 31 1/4
Third Quarter.................................... 47 1/2 20 3/4
Fourth Quarter................................... 45 1/4 26 1/4
1997:
First Quarter.................................... $36 3/4 $23 1/4
Second Quarter................................... 42 3/8 18 1/4
Third Quarter.................................... 43 5/8 33 3/4
Fourth Quarter................................... 43 1/2 30
1998:
First Quarter (through February 13, 1998)........ $43 $33
</TABLE>
On February 13, 1998, the last reported sale price of the Common Stock on
the Nasdaq National Market was $36.00 per share. As of February 13, 1998, there
were approximately 186 holders of record of the Common Stock.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its capital
stock. The Company currently anticipates that it will retain all future earnings
for use in its business and does not anticipate paying any cash dividends in the
foreseeable future. The Company's bank credit agreement prohibits the Company
from declaring or paying any cash dividends without the bank's consent.
17
<PAGE> 20
CAPITALIZATION
The following table sets forth the capitalization of HNC at December 31,
1997 and as adjusted to give effect to the sale by the Company of the Notes
offered hereby and the receipt of the estimated net proceeds therefrom.
<TABLE>
<CAPTION>
DECEMBER 31, 1997
------------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
% Convertible Subordinated Notes due 2003....................... $ -- $ 75,000
-------- --------
Stockholders' equity:
Preferred stock, $0.001 par value -- 4,000,000 shares
authorized: no shares issued or outstanding.................. -- --
Common stock, $0.001 par value -- 50,000,000 shares authorized:
24,537,550 shares issued and outstanding(1).................. 25 25
Paid-in capital................................................. 95,919 95,919
Unrealized loss on investments available for sale............... (2) (2)
Foreign currency translation adjustment......................... (111) (111)
Retained earnings............................................... 8,029 8,029
-------- --------
Total stockholders' equity................................... 103,860 103,860
-------- --------
Total capitalization.................................... $103,860 $ 178,860
======== ========
</TABLE>
- ---------------
(1) Excludes the shares reserved for issuance upon conversion of the
Notes, 4,591,133 shares of Common Stock subject to stock options outstanding
at December 31, 1997 at a weighted average exercise price of $23.92 per
share and an additional 393,075 shares of Common Stock reserved for issuance
under the Company's stock option and stock purchase plans at such date. In
February 1998, the Company adopted a nonqualified stock option plan and
reserved 1,000,000 shares of Common Stock for issuance thereunder. The
Underwriters are concurrently offering 1,500,000 shares of the Company's
Common Stock, of which 20,000 shares will be issued and sold by the Company.
The net proceeds from such sale will not be material.
18
<PAGE> 21
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data as of December 31, 1996 and 1997
and for each of the years in the three-year period ended December 31, 1997 have
been derived from HNC's Consolidated Financial Statements included elsewhere in
this Prospectus, which have been audited by Price Waterhouse LLP, independent
accountants, as indicated in their report thereon appearing elsewhere herein.
The selected consolidated financial data as of December 31, 1994 and 1995 and
for the year ended December 31, 1994 have been derived from separate audited
financial statements for HNC and CompReview not included herein. The selected
consolidated financial data as of and for the year ended December 31, 1993 have
been derived from separate financial data for HNC and CompReview not included
herein. The data set forth below are qualified in their entirety by reference
to, and should be read in conjunction with, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Consolidated
Financial Statements and related notes thereto included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
------- ------- -------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C> <C>
STATEMENT OF INCOME DATA(1):
Revenues:
License and maintenance..................................................... $24,561 $48,890 $89,643
Installation and implementation............................................. 4,648 6,691 10,702
Contracts and other......................................................... 9,146 11,128 7,772
Service bureau.............................................................. 5,349 4,730 5,618
-------- ------- -------
Total revenues....................................................... 43,704 71,439 113,735
-------- ------- -------
Operating expenses:
License and maintenance..................................................... 7,903 13,725 19,937
Installation and implementation............................................. 1,425 2,714 5,174
Contracts and other......................................................... 6,894 7,694 5,438
Service bureau.............................................................. 3,025 3,365 4,320
Research and development.................................................... 6,998 13,808 21,151
Sales and marketing......................................................... 7,276 11,923 22,049
General and administrative.................................................. 5,101 8,551 12,626
-------- ------- -------
Total operating expenses............................................. 38,622 61,780 90,695
-------- ------- -------
Operating income.............................................................. 5,082 9,659 23,040
Interest and other income..................................................... 912 2,178 2,003
Interest expense.............................................................. (428) (478) (81)
Minority interest in income of consolidated subsidiary........................ -- -- (43)
-------- ------- -------
Income before income tax (benefit) provision......................... 5,566 11,359 24,919
Income tax (benefit) provision................................................ (511) (534) 7,354
-------- ------- -------
Net income........................................................... $ 6,077 $11,893 $17,565
======== ======= =======
Earnings per share:
Basic net income per common share(2)........................................ $ 0.38 $ 0.50 $ 0.72
======== ======= =======
Diluted net income per common share(2)...................................... $ 0.28 $ 0.47 $ 0.68
======== ======= =======
Unaudited pro forma data(3):
Income before income tax provision.......................................... $ 5,566 $11,359 $24,919
Income tax provision........................................................ 1,032 1,628 9,502
-------- ------- -------
Net income........................................................... $ 4,534 $ 9,731 $15,417
======== ======= =======
Basic pro forma net income per common share(3).............................. $ 0.64
=======
Diluted pro forma net income per common share(3)............................ $ 0.60
=======
Shares used in computing basic net income per common share and unaudited basic
pro forma net income per common share....................................... 15,195 23,552 24,275
======== ======= =======
Shares used in computing diluted net income per common share and unaudited
diluted pro forma net income per common share............................... 21,510 25,363 25,681
======== ======= =======
</TABLE>
19
<PAGE> 22
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT RATIO AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
ADDITIONAL STATEMENT OF INCOME DATA:(1)
Total revenues............................... $16,167 $29,838 $43,704 $71,439 $113,735
Operating income............................. 1,034 2,881 5,082 9,659 23,040
Net income................................... 875 3,142 6,077 11,893 17,565
Basic net income per common share(2)......... 0.02 0.28 0.38 0.50 0.72
Diluted net income per common share(2)....... 0.02 0.17 0.28 0.47 0.68
Pro forma net income(3)...................... 641 2,137 4,534 9,731 15,417
Basic pro forma net income per common
share(3)................................... 0.64
Diluted pro forma net income per common
share(3)................................... 0.60
Shares used in computing unaudited basic net
income per common share and basic pro forma
net income per common share................ 8,591 8,642 15,195 23,552 24,275
Shares used in computing unaudited diluted
net income per common share and diluted pro
forma net income per common share.......... 9,289 18,142 21,510 25,363 25,681
OTHER DATA:
Ratio of earnings to fixed charges(4)........ 3.00x 4.87x 6.99x 12.15x 26.51x
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and investments
available for sale......................... $ 4,679 $ 7,827 $44,975 $34,849 $ 42,946
Total assets................................. 10,944 20,663 63,113 98,293 119,877
Long-term obligations, less current
portion.................................... 367 931 1,373 264 63
Mandatorily redeemable convertible preferred
stock...................................... 12,452 13,169 -- -- --
</TABLE>
- ---------------
(1) The selected consolidated financial data gives retroactive effect to the
acquisitions of Risk Data, Retek and CompReview for all periods presented,
accounted for as poolings of interests.
(2) The computations of basic net income per common share for 1993, 1994 and
1995 include reductions of consolidated net income in the amounts of
$717,000, $717,000 and $348,000, respectively, related to the accretion of
dividends on mandatorily redeemable convertible Preferred Stock, which
converted into Common Stock upon the closing of the Company's initial public
offering on June 26, 1995. The computation of diluted net income per common
share for 1993 does not include the assumed conversion of all outstanding
shares of mandatorily redeemable convertible Preferred Stock into 7,675,000
shares of Common Stock or an increase to net income per common share related
to the elimination of dividend accretion on such Preferred Stock as the
impact would be antidilutive.
(3) Pro forma net income and net income per common share reflect a provision for
taxes on the income of CompReview, which was a subchapter S corporation
prior to its acquisition by HNC, as if CompReview had been subject to
corporate income taxes as a C corporation for all periods presented.
(4) The ratio of earnings to fixed charges has been computed by dividing
earnings available for fixed charges (earnings before income taxes plus
fixed charges less capitalized interest) by fixed charges (interest expense
plus capitalized interest and the portion of rental expense that represents
interest).
20
<PAGE> 23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Prospectus (including without limitation the following section
regarding Management's Discussion and Analysis of Financial Condition and
Results of Operations) contains forward-looking statements (within the meaning
of Section 27A of the Securities Act and Section 21E of the Exchange Act)
regarding the Company and its business, financial condition, results of
operations and prospects. Words such as "expects," "anticipates," "intends,"
"plans," "believes," "seeks," "estimates" and similar expressions or variations
of such words are intended to identify forward-looking statements, but are not
the exclusive means of identifying forward-looking statements in this
Prospectus. Additionally, statements concerning future matters such as the
development of new products, enhancements or technologies, possible changes in
legislation and other statements regarding matters that are not historical are
forward-looking statements.
Although forward-looking statements in this Prospectus reflect the good
faith judgment of the Company's management, such statements can only be based on
facts and factors currently known by the Company. Consequently, forward-looking
statements are inherently subject to risks and uncertainties and actual results
and outcomes may differ materially from the results and outcomes discussed in
the forward-looking statements. Factors that could cause or contribute to such
differences in results and outcomes include without limitation those discussed
in "Risk Factors" as well as those discussed elsewhere in this Prospectus and in
any documents that are incorporated into this Prospectus by reference. Readers
are urged not to place undue reliance on these forward-looking statements, which
speak only as of the date of this Prospectus. The Company undertakes no
obligation to revise or update any forward-looking statements in order to
reflect any event or circumstance that may arise after the date of this
Prospectus. Readers are urged to carefully review and consider the various
disclosures made by the Company in this Prospectus and in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997 filed with the
Commission, which attempts to advise interested parties of the risks and factors
that may affect the Company's business, financial condition, results of
operations and prospects.
OVERVIEW
HNC develops, markets and supports predictive software solutions for
leading service industries. These predictive software solutions employ
proprietary neural-network predictive decision engines, profiles, traditional
statistical modeling, business models, expert rules and context vectors to
convert existing data and business experiences into meaningful recommendations
and actions. HNC was founded in 1986 to provide software tools and contracted
technology services using neural-network technology.
In August 1996, HNC completed its acquisition of Risk Data in a transaction
accounted for as a pooling of interests. Risk Data is based in Irvine,
California and develops, markets and supports proprietary software decision
products for use in the insurance industry. In 1996, HNC formed Aptex Software
Inc. ("Aptex"), a majority-owned subsidiary located in San Diego, California
that develops, markets and supports electronic text analysis technology in
products designed for the Internet and other environments. In November 1996, HNC
completed its acquisition of Retek in a transaction accounted for as a pooling
of interests. Retek is based in Minneapolis, Minnesota and develops, markets and
supports software products that provide merchandise management and other
management tools to retailers and their vendors. In November 1997, the Company
completed its acquisition of CompReview, in a transaction accounted for as a
pooling of interests. CompReview is located in Costa Mesa, California and
develops, markets and supports a software product and related services designed
to assist in the management and containment of the medical costs of workers'
compensation and automobile accident medical claims. CompReview provides its
product and services primarily to insurance companies, managed care
organizations, third party administrators and large self-insured employers. The
Company anticipates that from time to time it
21
<PAGE> 24
will consider acquisitions of other businesses in order to expand the markets
served by the Company and to acquire complementary technologies, products and
personnel. See "Risk Factors -- Acquisitions" and "Business -- HNC's Strategy."
After giving retroactive effect to the Company's acquisitions of Risk Data,
Retek and CompReview, HNC experienced compound annual growth in total revenues
of 63% from 1993 through 1997. See "Risk Factors -- Risks Associated with
Managing Growth." This revenue growth resulted primarily from increased license
fees for the Retek Merchandising System, CRLink, Falcon, MIRA and ProfitMax
products and, to a lesser extent, from increased license fees for the Active
Retail Intelligence, Retek Data Warehouse, PMAdvisor, CompCompare, Capstone and
AREAS products. Because of the long sales and development cycle associated with
the Company's products, the Company has not received significant revenues to
date from the SelectCast, SelectResponse, SelectResource, VeriComp or PMAdvisor
products. See "Risk Factors -- Lengthy and Unpredictable Sales Cycle."
The Company markets most of its predictive software solutions as an ongoing
service that includes software licenses, decision model updates, application
consulting and on-line or on-site support and maintenance. The Company's pricing
for the CRLink, the Falcon products, MIRA, ProfitMax, AREAS, PMAdvisor,
CompCompare and ProviderCompare products typically includes an annual or monthly
usage fee and a one to seven year contract commitment. In 1995, 1996 and 1997,
annual license and maintenance revenues from these contracts represented 61.2%,
56.1% and 55.2% of the Company's total revenues, respectively.
The Company's revenues and operating results have varied significantly in
the past and may do so in the future. Because the Company's expense levels are
based in part on its expectations regarding future revenues and in the short
term are fixed to a large extent, the Company may be unable to adjust its
spending in time to compensate for any unexpected revenue shortfall. Factors
affecting operating results include market acceptance of the Company's products;
the relatively large size and small number of customer orders that may be
received during a given period; customer cancellation of long-term contracts
yielding recurring revenues or customers' ceasing their use of Company products
for which the Company's fees are usage based; the length of the Company's sales
cycle; the Company's ability to develop, introduce and market new products and
product enhancements; the timing of new product announcements and introductions
by the Company and its competitors; changes in the mix of distribution channels;
changes in the level of operating expenses; the Company's ability to achieve
progress on percentage-of-completion contracts; the Company's success in
completing certain pilot installations for contracted fees; competitive
conditions in the industry; domestic and international economic conditions; and
market conditions in the Company's targeted markets. Furthermore, the Company's
operating results may be affected by factors unique to certain of its product
lines. For example, the Company derives a substantial and increasing portion of
its revenues from its retail products, which are generally priced as "perpetual"
license transactions in which the Company receives a one-time license fee. The
Company recognizes these fees as revenue upon delivery of the software and
acceptance by the customer. Thus, failure to complete a perpetual license
transaction during a fiscal quarter could have a disproportionate adverse impact
on the Company's operating results for that quarter.
The Company expects fluctuations in its operating results to continue for
the foreseeable future. Accordingly, the Company believes that period-to-period
comparisons of its financial results should not be relied upon as an indication
of future performance. The Company may not be able to maintain profitability on
a quarterly or annual basis in the future. Due to all of the foregoing factors,
it is possible that in some future quarter the Company's operating results will
be below the expectations of public market analysts and investors. In that
event, the price of the Company's Common Stock and, in turn, the market price of
the Notes, would likely be materially adversely affected.
22
<PAGE> 25
RESULTS OF OPERATIONS
The Company's statements of income for all periods presented give
retroactive effect to the acquisitions of Risk Data, Retek and CompReview in
August 1996, November 1996 and November 1997, respectively, each of which was
accounted for as a pooling of interests.
Total Revenues
The Company's revenues are comprised of license and maintenance revenues,
installation and implementation revenues, contracts and other revenues and
service bureau revenues. Total revenues increased by 63.5% to $71.4 million in
1996 and by 59.2% to $113.7 million in 1997. International operations and export
sales represented 12.6%, 17.7% and 18.5% of total revenues in 1995, 1996 and
1997, respectively. The retail product line currently has more sales in
international markets than the healthcare/insurance and financial services
product lines combined. The Company believes that international sales represent
a significant opportunity for revenue growth and expects international sales to
increase as a percent of total revenue.
License and Maintenance Revenues. The Company's license and
maintenance revenues are derived from annual license fees, monthly license
fees, perpetual license fees and annual maintenance fees. The Company
typically licenses many of its products for an annual or monthly usage fee
under long-term contracts that include software licenses, decision model
updates, application consulting, and on-line or on-site support and
maintenance. The Company's revenue from periodic software license and
maintenance agreements is generally recognized ratably over the respective
license or agreement periods. Revenue from certain short-term periodic
software license and maintenance agreements with guaranteed minimum license
fees is recognized as related services are performed. Transactional fees
are recognized as revenue based on system usage or when fees based on
system usage exceed the monthly minimum license fees. Revenue from
perpetual licenses of the Company's software for which there are no
significant continuing obligations and collection of the related
receivables is probable is recognized on delivery of the software and
acceptance by the customer.
License and maintenance revenues increased by 99.1% to $48.9 million
in 1996 and by 83.4% to $89.6 million in 1997. The increase from 1995 to
1996 was due primarily to the growth of license fees in all markets,
particularly from the Retek Merchandising System, CRLink and Falcon, and,
to a lesser extent, MIRA and CompCompare. The increase from 1996 to 1997
was due primarily to the growth of license fee revenues from the Retek
Merchandising System and CRLink. Also contributing to the increase were
increased license fees from other retail products, such as ARI and Retek
Data Warehouse, financial services products such as Falcon, ProfitMax and
Capstone, and other healthcare/insurance products, such as PMAdvisor and
MIRA.
Installation and Implementation Revenues. Revenues from software
installations and implementations are generally recognized as the services
are performed using the percentage of completion method based on costs
incurred to date compared to total estimated costs at completion. Amounts
received in advance of performance under the contracts are recorded as
deferred revenue and are generally recognized within one year from receipt.
Installation and implementation revenues increased by 44.0% to $6.7
million in 1996 and by 59.9% to $10.7 million in 1997. Substantially all of
the increase from 1995 to 1996 was due primarily to growth in the
installations of Retek Data Forecasting as this product moved from
development into production. The increase from 1996 to 1997 was due
primarily to growth in the installations of Capstone and ProfitMax.
23
<PAGE> 26
Contracts and Other Revenues. Contracts and other revenues are derived
primarily from new product development contracts with commercial customers
and research contracts with the United States Government. The Company
typically contracts with one or two commercial partners for pilot
development and installation of its new products and with the United States
Government for additional research funds. Revenues from contract services
are generally recognized as the services are performed using the percentage
of completion method based on costs incurred to date compared to total
estimated costs at completion. Revenue from hardware product sales, which
is included in contracts and other revenue, is recognized upon shipment to
the customer.
Contracts and other revenues increased by 21.7% to $11.1 million in
1996 and decreased by 30.2% to $7.8 million in 1997. The increase in 1996
was primarily the result of greater revenues from commercial new product
pilot installation contracts with customers in support of the Company's
development of ProfitMax, SelectCast, Falcon Sentry and Capstone. The
decrease in 1997 was primarily the result of products such as ProfitMax,
Retek Data Forecasting and Capstone moving from development into
production.
During 1997, the Company had fewer new product development projects
and new product pilot installations than during 1996. There can be no
assurance that any of these product development projects or pilot
installations will be successful or be completed within anticipated time
schedules or that the customers who serve as pilot installation sites will
be satisfied with these products or agree to license them. If the Company's
new product development efforts are unsuccessful, are not completed on a
timely basis or are not well received by pilot customers, the Company may
be compelled to delay or discontinue the release of production versions of
these products or bear increased expense to bring these pilot products to
market, either of which would have a material adverse effect on the
Company's business, financial condition and results of operations.
Service Bureau Revenues. Service bureau revenues are derived from the
Company's service bureau operations, which provide CRLink's functionality
to customers that do not wish to obtain a license, that use this service
until they can implement their own internal CRLink operation or that use
this service when their volumes peak to high levels. Service bureau
customers typically subscribe for services under month-to-month agreements.
Service bureau fees are recognized as revenue when the processing services
are performed.
Service bureau revenues decreased by 11.6% to $4.7 million in 1996 and
increased by 18.8% to $5.6 million in 1997. The decrease in 1996 was
primarily a result of the significant increase in license revenues as the
Company's sales efforts were focused on licensing CRLink to customers
rather than marketing service bureau services. The increase in 1997 was
primarily due to an increase in the number of customers utilizing service
bureau operations.
Gross Margin
The following table sets forth the gross margin for each of the Company's
revenue categories for each of the comparison periods.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
License and maintenance........................... 67.8% 71.9% 77.8%
Installation and implementation................... 69.3 59.4 51.7
Contracts and other............................... 24.6 30.9 30.0
Service bureau.................................... 43.4 28.9 23.1
</TABLE>
24
<PAGE> 27
License and Maintenance Gross Margin. License and maintenance costs
primarily represent the Company's expenses for personnel engaged in
customer support, travel to customer sites and documentation materials. The
Company's gross margin on licenses and maintenance revenues was 67.8%,
71.9% and 77.8% in 1995, 1996 and 1997, respectively. In 1996, the
improvement in gross margin was the result of the Company's ability to move
from price discounts for early adopters of its products to full pricing for
products sold to subsequent customers as well as a higher volume of
international licenses, which generate relatively higher margins than
domestic operations due, in part, to lower overhead expenses as a result of
less corporate infrastructure. Gross margin improved in 1997 due primarily
to license fees increasing at a higher rate than the costs associated with
providing these licenses. This increase was primarily attributable to
increased pricing producing higher margins in the retail and
healthcare/insurance markets.
Installation and Implementation Gross Margin. Installation and
implementation costs consist primarily of personnel-related costs, travel
and equipment. The Company's gross margin on installation and
implementation revenues was 69.3%, 59.4% and 51.7% in 1995, 1996 and 1997,
respectively. In 1996, the improved margin was due primarily to new
installations of Retek Data Forecasting, which have substantially lower
margins than installations of Falcon products, which represented a majority
of installations in 1995. Gross margin improved in 1997 due primarily to an
increase in Capstone implementations, which have substantially lower
margins than implementations of Falcon products.
Contracts and Other Gross Margin. Contracts and other costs consist
primarily of personnel-related costs. The Company's gross margin on
contracts and other revenues was 24.6%, 30.9% and 30.0% in 1995, 1996 and
1997, respectively. The improvement in gross margin during 1996 was due
primarily to the Company's increased ability to better price its new pilot
projects. The slight decrease in gross margin for 1997 was due to the
decrease in new product development contracts, while government projects
with substantially lower margins remained relatively constant in absolute
dollars.
Service Bureau Gross Margin. Service bureau costs consist primarily of
the personnel and facilities costs of operating the service bureaus. The
Company's gross margin on service bureau revenues was 43.4%, 28.9% and
23.1% in 1995, 1996 and 1997. The decrease in 1996 was a result of the loss
of a customer in early 1996 for which the Company was able to recognize
higher than usual margins during 1995. The decrease in 1997 was
attributable to an increase in fixed costs and in labor costs required to
support the service bureau business that outpaced the increase in revenue.
This was the result of a more static customer base and higher fixed costs
associated with the infrastructure necessary to run the service bureau
operation.
Other Operating Expenses
Research and Development Expenses. Research and development expenses
consist primarily of salaries and other personnel-related expenses,
subcontracted development services, depreciation for development equipment
and supplies. Research and development expenses increased from $7.0 million
in 1995 to $13.8 million in 1996 and to $21.2 million in 1997, representing
16.0%, 19.3% and 18.6% of total revenues in 1995, 1996 and 1997,
respectively. Research and development expenses increased in absolute
dollars due to the development costs associated with new releases of
several products in the retail and financial services product lines. The
increased research and development expenses in absolute dollars and as a
percentage of revenues in 1996 was primarily the result of greater staffing
to support more new product development programs, primarily for ProfitMax,
Capstone, CompCompare, ProviderCompare and the Retek Merchandising System.
The 1996 costs also included the initial product development costs of the
Company's Aptex business unit, which did not have a significant impact on
revenues. Statement of Financial Accounting Standards No. 86, "Ac-
25
<PAGE> 28
counting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed," requires capitalization of certain software development costs
subsequent to the establishment of technological feasibility. Based on the
Company's product development process, technological feasibility is not
established until completion of a working model. Costs incurred by the
Company between completion of the working model and the point at which a
product is ready for general release have been insignificant. As a result,
no significant software development costs were capitalized through December
31, 1997. The Company anticipates that research and development expenses
will increase in dollar amount and could increase as a percentage of total
revenues for the foreseeable future.
Sales and Marketing Expenses. Sales and marketing expenses consist
primarily of salaries and benefits, commissions, travel, entertainment and
promotional expenses. Sales and marketing expenses increased from $7.3
million in 1995 to $11.9 million in 1996 and to $22.0 million in 1997,
representing 16.6%, 16.7% and 19.4% of total revenues in 1995, 1996 and
1997, respectively. The increases were primarily a result of increased
staffing as the Company built its direct sales and marketing staff, opened
sales offices in Japan and in several locations in Europe, and increased
expenses for trade shows, advertising and other marketing programs. The
Company expects sales and marketing expenses to continue to increase for
the foreseeable future. Such expenses could also increase as a percentage
of total revenues as the Company continues to develop a direct sales force
in Europe and other international markets, expand its domestic sales and
marketing organization and increase the breadth of its product lines.
General and Administrative Expenses. General and administrative
expenses consist primarily of personnel costs for finance, contract
administration, human resources and general management, as well as
acquisition, insurance and professional services expenses. General and
administrative expenses increased from $5.1 million in 1995 to $8.6 million
in 1996 and $12.6 million in 1997, representing 11.7%, 10.3% and 9.8% of
total revenues, respectively. General and administrative expenses included
$1.2 million of acquisition expenses related to the acquisitions of Risk
Data and Retek in 1996 and $1.4 million of acquisition expenses primarily
related to the acquisition of CompReview in 1997. Excluding acquisition
expenses, general and administrative expenses were $5.1 million, $7.4
million and $11.2 million in 1995, 1996 and 1997, respectively. The primary
reason for these increases in absolute dollars was increased staffing to
support the Company's growth and additional expenses associated with being
a public company.
Operating Income
The above factors resulted in operating income of $5.1 million,
constituting 11.6% of total revenues in 1995, $9.7 million, constituting 13.5%
of total revenues in 1996, and $23.0 million, constituting 20.3% of total
revenues in 1997. The Company does not expect that operating income will
continue to increase significantly as a percentage of total revenues.
Other Income (Expense) Net
Interest and other income, net of interest expense, increased from $484,000
in 1995 to $1.7 million in 1996 and to $1.9 million in 1997. The increase in
1996 was primarily attributable to increased interest income in 1996 from higher
cash and investment balances, which consisted primarily of the proceeds from the
Company's initial public offering in June 1995 and secondary public offering in
December 1995. The increase in 1997 was primarily due to a decrease in interest
expense of approximately $397,000 primarily related to the repayment of Risk
Data's bank notes payable during the third quarter of 1996, offset by a decrease
in interest income of approximately $165,000.
26
<PAGE> 29
Income Tax (Benefit) Provision
The income tax benefit of $511,000 in 1995 was primarily attributable to
the recognition of a $2.2 million deferred tax asset based on anticipated future
utilization of all of the Company's remaining net operating loss carryforwards
and research and development credit carryforwards. The income tax benefit of
$534,000 in 1996 was primarily attributable to the recognition of a $2.7 million
deferred tax asset based on anticipated future utilization of all of the
remaining net operating loss carryforwards and research and development credit
carryforwards relating to Risk Data and Retek. That deferred tax asset had
previously been offset by a valuation allowance. The Company released the
valuation allowance during the fourth quarter of 1996, based upon management's
assessment that it was more likely than not that the Company would realize the
asset in future periods.
The 1997 income tax provision of $7.4 million, or 29.5% of pre-tax income,
was lower than 1997 taxes at statutory rates primarily as a result of
CompReview's subchapter S corporation status prior to the acquisition, which
resulted in most of CompReview's tax liability being borne by its former
shareholders. As of the date of the acquisition, CompReview's tax status was
changed to C corporation. In the future, the Company expects that the effective
tax rate will be reflective of the tax rate of other California-based companies.
27
<PAGE> 30
SELECTED PRO FORMA QUARTERLY OPERATING RESULTS
The following table presents unaudited pro forma quarterly financial
information for each of the eight quarters in the period ended December 31,
1997. This information has been derived from the Company's unaudited financial
statements. Pro forma net (loss) income reflects a provision for taxes on the
income of CompReview, which was a subchapter S corporation prior to its
acquisition by HNC, as if CompReview had been subject to corporate income taxes
as a C corporation for all periods presented. In the opinion of management, all
adjustments, consisting only of normal recurring adjustments, have been included
to present fairly the quarterly results. See "Risk Factors -- Potential
Fluctuations in Operating Results" and "-- Lengthy and Unpredictable Sales
Cycle."
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------------------------------
1996 1997
--------------------------------------- --------------------------------------
MAR. 31 JUN. 30 SEPT. 30 DEC. 31 MAR. 31 JUN. 30 SEPT. 30 DEC. 31
------- ------- -------- ------- ------- ------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:(1)
Revenues:
License and maintenance................... $ 8,479 $11,163 $ 13,831 $15,417 $18,331 $22,311 $ 23,705 $25,296
Installation and implementation........... 1,200 1,214 1,399 2,878 1,946 2,188 3,069 3,499
Contracts and other....................... 2,979 3,051 2,784 2,314 2,726 1,805 1,671 1,570
Service bureau............................ 1,219 1,269 1,101 1,141 1,069 1,289 1,544 1,716
------- ------- ------- ------- ------- ------- ------- -------
Total revenues...................... 13,877 16,697 19,115 21,750 24,072 27,593 29,989 32,081
------- ------- ------- ------- ------- ------- ------- -------
Operating expenses:
License and maintenance................... 3,180 3,120 3,689 3,736 3,994 5,036 4,957 5,950
Installation and implementation........... 589 597 560 968 801 1,251 1,499 1,623
Contracts and other....................... 2,071 1,938 1,860 1,825 1,850 1,454 1,111 1,023
Service bureau............................ 932 947 749 737 864 919 1,203 1,334
Research and development.................. 2,440 3,352 3,748 4,268 4,431 4,930 6,015 5,775
Sales and marketing....................... 2,485 2,981 3,041 3,416 4,553 5,233 5,691 6,572
General and administrative................ 1,829 1,961 2,351 2,410 2,459 2,768 3,142 4,257
------- ------- ------- ------- ------- ------- ------- -------
Total operating expense............. 13,526 14,896 15,998 17,360 18,952 21,591 23,618 26,534
------- ------- ------- ------- ------- ------- ------- -------
Operating income............................ 351 1,801 3,117 4,390 5,120 6,002 6,371 5,547
Interest income, net........................ 452 406 384 458 429 481 538 431
------- ------- ------- ------- ------- ------- ------- -------
Income before pro forma income tax
provision (benefit)..................... 803 2,207 3,501 4,848 5,549 6,483 6,909 5,978
Pro forma income tax provision (benefit).... 934 1,119 1,138 (1,563) 2,115 2,475 2,623 2,289
------- ------- ------- ------- ------- ------- ------- -------
Pro forma net (loss) income............... $ (131) $ 1,088 $ 2,363 $ 6,411 $ 3,434 $ 4,008 $ 4,286 $ 3,689
======= ======= ======= ======= ======= ======= ======= =======
AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
License and maintenance................... 61.1% 66.8% 72.3% 70.9% 76.2% 80.9% 79.1% 78.9%
Installation and implementation........... 8.6 7.3 7.3 13.2 8.1 7.9 10.2 10.9
Contracts and other....................... 21.5 18.3 14.6 10.6 11.3 6.5 5.6 4.9
Service bureau............................ 8.8 7.6 5.8 5.3 4.4 4.7 5.1 5.3
------- ------- ------- ------- ------- ------- ------- -------
Total revenues...................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
------- ------- ------- ------- ------- ------- ------- -------
Operating expenses:
License and maintenance................... 22.9 18.7 19.3 17.2 16.6 18.2 16.5 18.5
Installation and implementation........... 4.3 3.6 3.0 4.4 3.3 4.5 5.0 5.0
Contracts and other....................... 14.9 11.6 9.7 8.4 7.7 5.3 3.7 3.2
Service bureau............................ 6.7 5.7 3.9 3.4 3.6 3.3 4.0 4.2
Research and development.................. 17.6 20.1 19.6 19.6 18.4 17.9 20.1 18.0
Sales and marketing....................... 17.9 17.8 15.9 15.7 18.9 19.0 19.0 20.5
General and administrative................ 13.2 11.7 12.3 11.1 10.2 10.0 10.5 13.3
------- ------- ------- ------- ------- ------- ------- -------
Total operating expense............. 97.5 89.2 83.7 79.8 78.7 78.2 78.8 82.7
------- ------- ------- ------- ------- ------- ------- -------
Operating income............................ 2.5 10.8 16.3 20.2 21.3 21.8 21.2 17.3
Interest income, net........................ 3.3 2.4 2.0 2.1 1.8 1.7 1.8 1.3
------- ------- ------- ------- ------- ------- ------- -------
Income before pro forma income tax
provision (benefit)..................... 5.8 13.2 18.3 22.3 23.1 23.5 23.0 18.6
Pro forma income tax provision (benefit).... 6.7 6.7 5.9 (7.2) 8.8 9.0 8.7 7.1
------- ------- ------- ------- ------- ------- ------- -------
Pro forma net (loss) income............... (0.9)% 6.5% 12.4% 29.5% 14.3% 14.5% 14.3% 11.5%
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
- ---------------
(1) The above table gives retroactive effect to the acquisitions of Risk Data,
Retek and CompReview for all periods presented, accounted for as poolings of
interests.
28
<PAGE> 31
LIQUIDITY AND CAPITAL RESOURCES
The $21.0 million of net cash provided by operating activities in 1997
represented net income before depreciation and amortization of approximately
$22.4 million, further increased by a decrease in deferred income taxes of $6.9
million and offset by an increase in accounts receivable of $11.1 million. Net
cash used in investing activities was $7.7 million in 1997 primarily due to $9.6
million expended for property and equipment during 1997, including $6.0 million
for computer equipment to support the increased staffing across the Company, and
$1.9 million for furniture and fixtures primarily related to the relocation of
the Company's Minneapolis facility, offset by approximately $1.9 million of net
proceeds from the sale and maturity of investments. Net cash used in financing
activities was $3.2 million in 1997 primarily due to $6.8 million in
distributions to the former CompReview stockholders offset by $4.0 million in
net proceeds from issuances of common stock.
As of December 31, 1997, the Company had $42.9 million in cash, cash
equivalents and investments. The Company believes that its current cash, cash
equivalents and investments available for sale balances, together with the net
proceeds from the sale of the Notes, borrowings under its credit facility and
net cash provided by operating activities, will be sufficient to meet its
working capital and capital expenditure requirements for at least the next 12
months. The credit facility will not be available following issuance of the
Notes unless the Company obtains an appropriate consent or amendment from the
bank. A portion of the Company's cash could be used to repurchase shares of the
Company's Common Stock from time to time in the open market. Management intends
to invest the Company's cash in excess of current operating requirements in
short-term, interest-bearing, investment-grade securities. A portion of the
Company's cash could also be used to acquire or invest in complementary
businesses or products or otherwise to obtain the right to use complementary
technologies or data. From time to time, in the ordinary course of business, the
Company evaluates potential acquisitions of such businesses, products,
technologies or data. The Company has no present understandings, commitments or
agreements with respect to any material acquisitions of other businesses,
products or technologies.
YEAR 2000 COMPLIANCE
The Company anticipates that it will need to devote resources in the next
two years to modify its CRLink product to properly process dates beyond December
31, 1999. The Company expects that the cost of making these modifications and
distributing the modified product to existing customers will be approximately
$500,000. These modifications and the resources that the Company expects to
devote to such modifications may divert management and engineering attention
from, or delay the development and introduction of, new products and
enhancements to existing products. The inability of the Company to complete such
modifications successfully and on a timely basis, or the inability of the
Company to devote sufficient resources to continuing updates and enhancements to
the CRLink product, could have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, the
Company believes that the purchasing patterns of customers and potential
customers may be affected by Year 2000 issues as companies expend significant
resources to correct or patch their current software systems for Year 2000
compliance. These expenditures may result in reduced funds available to purchase
software products such as those offered by the Company, which could result in a
material adverse effect on the Company's business, financial condition and
results of operations.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130 ("FAS 130"), "Reporting
Comprehensive Income," which the Company is required to adopt for 1998. This
statement will require the Company to report in the financial statements, in
addition to net income, comprehensive income and its
29
<PAGE> 32
components including foreign currency items and unrealized gains and losses on
certain investments in debt and equity securities. Upon adoption of FAS 130, the
Company is also required to reclassify financial statements for earlier periods
provided for comparative purposes. The adoption of FAS 130 will not have a
significant impact on the Company's consolidated financial statement
disclosures.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and Related
Information," which the Company is required to adopt for its 1998 annual
financial statements. This statement establishes standards for reporting
information about operating segments in annual financial statements and requires
selected information about operating segments in interim financial reports
issued to stockholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. Under FAS
131, operating segments are to be determined consistent with the way that
management organizes and evaluates financial information internally for making
operating decisions and assessing performance. The Company has not determined
the impact of the adoption of this new accounting standard on its consolidated
financial statement disclosures.
In November 1997, the American Institute of Certified Public Accountants
issued Statement of Position No. 97-2 ("SOP 97-2"), "Software Revenue
Recognition," which the Company is required to adopt for agreements entered into
with customers beginning in 1998. This statement provides guidance for
recognizing revenue related to sales by software vendors. The adoption of SOP
97-2 will not have a significant impact on the timing of the Company's revenue
recognition.
30
<PAGE> 33
BUSINESS
HNC develops, markets and supports predictive software solutions for
leading service industries. These predictive software solutions employ
proprietary neural-network predictive decision engines, profiles, traditional
statistical modeling, business models, expert rules and context vectors to
convert existing data and business experiences into meaningful recommendations
and actions. Just as manufacturing organizations have implemented manufacturing
resource planning ("MRP") software to automate routine transactions, leading
service industries such as the health-care/insurance, financial services and
retail industries are using predictive software solutions to improve
profitability, competitiveness and customer satisfaction.
INDUSTRY BACKGROUND
Today's competitive business environment has forced many service companies
to increase business efficiency while improving their flexibility and
responsiveness to changing market conditions. Businesses continually seek new
ways to make better decisions by collecting and analyzing data. Consequently,
service companies have made, and continue to make, significant investments in
computer systems designed to gather and electronically store ever increasing
amounts of data. In most cases, these computerized systems automate manual tasks
and activities, resulting in the conversion of significant amounts of corporate
data from paper to electronic form. However, these systems generally do not
synthesize data in ways that help businesses make better real-time decisions.
Historically, the development of predictive software solutions was
inhibited by the lack of computing standards and effective computational
intelligence techniques. The emergence of client-server standards, including
relational database management systems, the Windows operating system and network
communications protocols, has fostered the increased transmission and
dissemination of electronically stored data within and among businesses. MRP
software systems were developed to automate production, accounting, human
resources and distribution transactions for primarily manufacturing
organizations. These systems manage and store large amounts of diverse business
information, providing continuous and simultaneous availability of information
to geographically dispersed employees, customers and suppliers. However, MRP
systems generally do not provide businesses with the functionality and
flexibility needed to utilize this data to simulate operations and make
real-time decisions and recommendations in diverse and rapidly changing business
environments.
Several service industries have a particular need to leverage large volumes
of real-time transactional and operational data in order to address systemic
issues that have historically affected profitability, competitiveness and
customer satisfaction. These industries and issues include:
- HEALTHCARE/INSURANCE INDUSTRY. Workers' compensation fraud and abuse is
currently receiving widespread attention in the healthcare/insurance
industry. Conning & Co. recently estimated that 10%-25% of the dollar
amount of filed workers' compensation claims in the United States are
fraudulent. This translates to more than $5 billion lost each year to
workers' compensation fraud.
- FINANCIAL SERVICES INDUSTRY. Based on reports from Visa and Mastercard,
Faulkner & Gray estimates that United States credit card credit losses
and chargeoffs were $18 billion in 1996.
- RETAIL INDUSTRY. Rapid changes in consumer buying patterns have caused
merchants to place increased emphasis on predicting consumer demand and
managing retail inventories. The change from mass to individual retail
marketing has multiplied the number of promotional offers and
stock-keeping units ("SKUs") required to address market opportunities.
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<PAGE> 34
The U.S. Department of Commerce estimates that the inventory carrying
costs for retail inventories nationwide were $316 billion at the end of
March 1997.
Historically, many companies in the healthcare/insurance, financial
services and retail industries have developed specialized in-house applications
to address these issues. Such applications are generally designed to access
large volumes of operational and transactional data stored on mainframe
computers. However, such systems are expensive, costly to support and maintain,
and do not offer flexible and enterprise-wide access to data. Furthermore, most
of these systems are not designed to meet the need for real-time recommendations
and actions. The widespread adoption of distributed client-server computing has
provided organizations with a much greater ability to access and manipulate
stored information but also has created the need for third-party vendors of
packaged applications software solutions that provide the same degree of
functionality and reliability as traditional in-house applications. These
vendors are able to provide a higher degree of functionality and reliability
than traditional in-house applications by combining the domain knowledge from
their customers and partners with expertise in computational intelligence and
client-server technologies.
THE HNC SOLUTION
HNC's predictive software solutions enable leading service industries, such
as the healthcare/insurance, financial services and retail industries, to
analyze and act upon operational and transactional data in real time. The
Company's products provide the following benefits:
Core predictive software technology. The Company's software includes a
variety of computational intelligence technologies such as proprietary
neural-network predictive decision engines, profiles, expert rules, context
vectors, traditional statistical modeling and business models that can be
customized to specific business applications. Neural networks can be adapted to
changing environments and applications quickly and have proven to be accurate
and effective in real-time operating environments. The Company's decision engine
also includes a user-defined rule-based technology. The neural networks and
rulebases are delivered through software that allows the Company's products to
adapt to many customer-specific business needs without extensive custom
programming. Adaptable functions include workflow queuing management, policy and
procedure guidelines, input data modification, flexible graphical user interface
("GUI") display, decision criteria and report formats.
Quick payback for customers. The Company's software solutions are designed
for quick customer payback. The Company typically installs its products in two
to six months, and customer payback periods for installation and first year
usage fees are typically less than one year. Payback is rapid because the
software products address applications that have a significant profit impact.
HNC personnel focus not only on the technical integration, but also on
delivering direct benefits to the customer throughout the service contract
period.
Transaction-based, real-time decision capability. HNC's software can
operate in real time, providing an immediate, situation-specific response to
each customer transaction. For example, the Falcon system for credit/debit card
fraud can monitor millions of transactions each day, identify fraudulent
transactions in progress and permit the card issuing bank to withhold an
authorization before the perpetrator completes a purchase. The Falcon system
differs from traditional modeling implementations, which operate in a batch or
off-line mode on a collection of historical transactions.
Flexible client-server solutions. HNC's solutions can be integrated into a
customer's existing environment or architecture. The Company's products are
available on industry-standard, client-server platforms, including Windows and
UNIX clients, NetWare, Windows NT, UNIX and CICS servers and IBM, Oracle, Sybase
and Informix databases. HNC's application products represent a complete software
solution, including decision models, deployment software, communications
interfaces and GUIs. The Company also supplies systems integration, ongoing
performance
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<PAGE> 35
analysis, model rebuilding and application consulting services to help ensure
ongoing success for the customer. The Company believes that this flexible
combination of products, services and deployment platforms represents an advance
that enables successful predictive software system deployment in many
mission-critical applications.
Turnkey, customized and user-developed model options. The choice of data
source is important to customers because data are the fundamental building
blocks used to create accurate predictive models. HNC provides various models
built on industry-specific or customer-specific data to meet individual
application requirements. Customers and data suppliers provide the Company with
historical transaction data for turnkey models, trend analyses and product
updates. This combination of proprietary turnkey (from data and individual
consumer profiles), customized and user-developed models allows the Company to
offer products that solve a broad range of predictive application problems.
HNC'S STRATEGY
HNC's objective is to be the leading supplier of predictive software
solutions by leveraging its core computational intelligence technology across a
series of product families targeted at specific service industries. The
Company's strategy for achieving this objective contains the following key
elements:
Maintain and strengthen HNC's position at the core of its customers'
applications infrastructure. Customers rely heavily on HNC's predictive software
solutions to anticipate and react to rapidly changing business conditions. The
Company's core computational intelligence technology serves as a platform upon
which services businesses can deploy and combine the Company's products to
manage and respond to operational and transactional data in real time.
Therefore, HNC attempts to establish a strong position within the applications
infrastructure of its customers. For example, the Company's first predictive
solution product, Falcon, is a credit/debit card fraud detection system for
monitoring individual credit card accounts. By adapting the core technology
developed for Falcon, the Company later introduced ProfitMax, a
transaction-based, real-time credit authorization system that manages the
profitability of credit card portfolios. The Company believes that the
opportunity exists for similar penetration within each of its core vertical
markets, including opportunities such as retail banking within the financial
services industry. As another example, the Company's context vectoring
technology could profile visitors to a financial institution's Web site and send
proactive direct e-mails regarding financial products.
Leverage core predictive technologies to enter new market segments.
Historically, the Company has applied its core predictive technology to the
domain knowledge of companies it has acquired to introduce new products. For
example, in August 1996, HNC acquired Risk Data, a developer of decision systems
in the workers' compensation industry. By combining Risk Data's industry
expertise with HNC's fraud detection technology, HNC is developing a VeriComp
module that applies predictive technology to employer fraud in the workers'
compensation industry. In addition, the Company is evaluating opportunities in
other data-intensive industries, such as telecommunications, where predictive
software may have the ability to improve business performance and profitability.
Earn recurring revenues through long-term contracts. The Company markets
most of its predictive software solutions as an ongoing service that includes
software licenses, decision model updates, application consulting and on-line or
on-site support and maintenance. Since many of the Company's applications are
enhanced by periodic model updates, customers derive significant value from the
Company's ongoing services. In addition, the mission-critical nature of many of
HNC's predictive software solutions creates customer demand for long-term
support commitments. Accordingly, the Company's customers typically pay for this
package of software and service with a monthly usage fee and a three to seven
year contract commitment.
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Use strategic relationships to support direct distribution. In each of its
primary markets, the Company uses strategic relationships with system
integrators and third-party service providers to support its direct distribution
efforts. These partners provide varying levels of distribution support, from
lead generation to resale of the Company's products. The Company maintains such
strategic relation\ships with Electronic Data Systems ("EDS"), Intracorp and
Marsh McLennan, Inc. in healthcare/insurance, First Data and EDS in financial
services, and Andersen Consulting and KPMG Peat Marwick LLP in retail.
Growth Through Acquisitions. The Company acquired First Data, Retek and
CompReview in 1996 and 1997, thereby significantly expanding its product
offerings in its target markets. On January 30, 1998, the Company signed a
definitive agreement to acquire Practical Control Systems Technologies, Inc.
("PCS"), a distribution center management software vendor based in Cincinnati,
Ohio, subject to the satisfaction of certain closing conditions and the approval
of PCS' shareholders. The Company expects to continue to review acquisitions of
businesses, products and technologies as a means to expand its product offerings
for existing and new target markets.
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MARKETS AND PRODUCTS
HNC has a broad family of predictive software products that provide
specific solutions for each of the healthcare/insurance, financial services and
retail markets. Revenues from each of the Company's three product lines
accounted for more than one-quarter of the Company's total revenues in 1997.
Revenues from three products, CRLink, Retek Merchandising System and Falcon,
accounted for 57.9% of the Company's total revenues in 1997. See "Risk
Factors -- Product Concentration."
Healthcare/Insurance
HNC offers and is developing products in the healthcare/insurance market.
These products are targeted to insurance carriers, insurance providers, managed
care organizations, state insurance funds, third-party administrators and large,
self-insured employers. HNC has developed predictive software solutions that
address the containment of the medical costs of workers' compensation and auto
accident insurance claims, workers' compensation loss reserving, workers'
compensation fraud, managed care effectiveness and provider effectiveness. These
solutions, CRLink, MIRA, CompCompare, ProviderCompare, PMAdvisor and VeriComp,
allow users the ability to reduce fraud losses and streamline operations.
HNC HEALTHCARE/INSURANCE INDUSTRY PRODUCTS
================================================================================
<TABLE>
<CAPTION>
PRODUCT PRODUCT DESCRIPTION
<S> <C> <C>
- -------------------------------------------------------------------------------------------------------
CRLink CRLink operates as the bill review engine that links all of the critical
components of an effective cost containment program to help clients control
the cost of workers' compensation, personal injury and other casualty risks.
- -------------------------------------------------------------------------------------------------------
MIRA MIRA uses statistical predictive methods to automatically determine workers'
compensation loss reserves based on historical data gathered from insurance
carriers, third-party administrators and state insurance funds throughout
the United States.
- -------------------------------------------------------------------------------------------------------
CompCompare CompCompare enables clients to compare claims costs or the effectiveness of
managed care programs by using benchmarking data from HNC's proprietary
workers' compensation database.
- -------------------------------------------------------------------------------------------------------
ProviderCompare ProviderCompare is a physician profiling product that provides on-line
access to HNC's proprietary workers' compensation database. ProviderCompare
enables clients to generate a detailed comparative analysis, such as
treatment costs, among providers within the same specialty.
- -------------------------------------------------------------------------------------------------------
PMAdvisor PMAdvisor enables claim payors to verify that the number of visits and type
of treatment for claims involving physical medicine (primarily chiropractic
and physical therapy) are appropriate for the diagnosis and severity of the
injury and to identify chiropractic and physical therapy claims that exceed
appropriate treatment guidelines.
- -------------------------------------------------------------------------------------------------------
VeriComp VeriComp is a workers' compensation claimant system designed to assist in
identifying claimant behavior that is likely to indicate the presence of
fraud or abuse.
- -------------------------------------------------------------------------------------------------------
</TABLE>
Financial Services
The increasing volume of electronic financial transactions requires
mission-critical decision-making in real time for applications such as credit
card charge authorization, that carry a substantial risk of consumer and
merchant fraud. HNC's Falcon and ProfitMax product lines are targeted at bank
and private label card issuers and payment processors. Falcon employs a
client/server architecture that consists of an interface into the customer's
legacy system, a decision engine, a cardholder profile database, a case
management database and a fraud workstation.
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HNC estimates that loan underwriting costs in the United States currently
exceed $2.5 billion each year. Competitive pressures including cost reduction,
rapid loan approval and the growth of on-line banking have compelled lenders to
turn to software solutions that can automate loan origination in order to lower
costs, improve customer service and provide remote access to lending services.
HNC's predictive software solutions for the loan origination markets, Capstone
and AREAS, allow lenders such as banks and private label card issuers, home
equity lenders, auto lenders and mortgage lenders to automate the loan approval
decision process.
HNC FINANCIAL SERVICES INDUSTRY PRODUCTS
================================================================================
<TABLE>
<CAPTION>
PRODUCT PRODUCT DESCRIPTION
<S> <C> <C>
- -------------------------------------------------------------------------------------------------------
Falcon Product Line
- ------------------------
Falcon Falcon products are neural network-based solutions that examine
Falcon Expert transaction, cardholder and merchant data to detect a wide range of
Falcon Select credit and debit card fraud. Using predictive software techniques,
Falcon Debit Falcon captures relationships and patterns that often are missed by
Falcon Retail traditional methods of detecting suspicious transactions.
Falcon Sentry
Eagle
- -------------------------------------------------------------------------------------------------------
Capstone Product Line
- ------------------------
Capstone for Payment Capstone is an intelligent, high-performance new account decision
Cards processing solution. Based on expert rules, Capstone allows users to
Capstone for automate lending decisions and design, test, implement and track
Consumer Lending lending policies.
Capstone for Mortgage
Lending
- -------------------------------------------------------------------------------------------------------
ProfitMax Product Line
- ------------------------
ProfitMax ProfitMax provides transaction-based, real-time authorization and
ProfitMax Bankruptcy action decisions from within a complete infrastructure for managing
the profitability of credit card portfolios. ProfitMax uses neural
networks, expert rules and HNC's cardholder behavior profiling
technology to analyze the expected profitability of each account in an
issuer's portfolio using the issuer's definition of financial profit.
ProfitMax Bankruptcy uses the basic ProfitMax structure to predict the
likelihood of cardholder bankruptcy even before the cardholder is
delinquent.
- -------------------------------------------------------------------------------------------------------
AREAS AREAS automated property valuation software uses neural networks and
other computational intelligence to provide an objective prediction of
the current market value of residential property.
- -------------------------------------------------------------------------------------------------------
</TABLE>
Retail
Although retailers have made significant investments in customer
information, point-of-sale and quick-response ordering systems, these
applications often do not include the forecasting ability required to maximize
profitability and respond to competition through timely "in-store"
replenishment, electronic networking and quick response initiatives. HNC has
developed a group of products that effectively addresses inventory control,
merchandise management and financial control management. These software
solutions allow retailers to build forecasting and marketing models to carry out
day-to-day buying and selling activities, thereby reducing carrying costs for
inventories and improving purchasing, promotion and logistics efficiencies. The
target markets for the Company's retail products are department stores, mass
merchandisers and specialty retail chains in multi-store and multi-warehouse
environments with gross sales in excess of $200 million.
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<PAGE> 39
HNC RETAIL INDUSTRY PRODUCTS
================================================================================
<TABLE>
<CAPTION>
PRODUCT PRODUCT DESCRIPTION
<S> <C> <C>
- -------------------------------------------------------------------------------------------------------
Retek Merchandising The Retek Merchandising System provides inventory control, merchandise
System management and financial control and addresses the definition and
management of merchandise at the SKU level and reporting and financial
control through stock ledgers.
- -------------------------------------------------------------------------------------------------------
Retek Data Warehouse Retek Data Warehouse provides the transaction infrastructure needed
for retailers to plan, buy, move, sell and pay for their merchandise.
- -------------------------------------------------------------------------------------------------------
Active Retail Active Retail Intelligence identifies performance exceptions and
Intelligence recommends the appropriate corrective action.
- -------------------------------------------------------------------------------------------------------
Retek Demand Retek Demand Forecasting provides forecasts to retailers' supply chain
Forecasting planning allocation and replenishment functions and uses predictive
causal techniques with automated forecasting and multi-dimensional
on-line analysis.
- -------------------------------------------------------------------------------------------------------
Falcon Retail Falcon Retail provides proactive detection of private label card
application and transaction fraud.
- -------------------------------------------------------------------------------------------------------
</TABLE>
EMERGING MARKET OPPORTUNITIES
The Company's experience and technology capabilities in the
healthcare/insurance, financial services and retail markets often lead to new
product ideas and concepts. The Company also evaluates new market opportunities
that arise through its commercial and government contract work. As contracts are
completed, the end products are evaluated for commercialization. For example,
contracts for the Advanced Research Projects Agency, United States Army Research
Laboratory, United States Air Force, Office of Naval Research, DataTimes
Corporation and Tracor Applied Sciences, Inc. generated a context-based text
analysis technology called MatchPlus. This core text analysis technology has
been under development at HNC for the last four years for Department of Defense
applications. During 1996, the Company formed Aptex to commercialize HNC's
MatchPlus text analysis technology for emerging markets. Aptex has developed a
strategic partnership with InfoSeek Corporation, an Internet search and
navigation service, to deliver products using this text analysis technology to
the Internet market. To date, three new Internet products have been launched:
SelectCast, SelectResponse and SelectResource.
Substantially all of the Company's revenues in recent years have been
attributable to sales of predictive software solutions and services, and these
products and services are currently expected to continue to account for a
substantial amount of the Company's future revenues. The market for predictive
software solutions is still emerging. The rate at which businesses have adopted
the Company's products has varied significantly by market and by product within
each market, and the Company expects to continue to experience such variations
with respect to its target markets and products in the future. The Company has
introduced products for the healthcare/insurance, financial services and retail
markets. The Company has recently announced several new products, including
PMAdvisor, VeriComp, SelectCast, SelectResponse and SelectResource. To date,
none of these products has achieved any significant degree of market acceptance,
and there can be no assurance that such products will ever be widely accepted.
Although businesses in the Company's target markets have recognized the
advantages of using predictive software solutions to automate the
decision-making process, many have developed decision automation systems
internally rather than licensing them from outside vendors. There can be no
assurance that the markets for the Company's products will continue to develop
or that the Company's products will be widely accepted, if at all. If the
markets for the Company's new or existing products fail to develop, or
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develop more slowly than anticipated, the Company's sales would be negatively
impacted, which would have a material adverse effect on the Company's business,
financial condition and results of operations.
CUSTOMER SERVICE AND SUPPORT
A high level of continuing maintenance, service and support is critical to
maintaining the performance of the Company's predictive software solutions.
Service and support are also essential to the Company's objective of developing
long-term relationships with, and obtaining recurring revenues from, customers.
The Company's service and support activities are related to system installation,
performance validation and ongoing consultation on the optimal use of HNC
products.
Model and Rule Updates. Most HNC product license agreements include
periodic data, model and/or rule updates to maintain system performance. HNC
technical personnel generally assist the customer with installation of updates.
The Company makes commitments to update models and rules at varying intervals,
from fixed times (such as quarterly and annually) to unscheduled times, provided
the customer has met its commitments to provide data to HNC.
Education. The Company offers comprehensive education and training programs
to its customers. The Company provides on-site training services associated with
many of its products. Fees for education and training services are generally
included in usage-priced products, but may be charged separately in other cases.
Consulting. The Company's consultants are available to work with customers'
user application groups and information systems organizations. Customers that
buy consulting services are usually planning large implementations or want to
optimize performance of the Company's products in their operating environments.
Fees for consulting are generally included in usage-priced products, but may be
charged separately in other cases.
PRICING
The Company generally establishes prices in one of two ways: usage-based
fees and fixed-fee licenses with maintenance. The Company generally employs
usage-based pricing for its healthcare/insurance products, Falcon, ProfitMax and
AREAS. Under the usage-based pricing structure, HNC generally provides a
fixed-term software license, software maintenance, model updates (in the case of
HNC-supplied models) and ongoing consulting services in exchange for recurring
revenue based on usage. Usage-based term contracts typically include annual
price index adjustments. In 1995, 1996 and 1997, recurring revenues from these
contracts represented 61.2%, 56.1% and 55.2% of the Company's total revenues,
respectively. The Company generally employs fixed-fee license pricing for
Capstone and all of the Company's retail products except Falcon Retail. Under
the fixed-fee license pricing structure, the Company generally licenses the
product for the customer's internal use on a perpetual basis. In most cases, the
user can separately contract for maintenance services on an annual basis. The
Company typically offers early adopter pricing for its usage-based products to
customers that agree to be part of pilot or other early product life cycle
installations. Early adopter pricing might include reduced-fee perpetual
licenses, reduced-fee services or both.
The Company often contracts for installation services associated with its
predictive software solutions. The Company provides user-specific proposals
priced at either fixed-fee levels or on a time and materials basis. In nearly
all cases, travel expenses are billed separately at cost.
The Company offers contract consulting services. Because of the complexity
associated with predictive software solutions, users often request that HNC help
them to develop models or analyze problems. Also, the Company from time to time
accepts engagements not associated with current product offerings in order to
become more familiar with a new application area and
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<PAGE> 41
determine the potential for new product development. Although consulting
services are included with many of the Company's usage-based products, customers
may request additional consulting, often associated with custom modeling.
SALES AND MARKETING
The Company sells and markets its software and services in North America
and internationally through its direct sales organization, joint marketing and
distribution agreements. The Company's worldwide sales and marketing
organization consisted of 125 employees as of December 31, 1997. The domestic
sales staff is based at the Company's corporate headquarters in San Diego and in
United States field offices in California, Colorado, Connecticut, Georgia,
Minnesota, New York, Pennsylvania, Texas and Virginia. Internationally, the
Company has field sales offices in Australia, Canada, France, Germany, Japan,
Singapore, South Africa and the United Kingdom. To support its sales force, the
Company conducts comprehensive marketing programs, which include direct mail,
public relations, advertising, seminars, trade shows and ongoing customer
communication programs. The sales staff is generally product-based, and each
representative is assigned a geographic territory.
The Company has licensed First Data and EDS to act as service bureaus to
provide an alternate channel of distribution for end-users to utilize the Falcon
product to process credit card receipts for banks and other credit card issuers.
The Company generally assists its service bureau partners in the sales effort,
often employing the Company's direct sales force in the process. Company sales
representatives earn a commission for service bureau sales in their territory.
These service bureaus pay the Company monthly usage fees based on the volume of
transactions processed for such credit card issuers. Product licenses to First
Data, the largest provider of credit card charge receipt processing services to
banks, accounted for 8.7%, 8.6% and 7.6% of the Company's total revenues in
1995, 1996 and 1997, respectively. The Company has licensed First Data to
provide its customers with access to the Company's ProfitMax product pursuant to
a license agreement entered into in January 1996. The Company's revenues under
the ProfitMax Contract represented approximately one-quarter of the Company's
revenues from First Data in 1997. In late January 1998, First Data asserted that
certain restrictive covenants under the ProfitMax Contract violated certain
intellectual property laws. First Data also asserted that the existence of such
restrictions made the ProfitMax Contract at least temporarily unenforceable and
that First Data is therefore not obligated to pay the Company license fees due
under the ProfitMax contract. The Company disputed First Data's claim, released
and waived the above-mentioned restrictive covenants in the ProfitMax Contract
and gave First Data written notice that the Company intended to terminate the
ProfitMax Contract pursuant to its terms unless First Data cured its failure to
pay the delinquent license fees in a timely manner. Currently, First Data and
the Company are working to resolve their dispute regarding the ProfitMax
Contract by negotiating a new agreement. First Data has resumed making license
fee payments on a delayed basis, and HNC has agreed to extend the date for First
Data to pay past due license fees until mid-April 1998. Although HNC expects to
reach a new agreement with First Data that will resolve the pending dispute,
there can be no assurance that such an agreement will be reached or that the
terms of such an agreement would be as favorable to HNC as its existing
contractual arrangements with First Data. If no such agreement can be reached
and First Data maintains its current position, it is possible that litigation or
arbitration could ensue, which would likely result in a loss of anticipated
revenue to the Company under the ProfitMax Agreement and possibly other
agreements between the Company and First Data, which could have a material
adverse affect on the Company's business, financial condition and results of
operation.
The Company also uses representative agents for certain products in certain
territories outside of North America. The Company has agents covering Australia,
Austria, France, Germany, Italy, New Zealand, Spain and Switzerland. In 1995,
1996 and 1997, international operations and export sales (includes sales in
Canada) represented 12.6%, 17.7% and 16.8% of the Company's total revenues,
respectively. International sales result primarily from Falcon product sales and
sales of
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<PAGE> 42
retail products. The Company intends to continue to expand its operations
outside the United States and to enter additional international markets,
including by adding sales and support offices in Europe and Japan, which will
require significant management attention and financial resources. The Company
has committed and continues to commit significant time and development resources
to customizing certain of its products for selected international markets and to
developing international sales and support channels. There can be no assurance
that the Company's efforts to develop products, databases and models for
targeted international markets or to develop additional international sales and
support channels will be successful. The failure of such efforts, which can
entail considerable expense, could have a material adverse effect on the
Company's business, financial condition and results of operations. See "Risk
Factors -- Risks Associated with International Sales."
International sales are subject to additional inherent risks, including
longer payment cycles, unexpected changes in regulatory requirements, import and
export restrictions and tariffs, difficulties in staffing and managing foreign
operations, the burdens of complying with a variety of foreign laws, greater
difficulty or delay in accounts receivable collection, potentially adverse tax
consequences and political and economic instability. The Company's international
sales are currently denominated predominantly in United States dollars and a
small portion are denominated in British pounds sterling. An increase in the
value of the United States dollar relative to foreign currencies could make the
Company's products more expensive, and therefore potentially less competitive,
in foreign markets. In the future, to the extent the Company's international
sales are denominated in local currencies, foreign currency translations may
contribute to significant fluctuations in the Company's business, financial
condition and results of operations. If for any reason exchange or price
controls or other restrictions on foreign currencies are imposed, the Company's
business, financial condition and results of operations could be materially
adversely affected.
Due in part to the mission-critical nature of certain of the Company's
applications, potential customers perceive high risk in connection with adoption
of the Company's products. As a result, customers have been cautious in making
decisions to acquire the Company's products. In addition, because the purchase
of the Company's products typically involves a significant commitment of capital
and may involve shifts by the customer to a new software and/or hardware
platform, delays in completing sales can arise while customers complete their
internal procedures to approve large capital expenditures and test and accept
new technologies that affect key operations. For these and other reasons, the
sales cycle associated with the purchase of the Company's products is typically
lengthy, unpredictable and subject to a number of significant risks over which
the Company has little or no control, including customers' budgetary constraints
and internal acceptance reviews. The sales cycle associated with the licensing
of the Company's products can typically range from 60 days to 18 months. As a
result of the length of the sales cycle and the typical size of customers'
orders, the Company's ability to forecast the timing and amount of specific
sales is limited. A lost or delayed sale could have a material adverse effect on
the Company's business, financial condition and results of operations.
TECHNOLOGY
The Company seeks to develop innovative products by combining industry and
application knowledge with its core neural-network technology to address
specific market needs. The Company's systems also employ rule-based technology
to implement customer strategy, policy and procedures. These technologies are
incorporated in computer software and hardware archi-
tectures, including client-server hardware, relational databases and
object-oriented programming. The Company intends to continue to develop
state-of-the-art technologies to enhance its current products and broaden
development opportunities.
Neural-Network Technology. Neural networks have predictive power that can
be improved with experience as the historical database increases in size. The
term "neural network" refers to a family of nonlinear, statistical modeling
techniques, sometimes called "computational intelli-
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gence." These techniques distinguish themselves through a process of automated
"learning" or "training" that replaces the time-consuming manual techniques of
traditional nonlinear, statistical modeling. The neural-network architecture
itself consists of groups of "processing elements," or equations with several
inputs and a single output. The output of each element becomes either the input
to another element or part of the dependent output. Each input receives a
"weight" or value, in the equation, which is adjusted during the training
process. The actual result from each training record is compared with the answer
from the neural network, and the weights are adjusted to reduce the error
between the two. This process can become computationally intensive, as millions
of training data records must be processed hundreds or thousands of times. HNC
has developed proprietary high-speed and parallel-processor boards to accelerate
training and execution of its neural-network software. The Company believes that
the rapid model development afforded by its technology provides a competitive
advantage in the development of predictive software solutions.
Rule-Based Technology. The Company's systems also employ rule-based
technology to implement customer strategy, policy and procedures. The rules are
implemented as part of predictive processes. The Company believes that its
combination of neural networks and rule bases in a single decision engine
represents a significant competitive advantage over more traditional approaches
to decision automation.
Context Vector Technology. Context vector technology that originated at HNC
and is being commercialized at Aptex is a way to explore, analyze and model
unstructured textual data. Context vector technology automatically discovers the
underlying structure of free form symbolic data. This structure enables modeling
from data elements previously considered impossible to include in predictive
software applications. Context vector technology also models behavior. Just as
relationships are discovered in unstructured data, observing electronic
transaction behavior identifies patterns. Compatibility predictions can be made
between information, behavior, people and products. When combined with other HNC
technologies, such as neural networks and rule-based systems, the Company
believes that context vectors can improve the performance of existing
applications while opening new market opportunities. Context vector technology
has been demonstrated to increase banner advertising click rates on the
Internet, automate e-mail responses and discover unknown relationships in credit
card transaction data.
The Company's success depends upon its ability to enter new markets by
successfully developing new products for such markets on a timely and
cost-effective basis. The Company's products often require customer data for
decision model development and system installation. As a result, completion of
new products (particularly new products for markets not previously served by the
Company) may be delayed while the Company extracts sufficient amounts of
statistically relevant data and develops the models. During this development
process, the Company relies on its potential customers in the new market to
provide data and to help train Company personnel in the use and meaning of the
data in the specific industry. These relationships also assist the Company in
establishing a market presence and credibility in the new market. These
potential customers, most of which have significantly greater financial and
marketing resources than the Company, may compete with the Company in the future
or otherwise discontinue their relationships with or support of the Company,
either during development of the Company's products or thereafter. The failure
by the Company to obtain adequate third-party support for new product
development would have a material adverse effect on the Company's ability to
enter new markets and, consequently, on the Company's business, financial
condition and results of operations. See "Risk Factors -- Risks Associated with
Technological Change and Delays in Developing New Products."
RESEARCH AND DEVELOPMENT
The Company believes that its future success depends in part on its ability
to maintain and improve its core technologies, enhance its existing products and
develop new products that meet an expanding range of markets and customer
requirements. The Company intends to expand its
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existing product offerings and to introduce new predictive software solutions.
In the development of new products and enhancements to existing products, the
Company uses its own tools extensively. Until 1996, the Company relied primarily
on internal development of its products. Based on timing and cost
considerations, however, the Company has acquired, and in the future may
consider acquiring, technology or products from third parties. For example, the
Company acquired technology and products in connection with its acquisitions of
Risk Data and Retek in 1996 and CompReview in 1997.
The Company performs all quality assurance and develops documentation
internally. The Company intends to continue to support industry standard
operating environments, client-server architectures and network protocols. The
Company's specialists in neural network model development, software engineering,
user interface design, product documentation and quality improvement are
responsible for maintaining and enhancing the performance, quality and usability
of all HNC predictive software solutions. The marketing services organization is
responsible for authoring and updating all user documentation and other
publications. See "Risk Factors -- Risks Associated with Technological Change
and Delays in Developing New Products."
The Company strategically targets its long-term research projects. In
addition to funds allocated by the Company for research, HNC receives research
contracts from a range of commercial sources and the United States Government.
Government and commercial contract customers have included the Advanced Research
Projects Agency, United States Air Force, Office of Naval Research and Tracor
Applied Sciences, Inc. The Company believes that these contracts augment its
ability to maintain existing technologies and investigate new technologies that
may or may not become part of its products. The United States Government
typically retains certain intellectual property rights and licenses in the
technologies the Company develops under research contracts directly or
indirectly sponsored by the government, and in some cases can terminate the
Company's rights in such technologies if the Company fails to commercialize them
on a timely basis. Historically, these contracts have not resulted in
development of products contributing to the Company's revenues in the fiscal
year in which the research contract is performed, or in the subsequent fiscal
year.
The market for the Company's predictive software solutions for service
industries is characterized by rapidly changing technology and improvements in
computer hardware, network operating systems, programming tools, programming
languages, operating systems and database technology. The Company's success will
depend upon its ability to continue to develop and maintain competitive
technologies, enhance its current products and develop, in a timely and
cost-effective manner, new products that meet changing market conditions,
including evolving customer needs, new competitive product offerings, emerging
industry standards and changing technology. For example, the rapid growth of the
Internet environment creates new opportunities, risks and uncertainties for
businesses, such as the Company, which develop software solutions that now may
have to be designed to operate in Internet, intranet and other on-line
environments. The Company may not be able to develop and market, on a timely
basis, or at all, product enhancements or new products that respond to changing
technologies. The Company has previously experienced significant delays in the
development and introduction of new products and product enhancements, primarily
due to difficulties with model development, which has in the past required
multiple iterations, as well as difficulties with acquiring data and adapting to
particular operating environments. The length of these delays has varied
depending upon the size and scope of the project and the nature of the problems
encountered. Any significant delay in the completion of new products, or the
failure of such products, if and when installed, to achieve any significant
degree of market acceptance, would have a material adverse effect on the
Company's business, financial condition and results of operations. Any failure
by the Company to anticipate or to respond adequately to changing technologies,
or any significant delays in product development or introduction, could cause
customers to delay or decide against purchases of the Company's products and
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would have a material adverse effect on the Company's business, financial
condition and results of operations.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company relies on a combination of patent, copyright, trademark and
trade secret laws and confidentiality procedures to protect its proprietary
rights. The Company currently owns seven issued United States patents and has
four United States patent applications pending. The Company has applied for
additional patents for its Falcon technology in Canada, Europe and Japan and for
its MIRA product in Australia, Canada and Europe. There can be no assurance that
patents will be issued with respect to pending or future patent applications or
that the Company's patents will be upheld as valid or will prevent the
development of competitive products. The Company seeks to protect its software,
documentation and other written materials under trade secret and copyright laws,
which afford only limited protection. As part of its confidentiality procedures,
the Company generally enters into invention assignment and proprietary
information agreements with its employees and independent contractors and
nondisclosure agreements with its distributors, corporate partners and
licensees, and limits access to and distribution of its software, documentation
and other proprietary information. Despite these precautions, it may be possible
for a third party to copy or otherwise to obtain and use the Company's products
or technology without authorization, or to develop similar technology
independently. In addition, to ensure that customers will not be adversely
affected by an interruption in the Company's business, the Company places source
code for certain of its products into escrow, which may increase the likelihood
of misappropriation or other misuse of the Company's intellectual property.
Moreover, effective protection of intellectual property rights may be
unavailable or limited in certain foreign countries in which the Company has
done and may do business. Also, the Company has developed technologies under
research projects conducted under agreements with various United States
Government agencies or subcontractors to such agencies. Although the Company has
acquired certain commercial rights to such technologies, the United States
Government typically retains ownership of certain intellectual property rights
and licenses in the technologies developed by the Company under such contracts,
and in some cases can terminate the Company's rights in such technologies if the
Company fails to commercialize them on a timely basis. In addition, under
certain United States Government contracts, the results of the Company's
research may be made public by the government, which could limit the Company's
competitive advantage with respect to future products based on such research.
In the past, the Company has received communications from third parties
asserting that Company trademarks infringe such other parties' trademarks, none
of which has resulted in litigation or losses to the Company. Given the
Company's ongoing efforts to develop and market new technologies and products,
the Company may receive communications from third parties asserting that the
Company's products infringe, or may infringe, their intellectual property
rights. If as a result of any such claims the Company were precluded from using
certain technologies or intellectual property rights, licenses to such disputed
third-party technology or intellectual property rights might not be available on
reasonable commercial terms, if at all. Furthermore, the Company may initiate
claims or litigation against third parties for infringement of the Company's
proprietary rights or to establish the validity of the Company's proprietary
rights. Litigation, either as plaintiff or defendant, could result in
significant expense to the Company and divert the efforts of the Company's
technical and management personnel from productive tasks, whether or not such
litigation is resolved in favor of the Company. In the event of an adverse
ruling in any such litigation, the Company might be required to pay substantial
damages, discontinue the use and sale of infringing products, expend significant
resources to develop non-infringing technology or obtain licenses to infringing
technology, and the court might invalidate the Company's patents, trademarks or
other proprietary rights. In the event of a successful claim against the Company
and the failure of the Company to develop or license a substitute technology,
the Company's business, financial condition and results of operations would be
materially and adversely affected.
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As the number of software products increases and the functionality of these
products further overlaps, the Company believes that software developers may
become increasingly subject to infringement claims. Any such claims, with or
without merit, can be time consuming and expensive to defend and could
materially and adversely affect the Company's business, financial condition and
results of operations.
COMPETITION
The market for predictive software solutions for service industries is
intensely competitive and subject to rapid change. Competitors, many of which
have substantially greater financial resources
than the Company, vary in size and in the scope of the products and services
they offer. The Company encounters competition from a number of sources,
including (i) other application software companies, (ii) management information
systems departments of customers and potential customers, including banks,
insurance companies and retailers, (iii) third party professional services
organizations, including without limitation, consulting divisions of public
accounting firms, (iv) hardware suppliers that bundle or develop complementary
software, (v) network and service providers that seek to enhance their
value-added services, (vi) neural-network tool suppliers, and (vii) managed care
organizations. In the healthcare/insurance market, the Company has experienced
competition primarily from NCCI, Corporate Systems and CSC Incorporated. In the
workers' compensation and medical cost administration market, the Company has
experienced competition from MediCode, Medata, Inc. and Embassy Software with
regard to software licensing, and Intracorp and Corvel Corporation in the
service bureau operations market. Additionally, the Company has faced
competition from ADP in the automobile accident medical claims market. In the
financial services market, the Company has experienced competition from Fair,
Isaac & Co., Inc., Cogensys (a subsidiary of Policy Management Systems
Corporation), Fannie Mae, Freddie Mac, IBM, Nestor, Inc., NeuralTech Inc.,
Neuralware Inc., PMI Mortgage Services Co., VISA International and others. In
the retail market, the Company has experienced competition from JDA Software
Group, Inc., SAP AG, PeopleSoft, Inc., IBM, Manugistics Group, Inc. and others.
The Company expects to experience additional competition from other established
and emerging companies, as well as other technologies. For example, the
Company's Falcon product competes against other methods of preventing credit
card fraud, such as card activation programs, credit cards that contain the
cardholder's photograph, smart cards and other card authorization techniques.
Increased competition, whether from other products or new technologies, could
result in price reductions, fewer customer orders, reduced gross margins and
loss of market share, any of which could materially adversely affect the
Company's business, financial condition and results of operations.
The Company believes that most of its products are currently priced at a
premium when compared to its competitors' products. The market for the Company's
products is highly competitive, and the Company expects that it will face
increasing pricing pressures from its current competitors and new market
entrants. In particular, increased competition could reduce or eliminate such
premiums and cause further price reductions. In addition, such competition could
adversely affect the Company's ability to obtain new long-term contracts and
renewals of existing long-term contracts on terms favorable to the Company. Any
reduction in the price of the Company's products could materially adversely
affect the Company's business, financial condition and results of operations.
The Company believes that the principal competitive factors affecting its
market include technical performance (for example, accuracy in detecting credit
card fraud or evaluating workers' compensation claims), access to unique
proprietary databases and product attributes such as adaptability, scalability,
ability to integrate with products produced by other vendors, functionality,
ease-of-use, product reputation, quality, performance, price, customer service
and support, the effectiveness of sales and marketing efforts and Company
reputation. Although the Company believes that its products currently compete
favorably with respect to such factors, there can be
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<PAGE> 47
no assurance that the Company can maintain its competitive position against
current and potential competitors, especially those with significantly greater
financial, marketing, service, support, technical and other resources.
Some of the Company's current, and many of the Company's potential,
competitors have significantly greater financial, technical, marketing and other
resources than the Company. As a result, they may be able to respond more
quickly to new or emerging technologies and changes in customer requirements or
to devote greater resources to the development, promotion and sale of their
products than the Company. In addition, current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties to increase the ability of their products to address the needs of
the Company's prospective customers. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly gain
significant market share. Also, the Company relies upon its customers to provide
data, expertise and other support for the ongoing updating of the Company's
models. The Company's customers, most of which have significantly greater
financial and marketing resources than the Company, may compete with the Company
in the future or otherwise discontinue their relationships with or support of
the Company. There can be no assurance that the Company will be able to compete
successfully against current and future competitors or that competitive
pressures faced by the Company will not materially adversely affect its
business, financial condition and results of operations.
EMPLOYEES
As of December 31, 1997, the Company had 706 employees, including 316 in
product development and support, 87 in customer service, 125 in sales and
marketing and 178 in finance, administration and MIS. Most of these employees
are located in the United States. None of the Company's employees are
represented by a labor union. The Company has experienced no work stoppages and
believes that its employee relationships are generally good.
The Company's success depends to a significant degree upon the continued
service of members of the Company's senior management and other key research,
development, sales and marketing personnel. Accordingly, the loss of any of the
Company's senior management or key research, development, sales or marketing
personnel could have a material adverse effect on the Company's business,
financial condition and results of operations. Only a small number of employees
have employment agreements with the Company, and there can be no assurance that
such agreements will result in the retention of these employees for any
significant period of time. In addition, the untimely loss of a member of the
management team or a key employee of a business acquired by the Company could
have a material adverse effect on the Company's business, financial condition
and results of operations, particularly if such loss occurred before the Company
has had adequate time to familiarize itself with the operating details of that
business. In the past, the Company has experienced difficulty in recruiting a
sufficient number of qualified sales and technical employees. In addition,
competitors may attempt to recruit the Company's key employees. There can be no
assurance that the Company will be successful in attracting, assimilating and
retaining such personnel. The failure to attract, assimilate and retain key
personnel could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Risk Factors -- Risks
Associated with Managing Growth."
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FACILITIES
The Company's principal administrative, sales, marketing, support, research
and development facilities are located in approximately 85,000 square feet of
space in San Diego, California. The Company and its subsidiaries also lease an
aggregate of approximately 95,000 square feet of additional office space
elsewhere in San Diego and in Atlanta, Georgia; Minneapolis, Minnesota; Costa
Mesa, California; and Irvine, California. The Company and its subsidiaries also
maintain numerous field offices in the United States and in foreign countries.
The Company believes that its current facilities are adequate to meet its needs
for the foreseeable future. The Company believes that suitable additional or
alternative space will be available in the future on commercially reasonable
terms as needed.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The names, ages and positions of the Company's directors and executive
officers as of February 17, 1998 are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
------------------------------------------ --- -----------------------------------------------
<S> <C> <C>
Robert L. North........................... 62 President, Chief Executive Officer and Director
Raymond V. Thomas......................... 55 Vice President, Finance and Administration,
Chief Financial Officer and Secretary
John Mutch................................ 41 Vice President, Marketing
Todd W. Gutschow.......................... 37 Vice President, Technology Development
Michael A. Thiemann....................... 41 President, Aptex Software Inc.
Edward K. Chandler(1)..................... 39 Director
Oliver D. Curme(2)........................ 44 Director
Thomas F. Farb(1)......................... 41 Director
Charles H. Gaylord, Jr.(2)................ 52 Director
</TABLE>
- ---------------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
Mr. North has been President and Chief Executive Officer and a director of
the Company since June 1987. Mr. North is also a director of Peerless Systems
Corporation. Mr. North holds Bachelor of Science and Master of Science degrees
in Electrical Engineering from Stanford University.
Mr. Thomas has been Vice President, Finance and Administration and Chief
Financial Officer of the Company since February 1995 and Secretary of the
Company since May 1995. From May 1993 to February 1995, he served as Executive
Vice President and Chief Financial Officer of Golden Systems, Inc., a power
supply manufacturer, and from September 1994 to February 1995 he also served as
Chief Operating Officer. From April 1991 to May 1993, Mr. Thomas served as
Senior Vice President of Finance and Administration and Chief Financial Officer
of Vitesse Semiconductor Corporation, a semiconductor manufacturer. Mr. Thomas
holds a Bachelor of Science degree in Industrial Management from Purdue
University and attended the Wharton School of Business at the University of
Pennsylvania.
Mr. Mutch joined the Company in July 1997 as Vice President, Marketing. He
was a founder of MVenture Holdings, Inc., a private equity fund that invests in
start-up technology companies, and served as a General Partner from June 1994 to
July 1997. From December 1986 to June 1994, Mr. Mutch held a variety of
positions with Microsoft Corporation, including Director of Organization
Marketing. He holds a Bachelor of Science degree in Applied Economics from
Cornell University and a Masters degree in Business Administration from the
University of Chicago.
Mr. Gutschow is a co-founder of the Company and has been Vice President,
Technology Development of the Company since October 1990. He was also Secretary
of the Company from January 1993 to May 1995. Mr. Gutschow holds a Bachelor of
Arts degree in Physics from Harvard University and attended the University of
California at San Diego.
Mr. Thiemann joined the Company in June 1989. He ran the Company's Aptex
text analysis division from January 1996 to September 1996 and in September 1996
was named President and Chief Executive Officer of Aptex Software Inc. From May
1993 to January 1996, he served as Executive Vice President, Sales and Marketing
of the Company. He has also served as Executive Vice President and General
Manager, Decision Systems of the Company from January 1993 to May 1993, Vice
President and General Manager, Decision Systems of the Company from February
1990 to January 1993 and Vice President, New Business Development of the Company
from June 1989 to February 1990. Mr. Thiemann holds a Bachelor of Arts degree in
Art, a Bachelor of Science degree in Electrical Engineering and a Masters degree
in Electrical
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Engineering from Stanford University and a Masters degree in Business
Administration from Harvard University.
Mr. Chandler has been a director of the Company since August 1991. Since
July 1991, he has been President of Prairie-EKC, Inc., a partner of the general
partner of PCE 1991 Limited Partnership, a venture capital firm. Since November
1996, Mr. Chandler has also been a Managing Director of Graystone Venture
Partners, LLC, a venture capital firm. Mr. Chandler holds a Bachelor of Arts
degree in Economics from Yale University and a Masters degree in Business
Administration from Harvard University.
Mr. Curme has been a director of the Company since June 1987. Since January
1988, he has been a general partner of the general partner of Battery Ventures,
L.P., a national venture capital firm. Mr. Curme also serves as a director of
several privately held technology companies. Mr. Curme is also a director of
InfoSeek Corporation, an Internet search and navigation service company. He
holds a Bachelor of Science degree in Biochemistry from Brown University and a
Masters degree in Business Administration from Harvard University.
Mr. Farb has been a director of the Company since November 1987. Since
April 1994, he has been Senior Vice President, Chief Financial Officer and
Treasurer of Interneuron Pharmaceuticals, Inc., a publicly-held diversified
pharmaceutical company, and an officer of several of its subsidiaries. From
October 1992 to March 1994, Mr. Farb served as Vice President of Corporate
Development, Chief Financial Officer and Controller of Cytyc Corporation, a
medical device and diagnostics company. Mr. Farb also serves as a director of
Redwood Trust, Inc., a California-based publicly-held Real Estate Investment
Trust. He holds a Bachelor of Arts degree in Sociology from Harvard College.
Mr. Gaylord has been a director of the Company since May 1995. He is
currently a private technology investor and a director of Stac Inc., a
publicly-held software company. From December 1993 to September 1994, Mr.
Gaylord served as Executive Vice President of Intuit Inc., a publicly-held
personal and small business finance software company, following Intuit's
acquisition of ChipSoft, Inc., a tax preparation software company. Prior to that
acquisition, from June 1990 to December 1993, he served first as President and
Chief Executive Officer and a director of ChipSoft and then as Chairman of the
Board of Directors and Chief Executive Officer. He holds Bachelor of Science and
Master of Science degrees in Aerospace Engineering from Georgia Institute of
Technology and a Masters degree in Business Administration from Harvard
University.
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<PAGE> 51
DESCRIPTION OF NOTES
The Notes will be issued under an indenture to be dated as of March 1, 1998
(the "Indenture"), between the Company and State Street Bank and Trust Company
of California, N.A., as trustee (the "Trustee"), a copy of which has been filed
as an exhibit to the Registration Statement of which this Prospectus forms a
part. The terms of the Notes will include those stated in the Indenture and
those made a part of the Indenture by reference to the Trust Indenture Act of
1939, as amended (the "TIA"), as in effect on the date of the Indenture. The
Notes will be subject to all such terms, and Holders of the Notes are referred
to the Indenture and the TIA for a statement of such terms. The following is a
summary of important terms of the Notes and does not purport to be complete and
is qualified in its entirety by reference to the Indenture and the TIA.
Reference should be made to all provisions of the Indenture, including the
definitions therein of certain terms and all terms made a part of the Indenture
by reference to the TIA. Wherever particular provisions or defined terms of the
Indenture (or the form of Note which is a part thereof) are referred to, such
provisions or defined terms are incorporated herein by reference. References in
this section to the "Company" are solely to HNC Software Inc., a Delaware
corporation, and not its subsidiaries.
GENERAL
The Notes will be general unsecured obligations of the Company, subordinate
in right of payment to certain other obligations of the Company as described
under "-- Subordination," and convertible into Common Stock as described under
"-- Conversion." The Notes will be limited to $75,000,000 aggregate principal
amount ($86,250,000 if the over-allotment option is exercised in full), will be
issued in fully registered form only in denominations of $1,000 or any integral
multiple thereof and will mature on March 1, 2003, unless earlier redeemed or
repurchased.
The Notes will bear interest from March , 1998 at the annual rate set
forth on the cover page hereof, payable semiannually on March 1 and September 1,
commencing on September 1, 1998, to Holders of record at the close of business
on the preceding February 15 and August 15, respectively (subject to certain
exceptions in the case of conversion, redemption or repurchase of such Notes
prior to the applicable interest payment date). Interest will be computed on the
basis of a 360-day year comprised of twelve 30-day months.
Principal of and premium, if any, and interest on the Notes will be
payable, and the transfer of Notes will be registrable, and the Notes may be
presented for conversion, at the office or agency of the Company maintained for
such purposes in The City of New York, the State of New York, which shall
initially be an office or agency of the Trustee. In addition, payment of
interest may, at the option of the Company, be made by check mailed to the
address of the person entitled thereto as it appears on the Note register,
provided that any Holder of a Note or Notes with an aggregate principal amount
in excess of $1,000,000 shall, at the election of such Holder, be paid by wire
transfer in immediately available funds.
No service charge will be made for any registration or transfer or exchange
of Notes, but the Company may require payment of a sum sufficient to cover any
tax or other governmental charge payable in connection therewith. The Company is
not required to exchange or register the transfer of (i) any Note for a period
of 15 days next preceding any selection of Notes to be redeemed, (ii) any Note
or portion thereof selected for redemption, (iii) any Note or portion thereof
surrendered for conversion or (iv) any Note or portion thereof surrendered for
repurchase (and not withdrawn) in connection with a Fundamental Change.
The Indenture does not contain any financial covenants or restrictions on
the payment of dividends by the Company, the incurrence of indebtedness,
including Senior Indebtedness (as defined), or the issuance or repurchase of
securities by the Company. The Indenture contains no covenants or other
provisions to afford protection to Holders of the Notes in the event of a highly
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<PAGE> 52
leveraged transaction or a change in control of the Company except to the extent
described below under "-- Repurchase at Option of Holders Upon a Fundamental
Change."
CONVERSION
The Holder of any Note will be entitled at any time through the close of
business on the final maturity date of the Notes, subject to prior redemption or
repurchase, to convert any Notes or portions thereof (in denominations of $1,000
or multiples thereof) into Common Stock of the Company, at the conversion price
set forth on the cover page of this Prospectus, subject to adjustment as
described below. Except as described below, no adjustment will be made on
conversion of any Notes for interest accrued thereon or for dividends on any
Common Stock issued. If Notes are converted after a record date for the payment
of interest and on or prior to the close of business on the business day prior
to the next succeeding interest payment date, such Notes, other than Notes
called for redemption, when submitted for conversion by the Holder, must be
accompanied by funds equal to the interest payable on such succeeding interest
payment date on the principal amount so converted. No such payment will be
required with respect to interest payable on March 1, 2001. The Company is not
required to issue fractional shares of Common Stock upon conversion of Notes
and, in lieu thereof, will pay a cash adjustment based upon the market price of
the Common Stock on the last business day prior to the date of conversion. In
the case of Notes called for redemption, conversion rights will expire at the
close of business on the business day preceding the date fixed for redemption,
unless the Company defaults in payment of the redemption price, in which case
the conversion right shall terminate on the date such default is cured and such
Note is redeemed. A Note for which a Holder has delivered a Fundamental Change
purchase notice exercising the option of such Holder to require the Company to
repurchase such Note may be converted only if such notice is withdrawn by a
written notice of withdrawal delivered by the Holder to the Company prior to the
close of business on the business day preceding the date fixed for repurchase.
The right of conversion attaching to any Note may be exercised by the
Holder by delivering the Note at the specified office of a conversion agent,
accompanied by a duly signed and completed notice of conversion, together with
any funds that may be required as described in the preceding paragraph. The
conversion date shall be the date on which the Note, the duly signed and
completed notice of conversion and any funds that may be required as described
in the preceding paragraph shall have been so delivered. A Holder delivering a
Note for conversion will not be required to pay any taxes or duties payable in
respect of the issue or delivery of Common Stock on conversion, but will be
required to pay any tax or duty which may be payable in respect of any transfer
involved in the issue or delivery of the Common Stock in a name other than that
of the Holder of the Note. Certificates representing shares of Common Stock will
not be issued or delivered unless all taxes and duties, if any, payable by the
Holder have been paid.
The initial conversion price of $ share of Common Stock (equivalent to
a conversion rate of approximately shares per $1,000 principal
amount of the Notes) is subject to adjustment (under formulae set forth in the
Indenture) in certain events, including: (i) the issuance of Common Stock as a
dividend or distribution on Common Stock; (ii) certain subdivisions and
combinations of the Common Stock; (iii) the issuance to all Holders of Common
Stock of certain rights or warrants to purchase Common Stock (provided that the
conversion price will be readjusted to the extent that such rights or warrants
are not exercised prior to the expiration thereof); (iv) the distribution to all
Holders of Common Stock of shares of capital stock of the Company (other than
Common Stock) or evidences of indebtedness of the Company or assets (including
securities, but excluding those rights, warrants, dividends and distributions
referred to above or paid in cash); (v) distributions consisting of cash,
excluding any quarterly cash dividend on the Common Stock to the extent that the
aggregate cash dividend per share of Common Stock in any quarterly period does
not exceed the greater of (x) the amount per share of Common Stock of the next
preceding quarterly cash dividend on the Common Stock to the extent that such
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<PAGE> 53
preceding quarterly dividend did not require an adjustment of the conversion
price pursuant to this clause (v), and (y) 3.75% of the average of the daily
Closing Prices (as defined) of the Common Stock for the ten consecutive Trading
Days (as defined) immediately prior to the date of declaration of such dividend,
and excluding any dividend or distribution in connection with the liquidation,
dissolution or winding up of the Company; (vi) payment in respect of a tender or
exchange offer by the Company for the Common Stock to the extent that the cash
and value of any other consideration included in such payment per share of
Common Stock exceeds the Current Market Price (as defined) per share of Common
Stock on the Trading Day next succeeding the last date on which tenders or
exchanges may be made pursuant to such tender or exchange offer; and (vii)
payment in respect of a tender offer or exchange offer by a person other than
the Company in which, as of the closing date of the offer, the Board of
Directors is not recommending rejection of the offer. In the event of a
distribution to substantially all Holders of Common Stock of rights to subscribe
for additional shares of the Company's capital stock as provided in clause (iii)
above, the Company may, instead of making any adjustment in the conversion
price, make proper provision so that each Holder of a Note who converts such
Note after the record date for such distribution and prior to the expiration or
redemption of such rights shall be entitled to receive upon such conversion, in
addition to shares of Common Stock, an appropriate number of such rights. If an
adjustment is required to be made as set forth in clause (v) above as a result
of a distribution that is not a quarterly dividend, such adjustment would be
based upon the full amount of the distribution. The adjustment referred to in
clause (vii) above will only be made if the tender offer or exchange offer is
for an amount which increases that person's ownership of Common Stock to more
than 25% of the total shares of Common Stock outstanding and if the cash and
value of any other consideration included in such payment per share of Common
Stock exceeds the Current Market Price per share of Common Stock on the business
day next succeeding the last date on which tenders or exchanges may be made
pursuant to such tender or exchange offer. The adjustment referred to in clause
(vii) above will not be made, however, if, as of the closing of the offer, the
offering documents with respect to such offer disclose a plan or an intention to
cause the Company to engage in a consolidation or merger of the Company or a
sale of all or substantially all of the Company's assets.
The Indenture will provide that if the Company implements a stockholders'
rights plan, such rights plan must provide that, subject to customary
exceptions, upon conversion of the Notes the Holders will receive, in addition
to the Common Stock issuable upon such conversion, such rights whether or not
such rights have separated from the Common Stock at the time of such conversion.
In the case of (i) any reclassification of the Common Stock or (ii) a
consolidation, merger or combination involving the Company or a sale or
conveyance to another person of the property and assets of the Company as an
entirety or substantially as an entirety, in each case, as a result of which
holders of Common Stock shall be entitled to receive stock, other securities,
other property or assets (including cash) with respect to or in exchange for
such Common Stock, the Holders of the Notes then outstanding will generally be
entitled thereafter to convert such Notes for the kind and amount of shares of
stock, other securities, other property or assets (including cash) which they
would have owned or been entitled to receive upon such reclassification,
consolidation, merger, combination, sale or conveyance had such Notes been
converted into Common Stock immediately prior to such reclassification,
consolidation, merger, combination, sale or conveyance, assuming that such
holder would not have exercised any rights of election as to the stock, other
securities, other property or assets (including cash) receivable in connection
therewith.
In the event of a taxable distribution to holders of Common Stock (or other
transaction) which results in any adjustment of the conversion price, the
Holders may, in certain circumstances, be deemed to have received a distribution
subject to the United States income tax as a dividend; in certain other
circumstances, the absence of such an adjustment may result in a taxable
dividend to the Holders of Common Stock. See "Certain United States Federal
Income Tax Considerations."
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The Company from time to time may, to the extent permitted by law, reduce
the conversion price by any amount for any period of at least 20 days, in which
case the Company shall give at least 15 days' notice of such reduction, if the
Board of Directors of the Company has made a determination that such reduction
would be in the best interests of the Company, which determination shall be
conclusive. The Company may, at its option, make such reductions in the
conversion price, in addition to those set forth above, as the Board of
Directors of the Company deems advisable to avoid or diminish any income tax to
holders of Common Stock resulting from any dividend or distribution of stock (or
rights to acquire stock) or from any event treated as such for income tax
purposes.
No adjustment in the conversion price will be required unless such
adjustment would require a change of at least 1% in the conversion price then in
effect; provided that any adjustment that would otherwise be required to be made
shall be carried forward and taken into account in any subsequent adjustment.
Except as stated above, the conversion price will not be adjusted for the
issuance of Common Stock or any securities convertible into or exchangeable for
Common Stock or carrying the right to purchase any of the foregoing.
SUBORDINATION
The indebtedness evidenced by the Notes is subordinated in right of payment
to the extent provided in the Indenture to the prior payment in full of all
Senior Indebtedness (as defined). Upon any distribution of assets of the Company
upon any dissolution, winding up, liquidation or reorganization (including any
of the foregoing as a result of bankruptcy or moratorium of payment), the
payment on account of the principal of, redemption of, or premium, if any, and
interest on the Notes (including on account of a Fundamental Change) is to be
subordinated to the extent provided in the Indenture in right of payment to the
prior payment in full of all Senior Indebtedness in cash or other payment
satisfactory to the holders of such Senior Indebtedness.
In the event of any acceleration of the Notes because of an Event of
Default (as defined), the holders of any Senior Indebtedness then outstanding
would be entitled to payment in full in cash or other payment satisfactory to
the holders of such Senior Indebtedness of all obligations in respect of such
Senior Indebtedness before the Holders of the Notes are entitled to receive any
payment or other distribution in respect thereof. The Indenture will require
that the Company promptly notify Holders of Senior Indebtedness if payment of
the Notes is accelerated because of an Event of Default.
The Company also may not make any payment upon, redemption of, or purchase
or otherwise acquire the Notes if (i) a default in the payment of the principal
of, premium, if any, interest, rent or other obligations in respect of Senior
Indebtedness occurs and is continuing beyond any applicable period of grace or
(ii) any other default occurs and is continuing with respect to Designated
Senior Indebtedness (as defined) that permits the Holders of the Designated
Senior Indebtedness as to which such default relates to accelerate its maturity
and the Trustee receives a notice of such default (a "Payment Blockage Notice")
from any person permitted to give such notice under the Indenture. Payments on
the Notes may and shall be resumed (a) in case of a payment default, upon the
date on which such default is cured or waived or ceases to exist and (b) in case
of a nonpayment default, the earlier of the date on which such nonpayment
default is cured or waived or ceases to exist or 179 days after the date on
which the applicable Payment Blockage Notice is received if the maturity of the
Designated Senior Indebtedness has not been accelerated. No new period of
payment blockage may be commenced pursuant to a Payment Blockage Notice unless
and until 365 days have elapsed since the effectiveness of the immediately prior
Payment Blockage Notice. No nonpayment default that existed or was continuing on
the date of delivery of any Payment Blockage Notice to the Trustee shall be, or
be made, the basis for a subsequent Payment Blockage Notice.
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By reason of the subordination provisions described above, in the event of
the Company's bankruptcy, dissolution or reorganization, holders of Senior
Indebtedness may receive more, ratably, and Holders of the Notes may receive
less, ratably, than the other creditors of the Company. Such subordination will
not prevent the occurrence of any Event of Default under the Indenture.
In the event that, notwithstanding the foregoing, the Trustee or any Holder
of Notes receives any payment or distribution of assets of the Company of any
kind in contravention of any of the subordination provisions of the Indenture,
whether in cash, property or securities, including, without limitation, by way
of set-off or otherwise, in respect of the Notes before all Senior Indebtedness
is paid in full, then such payment or distribution will be held by the recipient
in trust for the benefit of holders of Senior Indebtedness or their
representative or representatives to the extent necessary to make payment in
full of all Senior Indebtedness of the Company remaining unpaid, after giving
effect to any concurrent payment or distribution, or provision therefor, to or
for the holders of Senior Indebtedness.
The Notes are obligations exclusively of the Company. As a significant
portion of the Company's consolidated operations is conducted through
subsidiaries, the cash flow and the consequent ability to service debt of the
Company, including the Notes, is partially dependent upon the earnings of such
subsidiaries and the distribution of those earnings, or upon loans or other
payments of funds by those subsidiaries, to the Company. Such subsidiaries are
separate and distinct legal entities, and have no obligation, contingent or
otherwise, to pay any amounts due pursuant to the Notes or to make any funds
available therefor, whether by dividends, distributions, loans or other
payments. In addition, the payment of dividends or distributions and the making
of loans and advances to the Company by any such subsidiaries may be subject to
statutory or contractual restrictions, and may be contingent upon the earnings
of those subsidiaries and subject to various business considerations. Any right
of the Company to receive assets of subsidiaries upon their liquidation or
reorganization (and the consequent right of the Holders of the Notes to
participate in these assets) would be effectively subordinated to the claims of
that subsidiary's creditors (including trade creditors), except to the extent
that the Company is itself recognized as a creditor of such subsidiary, in which
case the claims of the Company would still be subordinate to any security
interests in the assets of such subsidiary and any indebtedness of such
subsidiary senior to that held by the Company.
As of December 31, 1997, the Company had no indebtedness outstanding that
would have constituted Senior Indebtedness and the Company's subsidiaries had
indebtedness and other liabilities outstanding aggregating approximately
$254,000 (excluding intercompany liabilities and liabilities of a type not
required to be reflected as liabilities on the balance sheets of such
subsidiaries in accordance with generally accepted accounting principles) to
which the Notes would have been effectively subordinated. The Indenture will not
limit the amount of additional indebtedness, including Senior Indebtedness,
which the Company can create, incur, assume or guarantee, nor will the Indenture
limit the amount of indebtedness which any subsidiary of the Company can create,
incur, assume or guarantee.
The Company is obligated to pay reasonable compensation to the Trustee and
to indemnify the Trustee against any losses, liabilities or expenses incurred by
it in connection with its duties relating to the Notes. The Trustee's claims for
such payments will be senior to those of Holders of the Notes in respect of all
funds collected or held by the Trustee.
The term "Senior Indebtedness" means the principal of, premium, if any,
interest (including all interest accruing subsequent to the commencement of any
bankruptcy or similar proceeding, whether or not a claim for post-petition
interest is allowable as a claim in any such proceeding) and rent payable on or
in connection with, and all fees, costs, expenses and other amounts accrued or
due on or in connection with, Indebtedness (as defined) of the Company, whether
outstanding on the date of the Indenture or thereafter created, incurred,
assumed, guaranteed or in
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effect guaranteed by the Company (including all deferrals, renewals, extensions
or refundings of, or amendments, modifications or supplements to, the
foregoing), unless in the case of any particular Indebtedness the instrument
creating or evidencing the same or the assumption or guarantee thereof expressly
provides that such Indebtedness shall not be senior in right of payment to the
Notes or expressly provides that such Indebtedness is pari passu or "junior" to
the Notes. Notwithstanding the foregoing, Senior Indebtedness shall not include
(i) Indebtedness of the Company to any Subsidiary of the Company or (ii) the
Notes.
The term "Indebtedness" means, with respect to any Person (as defined), and
without duplication, (a) all indebtedness, obligations and other liabilities
(contingent or otherwise) of such Person for borrowed money (including
obligations of the Person in respect of overdrafts, foreign exchange contracts,
currency exchange agreements, interest rate protection agreements, and any loans
or advances from banks, whether or not evidenced by notes or similar
instruments) or evidenced by bonds, debentures, notes or similar instruments
(whether or not the recourse of the lender is to the whole of the assets of such
Person or to only a portion thereof), (b) all reimbursement obligations and
other liabilities (contingent or otherwise) of such Person with respect to
letters of credit, bank guarantees or bankers' acceptances, (c) all obligations
and liabilities (contingent or otherwise) in respect of leases of such Person
required, in conformity with generally accepted accounting principles, to be
accounted for as capitalized lease obligations on the balance sheet of such
Person and all obligations and other liabilities (contingent or otherwise) under
any lease or related document (including a purchase agreement) in connection
with the lease of real property or improvements thereon which provides that such
Person is contractually obligated to purchase or cause a third party to purchase
the leased property and thereby guarantee a minimum residual value of the leased
property to the lessor and the obligations of such Person under such lease or
related document to purchase or to cause a third party to purchase such leased
property, (d) all obligations of such Person (contingent or otherwise) with
respect to an interest rate or other swap, cap or collar agreement or other
similar instrument or agreement or foreign currency hedge, exchange, purchase or
similar instrument or agreement, (e) all direct or indirect guaranties or
similar agreements by such Person in respect of, and obligations or liabilities
(contingent or otherwise) of such Person to purchase or otherwise acquire or
otherwise assure a creditor against loss in respect of, indebtedness,
obligations or liabilities of another Person of the kind described in clauses
(a) through (d), (f) any indebtedness or other obligations described in clauses
(a) through (d) secured by any mortgage, pledge, lien or other encumbrance
existing on property which is owned or held by such Person, regardless of
whether the indebtedness or other obligation secured thereby shall have been
assumed by such Person, and (g) any and all deferrals, renewals, extensions and
refundings of, or amendments, modifications or supplements to, any indebtedness,
obligation or liability of the kind described in clauses (a) through (f).
Notwithstanding the foregoing, "Indebtedness" shall not include any account
payable or other accrued current liability or obligation incurred in the
ordinary course of business in connection with the obtaining of materials or
services.
The term "Designated Senior Indebtedness" means any particular Senior
Indebtedness in which the instrument creating or evidencing the same or the
assumption or guarantee thereof (or related agreements or documents to which the
Company is a party) expressly provides that such Senior Indebtedness shall be
"Designated Senior Indebtedness" for purposes of the Indenture (provided that
such instrument, agreement or other document may place limitations and
conditions on the right of such Senior Indebtedness to exercise the rights of
Designated Senior Indebtedness).
OPTIONAL REDEMPTION
At any time on or after March 6, 2001, the Notes may be redeemed at the
Company's option on at least 20 and not more than 60 days' notice, in whole or
from time to time in part, at the
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following prices (expressed as percentages of the principal amount), together
with accrued interest to, but excluding, the Redemption Date.
If redeemed during the 12-month period beginning March 1 (beginning March
6, 2001 and ending February 28, 2002, in the case of the first such period):
<TABLE>
<CAPTION>
REDEMPTION
YEAR PRICE
-------------------------------------------------------- ----------
<S> <C>
2001.................................................... %
2002....................................................
</TABLE>
and 100% at March , 2003; provided that any semi-annual payment of interest
becoming due on the Redemption Date shall be payable to the Holders of record on
the Regular Record Date of the Notes being redeemed.
If fewer than all the Notes are to be redeemed, the Trustee will select the
Notes to be redeemed in principal amounts of $1,000 or multiples thereof by lot
or, in its sole discretion, on a pro rata basis. If any Note is to be redeemed
in part only, a new Note or Notes in principal amount equal to the unredeemed
principal portion thereof will be issued. If a portion of a Holder's Notes is
selected for partial redemption and such Holder converts a portion of such
Notes, such converted portion shall be deemed to be taken from the portion
selected for redemption.
There is no sinking fund provided for the Notes.
REPURCHASE AT OPTION OF HOLDERS UPON A FUNDAMENTAL CHANGE
If a Fundamental Change (as defined) occurs, each Holder of Notes shall
have the right, at the Holder's option, to require the Company to repurchase all
of such Holder's Notes, or any portion of a Note that is $1,000 or an integral
multiple of $1,000 in excess thereof, on the date (the "Repurchase Date") that
is 45 days after the date of the Company Notice (as defined), at a price (the
"Repurchase Price") (expressed as a percentage of the principal amount) equal to
(i) % if the Repurchase Date is during the 12-month period beginning March
1, 1998, (ii) % if the Repurchase Date is during the 12-month period
beginning March 1, 1999, (iii) % if the Repurchase Date is during the
12-month period beginning March 1, 2000 and (iv) thereafter at the redemption
price set forth under "-- Optional Redemption" which would be applicable to a
redemption at the option of the Company on the Repurchase Date; provided that,
if the Applicable Price (as defined) is less than the Reference Market Price (as
defined), the Company shall repurchase such Notes at a price equal to the
foregoing redemption price multiplied by the fraction obtained by dividing the
Applicable Price by the Reference Market Price. In each case, the Company shall
also pay accrued interest on the redeemed Notes to, but excluding, the
Repurchase Date. Any Notes repurchased by the Company shall be canceled.
Within 30 days after the occurrence of a Fundamental Change, the Company is
obligated to give to all Holders of the Notes notice, as provided in the
Indenture (the "Company Notice"), of the occurrence of such Fundamental Change
and of the repurchase right arising as a result thereof. The Company must also
deliver a copy of the Company Notice to the Trustee. To exercise the repurchase
right, a Holder of Notes must deliver on or before the 30th day after the date
of the Company Notice written notice to the Trustee or any Paying Agent of the
Holder's exercise of such right, together with the Notes with respect to which
the right is being exercised.
The term "Fundamental Change" means the occurrence of any transaction or
event in connection with which all or substantially all of the Common Stock
shall be exchanged for, converted into, acquired for or constitute solely the
right to receive, consideration (whether by means of an exchange offer,
liquidation, tender offer, consolidation, merger, combination, reclassification,
recapitalization or otherwise) which is not all or substantially all common
stock or shares which are (or, upon consummation of or immediately following
such transaction or event, will be) listed on a United States national
securities exchange or approved for quotation on the
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Nasdaq National Market or any similar United States system of automated
dissemination of quotations of securities prices. The term "Applicable Price"
means (i) in the event of a Fundamental Change in which the holders of Common
Stock receive only cash, the amount of cash received by the holders of one share
of Common Stock and (ii) in the event of any other Fundamental Change, the
average of the last reported sale price for the Common Stock during the ten
Trading Days prior to the record date for the determination of the holders of
Common Stock entitled to receive cash, securities, property or other assets in
connection with such Fundamental Change or, if no such record date exists, the
date upon which the holders of the Common Stock shall have the right to receive
such cash, securities, property or other assets in connection with the
Fundamental Change. The term "Reference Market Price" shall initially mean
$ (which is equal to 66 2/3% of the last bid price of the Common Stock
on , 1998, as reflected on the cover page of this Prospectus) and in
the event of any adjustment to the conversion price described above pursuant to
the provisions of the Indenture, the Reference Market Price shall also be
adjusted so that the ratio of the Reference Market Price to the conversion price
after giving effect to any such adjustment shall always be the same as the ratio
of $ to the conversion price specified on the cover page of this
Prospectus (without regard to any adjustment thereto).
Rule 13e-4 under the Exchange Act requires the dissemination of certain
information to security holders in the event of an issuer tender offer and may
apply in the event that the repurchase option becomes available to Holders of
the Notes. The Company will comply with this rule and any other securities laws
to the extent applicable at that time.
The repurchase option upon a Fundamental Change feature of the Notes may in
certain circumstances make more difficult or discourage a takeover of the
Company and, thus, the removal of incumbent management. The Fundamental Change
repurchase feature, however, is not the result of management's knowledge of any
specific effort to accumulate the Company's stock or to obtain control of the
Company by means of a merger, tender offer, solicitation or otherwise, or part
of a plan by management to adopt a series of anti-takeover provisions. Instead,
the Fundamental Change repurchase feature is a result of negotiations between
the Company and the Underwriters. Management has no present intention to engage
in a transaction involving a Fundamental Change, although it is possible that
the Company could decide to do so in the future. Subject to the limitations on
mergers, consolidations and sale of assets described herein, the Company could,
in the future, enter into certain transactions, including acquisitions,
refinancings or other recapitalizations, that would not constitute a Fundamental
Change under the Indenture, but that could increase the amount of indebtedness
(including Senior Indebtedness) outstanding at such time or otherwise affect the
Company's capital structure or credit ratings. The payment of the repurchase
price in the event of a Fundamental Change is subordinated to the prior payment
of Senior Indebtedness as described under "-- Subordination" above.
The term "Fundamental Change" is limited to certain specified transactions
and may not include other events that might adversely affect the financial
condition of the Company nor would the requirement that the Company offer to
repurchase the Notes upon a Fundamental Change necessarily afford Holders of the
Notes protection in the event of a highly leveraged transaction, reorganization,
merger or similar transaction involving the Company.
If a Fundamental Change were to occur, there can be no assurance that the
Company would have or be able to obtain sufficient funds to pay the repurchase
price for all Notes tendered by the Holders thereof. The Company's existing
credit agreement and any future credit agreements or other agreements relating
to other indebtedness (including other Senior Indebtedness) to which the Company
becomes a party may contain restrictions and provisions which prohibit the
Company from repurchasing any Notes or provide that a Fundamental Change would
constitute an event of default thereunder. In the event a Fundamental Change
occurs at a time when the Company is prohibited from repurchasing Notes, the
Company could seek the consent of its lenders to the repurchase of Notes or
could attempt to refinance the borrowings that contain such prohibition. If the
Company does not obtain such a consent or repay such borrowings, the
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<PAGE> 59
Company would remain prohibited from repurchasing Notes. In such case, the
Company's failure to repurchase tendered Notes would constitute an Event of
Default under the Indenture, which could, in turn, constitute a further default
under the other Indebtedness that the Company may enter into from time to time.
In such circumstances, the subordination provisions in the Indenture would
likely restrict payments to the Holders of Notes.
MERGERS AND SALES OF ASSETS BY THE COMPANY
The Company may not consolidate with or merge into any other Person (in a
transaction in which the Company is not the surviving entity) or transfer or
lease its properties and assets substantially as an entirety to any Person
unless (i) the Person formed by such merger or into which the Company is merged
or the Person to which the properties and assets of the Company are so
transferred or leased shall expressly assume the payment of the principal of,
premium, if any, and interest on the Notes, (ii) no default and no Event of
Default shall have occurred and be continuing as a result of such consolidation,
merger, transfer or lease and (iii) certain other conditions are met.
EVENTS OF DEFAULT
The following will be Events of Default under the Indenture: (i) failure to
pay principal of or premium, if any, on any Note (including the payment of any
redemption or repurchase price) when due; (ii) failure to pay any interest on
any Note when due continuing for 30 days; (iii) failure to perform any other
covenant of the Company in the Indenture, continuing for 60 days after written
notice as provided in the Indenture; and (iv) certain events of bankruptcy,
insolvency or reorganization.
The Indenture provides that the Trustee shall, within 90 days after the
occurrence of a default, give to the registered Holders of the Notes notice of
all uncured defaults known to it, but the Trustee shall be protected in
withholding such notice if it in good faith determines that the withholding of
such notice is in the best interest of such registered Holders, except in the
case of a default in the payment of the principal of, or premium, if any, or
interest on, any of the Notes when due or in the payment of any redemption or
repurchase obligation.
The Indenture provides that if any Event of Default shall have occurred and
be continuing, the Trustee or the Holders of not less than 25% in principal
amount of the Notes then outstanding by notice to the Company and the Trustee
may declare the principal of and premium, if any, on the Notes to be due and
payable immediately, but if the Company shall cure all defaults (except the
nonpayment of interest on, premium, if any, and principal of any Notes which
shall have become due by acceleration) and certain other conditions are met,
such declaration may be canceled and past defaults may be waived by the Holders
of a majority in principal amount of Notes then outstanding. If any Event of
Default resulting from certain events of bankruptcy, insolvency or
reorganization were to occur, all unpaid principal of and accrued interest on
the outstanding Notes will become due and payable immediately without any
declaration or other act on the part of the Trustee or any Holders of Notes,
subject to certain limitations.
The Indenture provides that the Holders of a majority in principal amount
of the outstanding Notes may direct the time, method and place of conducting any
proceeding for any remedy available to the Trustee or exercising any trust or
power conferred on the Trustee, subject to certain limitations specified in the
Indenture. Before proceeding to exercise any right or power under the Indenture
at the direction of such Holders, the Trustee shall be entitled to receive from
such Holders reasonable security or indemnity against the costs, expenses and
liabilities which might be incurred by it in complying with any such direction.
The right of a Holder to institute a proceeding with respect to the Indenture is
subject to certain conditions precedent, including the written notice by such
Holders of an Event of Default and an offer of indemnity to the Trustee, along
with the written request by the Holders of not less than 25% in principal amount
of the
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outstanding Notes that such a proceeding be instituted, but the Holder has an
absolute right to institute suit for the enforcement of payment of the principal
of, and premium, if any, and interest on, such Holder's Notes when due and to
enforce such Holder's right to convert such Notes.
The Holders of not less than a majority in principal amount of the
outstanding Notes may on behalf of the Holders of all Notes waive any past
defaults, except (i) a default in payment of the principal of, or premium, if
any, or interest on, any Note (including the payment of any redemption or
repurchase price) when due, (ii) a failure by the Company to convert any Notes
into Common Stock or (iii) in respect of certain provisions of the Indenture
which cannot be modified or amended without the consent of the Holder of each
outstanding Note affected thereby.
The Company is required to furnish to the Trustee annually within 120 days
of the end of the fiscal year a statement of certain officers of the Company
stating whether or not to the best of their knowledge the Company is in default
in the performance and observation of the terms of the Indenture and, if they
have knowledge that the Company is in default, specifying such default and its
status. The Company is also required, upon becoming aware of any default or
Event of Default, to deliver to the Trustee a statement specifying such default
or Event of Default and the action the Company has taken, is taking or proposes
to take with respect thereto.
MODIFICATIONS OF THE INDENTURE
The Indenture contains provisions permitting the Company and the Trustee,
with the consent of the Holders of not less than a majority in principal amount
of the Notes at the time outstanding, to modify the Indenture or any
supplemental indenture or the rights of the Holders of the Notes, except that no
such modification shall (i) extend the fixed maturity of any Note, reduce the
rate or extend the time for payment of interest thereon, reduce the principal
amount thereof or premium, if any, thereon, reduce any amount payable upon
redemption or repurchase thereof, impair or change in any respect adverse to the
Holders of Notes the obligation of the Company to make an offer to repurchase
Notes and repurchased Notes in accordance with such offer upon the happening of
a Fundamental Change, impair or adversely affect the right of a Holder to
institute suit for the payment thereof, change the currency in which the Notes
are payable, or impair or change in any respect adverse to the Holders of the
Notes the right to convert the Notes into Common Stock subject to the terms set
forth in the Indenture or modify the provisions of the Indenture with respect to
the subordination of the Notes in a manner adverse to the Holders of the Notes,
without the consent of the Holders of each Note so affected, or (ii) reduce the
aforesaid percentage of Notes, without the consent of the Holders of all of the
Notes then outstanding.
TAXATION OF NOTES
See "Certain United States Federal Income Tax Considerations" for a
discussion of certain federal tax aspects which will apply to Holders of Notes.
SATISFACTION AND DISCHARGE
The Company may discharge its obligations under the Indenture while Notes
remain outstanding if (i) all outstanding Notes will become due and payable at
their scheduled maturity within one year or (ii) all outstanding Notes are
scheduled for redemption within one year and, in either case, the Company has
deposited with the Trustee an amount sufficient to pay and discharge all
outstanding Notes on the date of their scheduled maturity or the scheduled date
of redemption.
GOVERNING LAW
The Indenture and the Notes will be governed by and construed in accordance
with the laws of the State of New York.
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INFORMATION CONCERNING THE TRUSTEE
State Street Bank and Trust Company of California, N.A., is the Trustee
under the Indenture. The Company may maintain deposit accounts and conduct other
banking transactions with the Trustee and its affiliates in the normal course of
business.
During the existence of an Event of Default, the Trustee will exercise such
rights and powers vested in it under the Indenture and use the same degree of
care and skill in its exercise as a prudent person would exercise under the
circumstances in the conduct of such person's own affairs. The Indenture and the
TIA will contain certain limitations on the rights of the Trustee, should it
become a creditor of the Company, to obtain payment of claims in certain cases
or to realize on certain property received in respect of any such claim as
security or otherwise. Subject to the TIA, the Trustee will be permitted to
engage in other transactions; provided, however, that if it acquires any
conflicting interest (as described in the TIA), it must eliminate such conflict
or resign.
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DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 50,000,000 shares
of Common Stock and 4,000,000 shares of Preferred Stock. As of December 31,
1997, there were 24,537,550 outstanding shares of Common Stock held of record by
approximately 186 stockholders and options to purchase 4,591,133 shares of
Common Stock.
COMMON STOCK
Subject to preferences that may apply to any Preferred Stock outstanding at
the time, the holders of outstanding shares of Common Stock are entitled to
receive dividends out of assets legally available therefor at such times and in
such amounts as the Board of Directors may from time to time determine. Each
stockholder is entitled to one vote for each share of Common Stock held on all
matters submitted to a vote of stockholders. Cumulative voting for the election
of directors is not provided for in the Company's Certificate of Incorporation,
which means that the holders of a majority of the shares voted can elect all of
the directors then standing for election. The Common Stock is not entitled to
preemptive rights and is not subject to conversion or redemption. Upon
liquidation, dissolution or winding-up of the Company, the assets legally
available for distribution to stockholders are distributable ratably among the
holders of the Common Stock and any participating Preferred Stock outstanding at
that time after payment of liquidation preferences, if any, on any outstanding
Preferred Stock and payment of other claims of creditors. Each outstanding share
of Common Stock is fully paid and nonassessable. The Company's Common Stock is
traded on the Nasdaq National Market under the symbol "HNCS."
PREFERRED STOCK
The Board of Directors is authorized, subject to any limitations prescribed
by Delaware law, to provide for the issuance of additional shares of Preferred
Stock in one or more series, to establish from time to time the number of shares
to be included in each such series, to fix the powers, designations, preferences
and rights of the shares of each wholly unissued series and any qualifications,
limitations or restrictions thereon, and to increase or decrease the number of
shares of any such series (but not below the number of shares of such series
then outstanding), without any further vote or action by the stockholders. The
Board of Directors may authorize the issuance of Preferred Stock with voting or
conversion rights that could adversely affect the voting power of other rights
of the holders of Common Stock. Thus, the issuance of Preferred Stock could have
the effect of delaying, deferring or preventing a change in control of the
Company. The Company has no current plan to issue any shares of Preferred Stock.
DELAWARE GENERAL CORPORATION LAW SECTION 203
As a corporation organized under the laws of the State of Delaware, the
Company is subject to Section 203 of the Delaware General Corporation Law (the
"DGCL"), which restricts certain business combinations between the Company and
an "interested stockholder" (in general, a stockholder owning 15% or more of the
Company's outstanding voting stock) or its affiliates or associates for a period
of three years following the date on which the stockholder becomes an
"interested stockholder." The restrictions do not apply if (i) prior to an
interested stockholder becoming such, the Board of Directors approves either the
business combination or the transaction in which the stockholder becomes an
interested stockholder, (ii) upon consummation of the transaction in which the
stockholder becomes an interested stockholder, such interested stockholder owns
at least 85% of the voting stock of the Company outstanding at the time the
transaction commences (excluding shares owned by certain employee stock
ownership plans and persons who are both directors and officers of the Company)
or (iii) on or subsequent to the date an interested stockholder becomes such,
the business combination is both approved by the Board of Directors and
authorized at an annual or special meeting of the Company's stockholders, not by
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written consent, but by the affirmative vote of at least 66 2/3% of the
outstanding voting stock not owned by the interested stockholder.
REGISTRATION RIGHTS; EXISTING SHELF REGISTRATION
1994 Registration Rights Agreement. Certain holders of outstanding shares
of Common Stock who are parties to the Company's Third Amended Registration
Rights Agreement dated April 26, 1994 (the "1994 Registration Rights Agreement")
have contractual rights to have certain shares of the Company's Common Stock
registered under the Securities Act. To the Company's best knowledge, based
solely on its review of its current stockholders of record, parties to the 1994
Registration Rights Agreement together own approximately 412,666 shares of
Common Stock that may be registered pursuant to the 1994 Registration Rights
Agreement (the "Registrable Shares"). If requested by holders of at least 50% of
the outstanding Registrable Shares, the Company must file a registration
statement under the Securities Act covering all Registrable Shares requested to
be included by all holders thereof. For purposes of exercising such demand
registration rights, the Registrable Shares do not include any shares of Common
Stock that were issued upon the conversion of formerly outstanding shares of the
Company's Series A Preferred Stock. The Company may be required to effect up to
four such demand registrations of Registrable Shares, plus one additional such
registration for each registration that does not include at least 80% of the
Registrable Shares requested to be included. All expenses incurred in connection
with such registrations (other than underwriters' discounts and commissions)
will be borne by the Company until there have been two such registrations that
include at least 80% of the Registrable Shares requested to be included. In
addition, if the Company proposes to register any of its securities under the
Securities Act (other than in connection with a Company employee benefit plan or
a business combination), the holder of Registrable Shares may require the
Company to include all or a portion of such shares in such registration,
although the managing underwriter of any such offering has certain rights to
limit the number of shares in such registration. All expenses incurred in
connection with such registrations (other than underwriters' discounts and
commissions) will be borne by the Company. If the Company is eligible to use
Form S-3 to register its shares, any holder or holders of Registrable Shares who
hold at least 10% of the Registrable Shares originally issued may request the
Company to register such shares on a Form S-3 registration statement, provided
the reasonably anticipated aggregate offering price of such shares exceeds
$500,000. The Company is not obligated to effect more than two such Form S-3
registrations in any calendar year. All expenses of such Form S-3 registrations
must be borne by the selling stockholders. The registration rights under the
1994 Registration Rights Agreement expire in July 2000.
Risk Data Registration Rights. Pursuant to a Registration Rights Agreement
dated August 30, 1996, former stockholders of Risk Data who hold at least 30% of
the shares of the Company's Common Stock that were issued in the Risk Data
acquisition and have not been publicly resold ("Risk Data Shares") may request
the Company to register such shares under the Securities Act on a Form S-3
registration statement, provided the aggregate public offering price of such
shares is at least $2,000,000. The Company is not obligated to register any
holder's Risk Data Shares if all such shares may be resold within a three-month
period under Rule 144 or Rule 145(d) of the Securities Act. The Company may be
required to effect up to two such Form S-3 registrations and will bear all
expenses incurred in connection with such registrations. These registration
rights expire on August 31, 1998.
CompReview Registration Rights. Pursuant to a Registration Rights Agreement
dated November 28, 1997, the former stockholders of CompReview are entitled to
have the shares of the Company's Common Stock that were issued to them in the
CompReview acquisition ("CompReview Shares") registered, at the Company's
expense, on a shelf registration statement on Form S-3 pursuant to Rule 415
under the Securities Act (the "CompReview Shelf Registration"). The Company
expects to file the CompReview Shelf Registration in the near future. Under
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the CompReview Registration Rights Agreement, once the former CompReview
stockholders have together sold an aggregate combined total of 1,250,000
CompReview Shares, sales of CompReview Shares may be made pursuant to the
CompReview Shelf Registration only during certain time periods after advance
notice to the Company. The Company is not obligated to maintain the
effectiveness of the CompReview Shelf Registration after November 28, 1998
unless, pursuant to the CompReview registration rights agreement, the Company
exercises its rights to defer a requested sale of CompReview Shares, in which
case the time period during which the CompReview Shelf Registration must be kept
effective must be extended by a period of time equal to the period of deferral.
Retek Shelf Registration. Pursuant to a Registration Rights Agreement dated
October 25, 1996, as amended, the Company has filed a Form S-3 registration
statement pursuant to Rule 415 under the Securities Act (the "Retek Shelf
Registration"), covering the sale of the shares of the Company's Common Stock
issued in the Retek acquisition (the "Retek Shares"). Sales of Retek Shares may
be made pursuant to the Retek Shelf Registration only during certain time
periods after advance notice to the Company. The Company is not obligated to
maintain the effectiveness of the Retek Shelf Registration after November 29,
1998 unless, pursuant to the Retek registration rights agreement, the Company
exercises its rights to defer a requested sale of Retek Shares, in which case
the time period during which the Retek Shelf Registration must be kept effective
must be extended by a period of time equal to the period of deferral.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Company's Common Stock is
BancBoston, N.A.
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<PAGE> 65
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following is a general discussion of certain U.S. federal income and
related tax considerations relevant to holders of the Notes and Common Stock
into which the Notes may be converted. This discussion is based upon the
Internal Revenue Code of 1986, as amended (the "Code"), Treasury Regulations,
Internal Revenue Service ("IRS") rulings and judicial decisions now in effect,
all of which are subject to change (possibly with retroactive effect) or
different interpretations. There can be no assurance that the IRS will not
challenge one or more of the tax consequences described herein, and the Company
has not obtained, nor does it intend to obtain, a ruling from the IRS with
respect to the U.S. federal income tax, state tax, local tax, foreign tax or
other tax consequences of acquiring or holding Notes or Common Stock. This
discussion does not purport to deal with all aspects of U.S. federal income
taxation that may be relevant to a particular holder in light of the holder's
particular circumstances (for example, persons subject to the alternative
minimum tax provisions of the Code). Also, it is not intended to be wholly
applicable to all categories of investors, some of which (such as dealers in
securities, banks, insurance companies, tax-exempt (employment, charitable or
other) organizations, and persons holding Notes or Common Stock as part of a
hedging or conversion transaction or straddle or persons deemed to sell Notes or
Common Stock under the constructive sale provisions of the Code) may be subject
to special rules. The discussion also does not discuss any aspect of state,
local or foreign law, or U.S. federal estate and gift tax law as applicable to
U.S. Holders (as defined below). In addition, this discussion is limited to
original purchasers of Notes who acquire the Notes at their original issue price
within the meaning of Section 1273 of the Code, and who will hold the Notes and
Common Stock as "capital assets" within the meaning of Section 1221 of the Code.
ALL PROSPECTIVE PURCHASERS OF THE NOTES ARE ADVISED TO CONSULT THEIR OWN
TAX ADVISORS REGARDING THE FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES OF
THE PURCHASE, OWNERSHIP AND DISPOSITION OF THE NOTES AND THE COMMON STOCK.
U.S. HOLDERS
As used herein, the term "U.S. Holder" means the beneficial holder of a
Note or Common Stock that for United States federal income tax purposes is (i) a
citizen or resident (as defined in Section 7701(b) of the Code) of the United
States, (ii) a corporation, partnership or other entity formed under the laws of
the United States or any political subdivision thereof, (iii) an estate the
income of which is subject to U.S. federal income taxation regardless of its
source and (iv) in general, a trust subject to the primary supervision of a
court within the United States and the control of a United States person as
described in Section 7701(a)(30) of the Code. A "Non-U.S. Holder" is any holder
other than a U.S. Holder.
Interest
Stated interest on the Notes will generally be includable in a U.S.
Holder's gross income and taxable as ordinary income for U.S. federal income tax
purposes at the time it is paid or accrued in accordance with the U.S. Holder's
regular method of accounting. There are several circumstances under which the
Company could make a payment on a Note which would affect the yield to maturity
of a Note, including (as described under "Description of Notes") the redemption
of a Note by the Company, or the repurchase of a Note at the option of a Holder
in the event of a Fundamental Change. According to Treasury Regulations, the
possibility of a change in the timing or amount of a payment on the debt
obligation will not affect the amount of interest income recognized by a holder
(or the timing of such recognition) if the likelihood of the change, as of the
date the debt obligations are issued, is remote. The Company believes that the
likelihood of a change in the timing or amount of a payment on the Notes is
remote and does not intend to treat the possibility of a change in the interest
rate as affecting the yield to maturity of any Note.
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<PAGE> 66
Conversion of Notes Into Common Stock
A U.S. Holder generally will not recognize any income, gain or loss upon
conversion of a Note into Common Stock except to the extent the Common Stock is
considered attributable to accrued interest not previously included in income
(which is taxable as ordinary income). Cash received in lieu of a fractional
share of Common Stock should generally be treated as a payment in exchange for
such fractional share rather than as ordinary dividend income. Gain or loss
recognized on the receipt of cash paid in lieu of such fractional share
generally will equal the difference between the amount of cash received and the
amount of tax basis allocable to the fractional share. The adjusted basis of
shares of Common Stock received on conversion will equal the adjusted basis of
the Note converted (reduced by the portion of adjusted basis allocated to any
fractional share of Common Stock exchanged for cash). The holding period of the
Common Stock received on conversion will generally include the period during
which the converted Notes were held prior to conversion. However, a U.S.
Holder's tax basis in shares of Common Stock considered attributable to accrued
interest as described above, generally will equal the amount of such accrued
interest included in income, and the holding period for such shares shall begin
as of the date of the conversion.
The conversion price of the Notes is subject to adjustment under certain
circumstances. Section 305 of the Code and the Treasury Regulations issued
thereunder may treat the holders of the Notes as having received a constructive
distribution, resulting in ordinary income (subject to a possible dividends
received deduction in the case of corporate holders) to the extent of the
Company's current and/or accumulated earnings and profits, if, and to the extent
that certain adjustments in the conversion price, which may occur in limited
circumstances (particularly an adjustment to reflect a taxable dividend to
holders of Common Stock), increase the proportionate interest of a holder of
Notes in the fully diluted Common Stock, whether or not such holder ever
exercises its conversion privilege. Moreover, if there is not a full adjustment
to the conversion ratio of the Notes to reflect a stock dividend or other event
increasing the proportionate interest of the holders of outstanding Common Stock
in the assets or earnings and profits of the Company, then such increase in the
proportionate interest of the holders of the Common Stock generally will be
treated as a distribution to such holders, taxable as ordinary income (subject
to a possible dividends received deduction in the case of corporate holders) to
the extent of the Company's current and/or accumulated earnings and profits.
Therefore, U.S. Holders may recognize income in the event of a deemed
distribution in such circumstances under Section 305 of the Code even though
they may not receive any cash or property if these type of conversion
adjustments occur.
Sale, Exchange or Retirement of the Notes
Each U.S. Holder generally will recognize gain or loss upon the sale,
exchange, redemption, retirement or other disposition of Notes measured by the
difference (if any) between (i) the amount of cash and the fair market value of
any property received (except to the extent that such cash or other property is
attributable to the payment of accrued interest not previously included in
income, which amount will be taxable as ordinary income) and (ii) such holder's
adjusted tax basis in the Notes. Any such gain or loss recognized on the sale,
exchange, redemption, retirement or other disposition of a Note should be
capital gain or loss and will generally be long-term capital gain or loss if the
Note has been held or deemed held for more than one year at the time of the sale
or exchange. Gain on most capital assets held by an individual more than 18
months is subject to a maximum tax rate of 20%, and gain on most capital assets
held by an individual more than one year and up to 18 months is subject to tax
at a maximum rate of 28%. Deductions for capital losses in excess of capital
gains for individuals may be limited and are not allowed for noncorporate
taxpayers. Carryback and carryover of such excess capital losses may be allowed.
A holder's initial basis in a Note will be the amount paid therefor.
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<PAGE> 67
The Common Stock
Distributions, if any, paid on the Common Stock after a conversion, to the
extent made from current and/or accumulated earnings and profits of the Company,
as determined for U.S. federal income tax purposes, will be included in a U.S.
Holder's income as ordinary income (subject to a possible dividends received
deduction in the case of corporate holders) as they are properly accrued as
dividend income. Gain or loss realized on the sale or exchange of Common Stock
will equal the difference between the amount realized on such sale or exchange
and the U.S. Holder's adjusted tax basis in such Common Stock. Such gain or loss
will generally be long-term capital gain or loss if the holder has held or is
deemed to have held the Common Stock for more than one year. Long-term capital
gain realized on a sale or exchange of Common Stock by an individual will be
subject to certain maximum tax rates, and losses realized on a sale or exchange
of Common Stock held by any type of taxpayer may be limited. See the discussion
in "Sale, Exchange or Retirement of the Notes" above. The adjusted tax basis and
holding period for Common Stock received in a conversion is described above.
Information Reporting and Backup Withholding
A U.S. Holder of Notes or Common Stock may be subject to "backup
withholding" at a rate of 31% with respect to certain "reportable payments,"
including interest payments, dividend payments and, under certain circumstances,
principal payments on the Notes. These backup withholding rules apply if the
holder, among other things, (i) fails to furnish a social security number or
other taxpayer identification number ("TIN") certified under penalties of
perjury within a reasonable time after the request therefor, (ii) furnishes a
TIN as to which the IRS provides notification that it is an incorrect TIN, (iii)
fails to report properly interest or dividends, or (iv) under certain
circumstances, fails to provide a certified statement, signed under penalties of
perjury, that the TIN furnished is the correct number and that such holder is
not subject to backup withholding. A holder who does not provide the Company
with its correct TIN also may be subject to penalties imposed by the IRS. Any
amount withheld from a payment to a holder under the backup withholding rules is
creditable against the holder's federal income tax liability, provided that the
required information is furnished to the IRS. Backup withholding will not apply,
however, with respect to payments made to certain holders, including
corporations, tax-exempt organizations and certain foreign persons, provided
their exemptions from backup withholding are properly established.
The Company will report to the U.S. Holders of Notes and Common Stock and
to the IRS the amount of any "reportable payments" for each calendar year and
the amount of tax withheld, if any, with respect to such payments.
NON-U.S. HOLDERS
The following discussion is limited to the U.S. federal income tax
consequences relevant to a Non-U.S. Holder. Non-U.S. Holders should consult
their own tax advisors concerning the state, local, foreign and other tax
consequences of the purchase, ownership and disposition of the Notes and the
Common Stock.
For purposes of U.S. federal withholding tax on interest and dividends
discussed below, a Non-U.S. Holder (as defined above) includes a non-resident
fiduciary of an estate or trust. For purposes of the following discussion,
interest, dividends and gain on the sale, exchange or other disposition of a
Note or Common Stock will be considered to be "U.S. trade or business income" if
such income or gain is (i) effectively connected with the conduct of a trade or
business within the U.S. of such Non-U.S. Holder or (ii) in the case of a
certain residents of certain countries which have an income tax treaty in force
with the U.S., attributable to a permanent establishment (or, in the case of an
individual, a fixed base) in the United States as such terms are defined in the
applicable treaty.
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Stated Interest
Generally, any interest paid to a Non-U.S. Holder of a Note that is not
U.S. trade or business income will not be subject to U.S. federal income tax if
the interest qualifies as "portfolio interest." Generally, interest on the Notes
will qualify as portfolio interest if (i) the Non-U.S. Holder does not actually
or constructively own 10% or more of the total voting power of all voting stock
of the Company and is not a "controlled foreign corporation" with respect to
which the Company is a "related person" within the meaning of the Code, (ii) the
beneficial owner, under penalty of perjury, certifies that the beneficial owner
is not a U.S. person and such certificate provides the beneficial owner's name
and address, (iii) the Non-U.S. Holder is not a bank receiving interest on an
extension of credit made pursuant to a loan agreement made in the ordinary
course of its trade or business, and (iv) the Notes are in registered form.
The gross amount of payments of interest to a Non-U.S. Holder that do not
qualify for the portfolio interest exemption and that are not U.S. trade or
business income will be subject to U.S. federal income tax at the rate of 30%,
unless a U.S. income tax treaty applies to reduce or eliminate such tax. U.S.
trade or business income will be taxed at regular U.S. income tax rates rather
than the 30% gross rate. In the case of a Non-U.S. Holder that is a corporation,
such U.S. trade or business income may also be subject to the branch profits tax
(which is generally imposed on a foreign corporation on the actual or deemed
repatriation from the United States of earnings and profits attributable to U.S.
trade or business income) at a 30% rate. The branch profits tax may not apply
(or may apply at a reduced rate) if a recipient is a qualified resident of
certain countries with which the United States has an income tax treaty in
force. To claim the benefit of an income tax treaty or to claim exemption from
withholding because the income is U.S. trade or business income, the Non-U.S.
Holder must provide a properly executed IRS Form 1001 or IRS Form 4224 (or such
successor forms as the IRS designates), as applicable, prior to the payment of
interest. Under recently issued Treasury Regulations generally under Sections
1441 and 1442 of the Code that will generally be effective on and after January
1, 1999 (the "Withholding Regulations"), the required Forms 1001 and 4224 will
be replaced by a new Form W-8. Under the Withholding Regulations, a Non-U.S.
Holder may under certain circumstances be required to obtain a U.S. taxpayer
identification number and make certain certificates to the Company. Special
procedures are provided in the Withholding Regulations for payments through
qualified intermediaries. Prospective investors should consult their tax
advisors regarding the effect, if any, of the Withholding Regulations.
Dividends
In general, distributions on Common Stock treated as dividend income paid
to a Non-U.S. Holder of Common Stock will be subject to withholding of U.S.
federal income tax at a 30% rate unless such is reduced by an applicable income
tax treaty. Dividends that are connected with such holder's conduct of a trade
or business in the United States (U.S. trade or business income) could be
subject to U.S. federal income tax at regular ordinary income tax rates, but are
not generally subject to the 30% U.S. federal withholding tax if the Non-U.S.
Holder makes the appropriate notification to the payor. To claim the benefit of
an income tax treaty or to claim exemption from withholding because the income
is U.S. trade or business income, the Non-U.S. Holder must provide a properly
executed IRS Form 1001 or IRS Form 4224 (or such successor forms as the IRS
designates), as applicable, prior to the payment of dividend income. Any U.S.
trade or business income received by a Non-U.S. Holder that is a corporation may
also, under certain circumstances, be subject to an additional "branch profits
tax" at a 30% rate or such lower rate as may be applicable under an income tax
treaty. Dividends paid to an address in a foreign country generally are presumed
(absent actual knowledge to the contrary) to be paid to a resident of such
country for purposes of the withholding tax discussed above and for purposes of
determining the applicability of a tax treaty rate. Under the Withholding
Regulations, a Non-U.S. Holder claiming the benefits of a treaty generally will
be required to provide a Form W-8 (or suitable substitute form)
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<PAGE> 69
to the Company certifying such Non-U.S. Holder's entitlements to treaty
benefits. Other recently adopted Treasury Regulations generally under Section
894 of the Code that are effective with respect to payments made on and after
January 1, 1998, provide special rules to determine whether, for purposes of
determining the applicability of a tax treaty, dividends paid to a Non-U.S.
Holder that is an entity should be treated as paid to the entity or those
holding an interest in that entity. Prospective investors should consult their
tax advisors regarding the effect, if any, of the recently adopted regulations.
A Non-U.S. Holder of Common Stock that is eligible for a reduced rate of
U.S. withholding tax pursuant to an income tax treaty may obtain a refund of any
amounts withheld at the 30% statutory rate by filing an appropriate claim for a
refund with the IRS.
Conversion
A Non-U.S. Holder generally will not be subject to U.S. federal income tax
on the conversion of Notes into Common Stock, except with respect to cash (if
any) received in lieu of a fractional share, cash received for interest not
previously included in income, or Common Stock received for interest not
previously included in income. Cash received in lieu of a fractional share may
give rise to gain that would be subject to the rules described below for the
sale of Notes. Cash or Common Stock issued for accrued interest would be treated
as interest under the rules described above.
Sale, Exchange or Redemption of Notes or Common Stock
Except as described below and subject to the discussion concerning backup
withholding, any gain realized by a Non-U.S. Holder on the sale, exchange or
redemption of a Note or Common Stock generally will not be subject to U.S.
federal income tax, unless (i) such gain is U.S. trade or business income, (ii)
subject to certain exceptions, the Non-U.S. Holder is an individual who holds
the Note or Common Stock as a capital asset and is present in the United States
for 183 days or more in the taxable year of the disposition, (iii) the Non-U.S.
Holder is subject to tax pursuant to the provisions of U.S. tax law applicable
to certain U.S. expatriates (including certain former citizens or residents of
the United States) or (iv) in the case of the disposition of Common Stock, the
Company is a U.S. real property holding corporation. The Company does not
believe that it is currently a "United States real property holding
corporation," or that it will become one in the future.
Federal Estate Tax
Notes held (or treated as held) by an individual who is not a citizen or
resident of the United States (for federal estate tax purposes) at the time of
his or her death will not be subject to U.S. federal estate tax provided that
the interest thereon qualifies as portfolio interest and was not U.S. trade or
business income. Common Stock owned or treated as owned by an individual who is
not a citizen or resident of the United States (for federal estate tax purposes)
will be included in such individual's estate for U.S. federal income tax
purposes unless an applicable estate tax treaty otherwise provides.
Information Reporting and Backup Withholding
The Company must report annually to the IRS and to each Non-U.S. Holder any
interest or dividend that is subject to withholding, or that is exempt from U.S.
withholding tax pursuant to a tax treaty, or interest that is exempt from U.S.
tax under the portfolio interest exception or because it is U.S. trade or
business income. Copies of these information returns may also be made available
under the provisions of a specific treaty or agreement to the tax authorities of
the country in which the Non-U.S. Holder resides. Under certain circumstances
the Company will have to report to the IRS payments of principal.
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Generally, information reporting and backup withholding of a United States
federal income tax at a rate of 31% may apply to payments of principal, interest
and premium (if any) to Non-U.S. Holders if the payee fails to certify that the
holder is a non-U.S. person or if the Company or its paying agent has actual
knowledge that the payee is a United States person. The 31% backup withholding
tax generally will not apply to dividends paid to foreign holders outside the
United States that are subject to 30% withholding as discussed above or that are
subject to a tax treaty that reduces such withholding.
The payment of the proceeds on the disposition of the Notes or shares of
Common Stock to or through a United States office of a United States or foreign
broker will be subject to information reporting and backup withholding unless
the owner provides certification as to its Non-U.S. Holder status under penalty
of perjury or otherwise establishes an exemption, provided that the broker does
not have actual knowledge that the holder is a U.S. person or that the
conditions of any other exception are not, in fact, satisfied. The proceeds of
the disposition by a Non-U.S. Holder of the Notes or shares of Common Stock to
or through a foreign office of a broker will generally not be subject to backup
withholding. However, if such broker is a U.S. person, a controlled foreign
corporation for United States tax purposes, or a foreign person 50% or more of
whose gross income from all sources for certain periods is effectively connected
with a United States trade or business, information reporting will apply unless
such broker has documentary evidence in its files of the Non-U.S. Holder's
foreign status and has no actual knowledge to the contrary or unless the
Non-U.S. Holder otherwise establishes an exemption. Both backup withholding and
information reporting will apply to the proceeds of such dispositions if the
broker has actual knowledge that the payee is a U.S. Holder.
The Withholding Regulations alter the foregoing rules in certain respects.
The Withholding Regulations provide presumptions under which a Non-U.S. Holder
is subject to information reporting and backup withholding at the rate of 31%
unless the Company receives certification of the holder's non-U.S. status.
Depending on the circumstances, this certification will need to be provided (i)
directly by the Non-U.S. Holder, (ii) in the case of a Non-U.S. Holder that is
treated as a partnership or other fiscally transparent entity, by the partners,
shareholders or other beneficiaries of such entity, or (iii) by certain
qualified financial institutions or other qualified entities on behalf of the
Non-U.S. Holder.
Any amounts withheld under the backup withholding rules from a payment to a
Non-U.S. Holder will be allowed as a refund or a credit against such Non-U.S.
Holder's U.S. federal income tax liability, provided that the requisite
procedures for claiming such refund or credit are followed.
THE PRECEDING DISCUSSION OF CERTAIN U.S. FEDERAL INCOME AND ESTATE TAX
CONSEQUENCES IS FOR GENERAL INFORMATION ONLY AND IS NOT TAX ADVICE. ACCORDINGLY,
EACH INVESTOR SHOULD CONSULT ITS OWN TAX ADVISER AS TO PARTICULAR U.S. FEDERAL,
STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES TO IT OF PURCHASING, HOLDING
AND DISPOSING OF THE NOTES AND THE COMMON STOCK OF THE COMPANY, INCLUDING THE
APPLICABILITY AND EFFECT OF ANY STATE, LOCAL OR FOREIGN TAX LAWS, AND OF ANY
PROPOSED CHANGES IN APPLICABLE LAWS.
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UNDERWRITING
The Underwriters named below have severally agreed, subject to the terms
and conditions contained in the Underwriting Agreement (the form of which will
be filed as an exhibit to the Company's Registration Statement, of which this
Prospectus is a part), to purchase from the Company the respective principal
amount of Notes indicated below opposite their respective names. The
Underwriters are committed to purchase all of the Notes (other than those
covered by the over-allotment option), if they purchase any.
<TABLE>
<CAPTION>
PRINCIPAL
NAME AMOUNT
----------------------------------------------------- -----------
<S> <C>
Deutsche Morgan Grenfell Inc.........................
BancAmerica Robertson Stephens.......................
Smith Barney Inc.....................................
----------
Total...................................... $75,000,000
==========
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters thereunder are subject to approval of certain legal matters by
counsel and to various other conditions.
The Underwriters have advised the Company that the Underwriters propose
initially to offer the Notes to the public on the terms set forth on the cover
page of this Prospectus. The Underwriters may allow to selected dealers (who may
include the Underwriters) a concession of not more than $ per Note. The
selected dealers may reallow a concession of not more than $ per Note to
certain other dealers. After the initial public offering of the Notes, the price
and concessions and re-allowances to dealers and other selling terms may be
changed by the Underwriters. The Notes are offered subject to receipt and
acceptance by the Underwriters, and to certain other conditions, including the
right to reject orders in whole or in part. The Underwriters do not intend to
sell any of the Notes offered hereby to accounts for which they exercise
discretionary authority.
The Company has granted an option to the Underwriters to purchase up to
maximum of $11,250,000 additional aggregate principal amount of Notes to cover
over-allotments, if any, at the public offering price, less the underwriting
discount set forth on the cover page of this Prospectus. Such option may be
exercised at any time until 30 days after the date of the Underwriting
Agreement. To the extent the Underwriters exercise this option, each of the
Underwriters will be committed, subject to certain conditions, to purchase such
additional shares in approximately the same proportion as set forth in the above
table. The Underwriters may purchase such Notes only to cover over-allotments
made in connection with this offering.
The Company, certain of its stockholders and each of its directors and
executive officers have agreed that, without the prior written consent of
Deutsche Morgan Grenfell Inc. on behalf of the Underwriters, it will not, during
the period ending 90 days after the date of this Prospectus (i) offer, pledge,
sell, contract to sell, sell any option or contract to purchase, purchase any
option or contract to sell, grant any option, right or warrant to purchase, or
otherwise transfer, lend or dispose of, directly or indirectly, any shares of
Common Stock or any securities convertible into or exercisable or exchangeable
for Common Stock or (ii) enter into any swap or other arrangement that transfers
to another, in whole or in part, any of the economic consequences of ownership
of the Common Stock, whether any such transaction described in clause (i) or
(ii) above is to be settled by delivery of Common Stock or such other
securities, in cash or otherwise, except under certain limited circumstances.
The Underwriting Agreement provides that the Company will indemnify the
several Underwriters against certain liabilities, including civil liabilities
under the Securities Act, as amended, or will contribute to payments the
Underwriters may be required to make in respect thereof.
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The Underwriters are also currently offering 1,500,000 shares of the
Company's Common Stock (of which 1,480,000 shares will be sold by Selling
Stockholders) and intends to enter into an Underwriting Agreement (the form of
which will be filed as an exhibit to the Company's Registration Statement, of
which this Prospectus is a part) for that purpose. Pursuant to that agreement,
the Underwriters will be entitled to exercise an over-allotment option for
225,000 additional shares of Common Stock, will receive customary underwriters'
compensation for an offering of that size and type and will be indemnified by
the Company and the Selling Stockholders. The completion of the Note offering is
contingent upon completion of such Common Stock offering.
Prior to this offering, there has been no public market for the Notes. Each
of the Representatives has informed the Company that it currently intends to
make a market in the Notes subsequent to the effectiveness of this offering;
however, they are not obligated to do so and any market-making activities with
respect to the Notes may be discontinued at any time without notice. There can
be no assurance that an active trading market for the Notes will develop or be
maintained. See "Risk Factors -- Absence of Public Market for the Notes."
Certain persons participating in this offering may over-allot or effect
transactions which stabilize, maintain or otherwise affect the market price of
the Notes or the Common Stock at levels above those which might otherwise
prevail in the open market, including by entering stabilizing bids, imposing
penalty bids or otherwise. A stabilizing bid means the placing of any bid or
effecting of any purchase for the purpose of pegging, fixing or maintaining the
price of the Notes or the Common Stock. A syndicate covering transaction means
the placing of any bid on behalf of the underwriting syndicate or the effecting
of any purchase to reduce a short position created in connection with this
offering. A penalty bid means an arrangement that permits the Underwriters to
reclaim a selling concession from an Underwriter when Notes sold by the
Underwriter are purchased in stabilization transactions. Such transactions may
be effected on the Nasdaq Stock Market, in the over-the-counter market, or
otherwise. Such stabilizing, if commenced, may be discontinued at any time.
The Underwriters and dealers may engage in passive market making
transactions in the Common Stock in accordance with Rule 103 of Regulation M
promulgated by the Commission. In general, a passive market maker may not bid
for, or purchase, the Common Stock at a price that exceeds the highest
independent bid. In addition, the net daily purchases made by any passive market
maker generally may not exceed 30% of its average daily trading volume in the
Common Stock during a specified two month prior period, or 200 shares, whichever
is greater. A passive market maker must identify passive market making bids as
such on the Nasdaq electronic inter-dealer reporting system. Passive market
making may stabilize or maintain the market price of the Common Stock above
independent market levels. Underwriters and dealers are not required to engage
in passive market making and may end passive market making activities at any
time.
LEGAL MATTERS
The validity of the issuance of the Notes and the Common Stock issuable
upon conversion thereof will be passed upon for the Company by Fenwick & West
LLP, Palo Alto, California. Certain legal matters will be passed upon for the
Underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo
Alto, California.
EXPERTS
The consolidated financial statements as of December 31, 1996 and 1997 and
for each of the three years in the period ended December 31, 1997 included in
this Prospectus have been so included in reliance on the report of Price
Waterhouse LLP, independent accountants, given on the authority of said firm as
experts in auditing and accounting.
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HNC SOFTWARE INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants..................................................... F-2
Consolidated Balance Sheet............................................................ F-3
Consolidated Statement of Income...................................................... F-4
Consolidated Statement of Cash Flows.................................................. F-5
Consolidated Statement of Changes in Stockholders' Equity............................. F-6
Notes to Consolidated Financial Statements............................................ F-7
</TABLE>
F-1
<PAGE> 74
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of HNC Software Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of cash flows and of changes in stockholders'
equity present fairly, in all material respects, the financial position of HNC
Software Inc. and its subsidiaries at December 31, 1996 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
San Diego, California
January 29, 1998,
except as to Note 11
which is as of February 13, 1998
F-2
<PAGE> 75
HNC SOFTWARE INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1997
------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents......................................... $ 8,121 $ 18,068
Investments available for sale.................................... 26,728 24,878
Accounts receivable, net.......................................... 21,856 32,980
Current portion of deferred income taxes.......................... 6,383 11,310
Other current assets.............................................. 2,553 2,802
------- --------
Total current assets...................................... 65,641 90,038
Deferred income taxes, less current portion......................... 22,966 15,322
Property and equipment, net......................................... 6,339 12,102
Other assets........................................................ 3,330 2,415
------- --------
$98,276 $119,877
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................................. $ 4,368 $ 5,728
Accrued liabilities............................................... 4,433 5,933
Deferred revenue.................................................. 3,377 3,883
Other current liabilities......................................... 445 191
------- --------
Total current liabilities................................. 12,623 15,735
Non-current liabilities............................................. 683 239
Minority interest in consolidated subsidiary........................ -- 43
Commitments and contingencies (Notes 5 and 10)
Stockholders' equity:
Preferred stock, $0.001 par value -- 4,000 shares authorized:
no shares issued or outstanding................................ -- --
Common stock, $0.001 par value -- 50,000 shares authorized:
24,012 and 24,538 shares issued and outstanding,
respectively.................................................. 24 25
Paid-in capital................................................... 83,991 95,919
Unrealized loss on investments available for sale................. (59) (2)
Foreign currency translation adjustment........................... 54 (111)
Retained earnings................................................. 960 8,029
------- --------
Total stockholders' equity................................ 84,970 103,860
------- --------
$98,276 $119,877
======= ========
</TABLE>
See accompanying notes to consolidated financial statements
F-3
<PAGE> 76
HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1995 1996 1997
-------- ------- -------
<S> <C> <C> <C>
Revenues:
License and maintenance.............................. $ 24,561 $48,890 $89,643
Installation and implementation...................... 4,648 6,691 10,702
Contracts and other.................................. 9,146 11,128 7,772
Service bureau....................................... 5,349 4,730 5,618
-------- ------- -------
Total revenues............................... 43,704 71,439 113,735
-------- ------- -------
Operating expenses:
License and maintenance.............................. 7,903 13,725 19,937
Installation and implementation...................... 1,425 2,714 5,174
Contracts and other.................................. 6,894 7,694 5,438
Service bureau....................................... 3,025 3,365 4,320
Research and development............................. 6,998 13,808 21,151
Sales and marketing.................................. 7,276 11,923 22,049
General and administrative........................... 5,101 8,551 12,626
-------- ------- -------
Total operating expenses..................... 38,622 61,780 90,695
-------- ------- -------
Operating income....................................... 5,082 9,659 23,040
Interest and other income.............................. 912 2,178 2,003
Interest expense....................................... (428) (478) (81)
Minority interest in income of consolidated
subsidiary........................................... -- -- (43)
-------- ------- -------
Income before income tax (benefit)
provision.................................. 5,566 11,359 24,919
Income tax (benefit) provision......................... (511) (534) 7,354
-------- ------- -------
Net income................................... $ 6,077 $11,893 $17,565
======== ======= =======
Earnings per share:
Basic net income per common share.................... $ 0.38 $ 0.50 $ 0.72
======== ======= =======
Diluted net income per common share.................. $ 0.28 $ 0.47 $ 0.68
======== ======= =======
Unaudited pro forma data (Note 1):
Income before income tax provision................... $ 5,566 $11,359 $24,919
Income tax provision................................. 1,032 1,628 9,502
-------- ------- -------
Net income................................... $ 4,534 $ 9,731 $15,417
======== ======= =======
Basic pro forma net income per common share.......... $ 0.64
=======
Diluted pro forma net income per common share........ $ 0.60
=======
Shares used in computing basic net income per common
share and unaudited basic pro forma net income per
common share (Notes 1 and 8)......................... 15,195 23,552 24,275
======== ======= =======
Shares used in computing diluted net income per common
share and unaudited diluted pro forma net income per
common share (Notes 1 and 8)......................... 21,510 25,363 25,681
======== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 77
HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income....................................................... $ 6,077 $ 11,893 $ 17,565
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization.................................. 1,874 3,605 4,833
Tax benefit from stock option transactions..................... 800 896 3,848
Changes in assets and liabilities:
Accounts receivable, net..................................... (1,658) (10,978) (11,124)
Other assets................................................. (674) (1,207) (295)
Deferred income taxes........................................ (1,551) (1,324) 6,909
Accounts payable............................................. 1,172 2,167 1,360
Accrued liabilities.......................................... 1,756 625 (2,348)
Deferred revenue............................................. 1,337 1,472 375
Other liabilities............................................ 22 (441) (116)
-------- -------- --------
Net cash provided by operating activities................. 9,155 6,708 21,007
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investments available for sale....................... (28,666) (26,113) (26,517)
Maturities of investments available for sale..................... 4,182 18,125 24,666
Proceeds from sales of investments available for sale............ 2,467 3,707 3,716
Acquisitions of property and equipment........................... (2,246) (3,978) (9,593)
-------- -------- --------
Net cash used in investing activities..................... (24,263) (8,259) (7,728)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuances of common stock...................... 33,726 1,935 4,039
Proceeds from issuances of notes payable to stockholders......... 1,000 -- --
Repayments of notes payable to stockholders...................... -- (1,000) --
Proceeds from bank line of credit................................ 1,085 309 --
Repayments of bank line of credit................................ (265) (2,504) --
Repayments of debt from asset purchases.......................... -- (4,710) --
Capital lease payments........................................... (502) (553) (408)
Proceeds from issuances of bank notes payable.................... -- 1,999 --
Repayments of bank notes payable................................. (687) (1,999) --
Distributions to CompReview stockholders......................... (3,845) (5,908) (6,798)
-------- -------- --------
Net cash provided by (used in) financing activities....... 30,512 (12,431) (3,167)
-------- -------- --------
Effect of exchange rate changes on cash............................ -- 54 (165)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents............... 15,404 (13,928) 9,947
Cash and cash equivalents at beginning of period................... 6,645 22,049 8,121
-------- -------- --------
Cash and cash equivalents at end of period......................... $ 22,049 $ 8,121 $ 18,068
======== ======== ========
SIGNIFICANT NON-CASH INVESTING AND FINANCING ACTIVITIES:
Assets purchased through issuance of debt........................ $ -- $ 4,710 $ --
======== ======== ========
Acquisitions of property and equipment under capital leases...... $ 411 $ 344 $ --
======== ======== ========
Conversion of preferred stock.................................... $ 13,518 $ -- $ --
======== ======== ========
Accretion of dividends on mandatorily redeemable convertible
preferred stock................................................ $ 348 $ -- $ --
======== ======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Interest paid.................................................... $ 390 $ 448 $ 101
======== ======== ========
Income taxes paid................................................ $ 190 $ 165 $ 547
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements
F-5
<PAGE> 78
HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED STOCK
---------------------------------
SERIES A SERIES E COMMON STOCK
--------------- --------------- ---------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1994......... 380 $ -- 1,282 $ 1 8,656 $ 9
Common stock options exercised....... 207
Accretion of dividends...............
Issuance of common stock in initial
public offering, net of issuance
costs............................... 2,376 2
Conversion of convertible preferred
stock into common stock............. (380) -- (1,282) (1) 8,956 9
Issuance of common stock in follow-on
public offering, net of issuance
costs............................... 1,116 2
Issuance of common stock at inception
of Retek (Note 1)................... 1,367 1
Tax benefit from stock option
transactions........................
Unrealized gain on investments.......
Stock warrant exercised.............. 100
Distributions to CompReview
stockholders........................
Net income...........................
---- ----- ------ --- ------ ---
BALANCE AT DECEMBER 31, 1995......... -- -- -- -- 22,778 23
Common stock options exercised....... 1,140 1
Common stock issued under Employee
Stock Purchase Plan................. 94
Tax benefit from stock option
transactions........................
Tax benefit from Retek taxable
pooling (Note 7)....................
Unrealized loss on investments.......
Foreign currency translation
adjustment..........................
Distributions to CompReview
stockholders........................
Net income...........................
---- ----- ------ --- ------ ---
BALANCE AT DECEMBER 31, 1996......... -- -- -- -- 24,012 24
Common stock options exercised....... 475 1
Common stock issued under Employee
Stock Purchase Plan................. 51
Tax benefit from stock option
transactions........................
Unrealized gain on investments.......
Foreign currency translation
adjustment..........................
Distributions to CompReview
stockholders........................
CompReview contribution to capital...
Net income...........................
---- ----- ------ --- ------ ---
BALANCE AT DECEMBER 31, 1997......... -- $ -- -- $ -- 24,538 $ 25
==== ===== ====== === ====== ===
<CAPTION>
UNREALIZED
GAIN (LOSS) ON FOREIGN (ACCUMULATED
INVESTMENTS CURRENCY DEFICIT) TOTAL
PAID-IN AVAILABLE TRANSLATION RETAINED STOCKHOLDERS'
CAPITAL FOR SALE ADJUSTMENT EARNINGS EQUITY
--------- -------------- ----------- ------------ -------------
<S> <<C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1994.........$ 10,980 $ -- $ -- $(10,149) $ 841
Common stock options exercised....... 85 85
Accretion of dividends............... (348) (348)
Issuance of common stock in initial
public offering, net of issuance
costs............................... 14,329 14,331
Conversion of convertible preferred
stock into common stock............. 10,618 2,892 13,518
Issuance of common stock in follow-on
public offering, net of issuance
costs............................... 19,184 19,186
Issuance of common stock at inception
of Retek (Note 1)................... (1) --
Tax benefit from stock option
transactions........................ 800 800
Unrealized gain on investments....... 92 92
Stock warrant exercised.............. 124 124
Distributions to CompReview
stockholders........................ (3,845) (3,845)
Net income........................... 6,077 6,077
------- ----- ----- -------- --------
BALANCE AT DECEMBER 31, 1995......... 55,771 92 -- (5,025) 50,861
Common stock options exercised....... 1,095 1,096
Common stock issued under Employee
Stock Purchase Plan................. 839 839
Tax benefit from stock option
transactions........................ 7,889 7,889
Tax benefit from Retek taxable
pooling (Note 7).................... 18,397 18,397
Unrealized loss on investments....... (151) (151)
Foreign currency translation
adjustment.......................... 54 54
Distributions to CompReview
stockholders........................ (5,908) (5,908)
Net income........................... 11,893 11,893
------- ----- ----- -------- --------
BALANCE AT DECEMBER 31, 1996......... 83,991 (59) 54 960 84,970
Common stock options exercised....... 2,845 2,846
Common stock issued under Employee
Stock Purchase Plan................. 1,193 1,193
Tax benefit from stock option
transactions........................ 4,192 4,192
Unrealized gain on investments....... 57 57
Foreign currency translation
adjustment.......................... (165) (165)
Distributions to CompReview
stockholders........................ (6,798) (6,798)
CompReview contribution to capital... 3,698 (3,698) --
Net income........................... 17,565 17,565
------- ----- ----- -------- --------
BALANCE AT DECEMBER 31, 1997.........$ 95,919 $ (2) $(111) $ 8,029 $ 103,860
======= ===== ===== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements
F-6
<PAGE> 79
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 1 -- THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES
The Company
Headquartered in San Diego, California, HNC Software Inc. (the "Company" or
"HNC") develops, markets and supports predictive software solutions in
client/server environments. HNC provides innovative predictive software systems
in the healthcare/insurance, financial services and retail markets.
Acquisitions
On August 30, 1996, the Company completed an acquisition of all of the
outstanding shares of Risk Data Corporation ("Risk Data"). Risk Data is an
insurance information technology services firm that develops, markets and
supports analytical benchmarking and risk management software products primarily
for insurance carriers, state insurance funds and third party administrators
primarily in the workers' compensation insurance field. Under the terms of the
acquisition, accounted for as a pooling of interests, the Company exchanged
1,891 shares of common stock for all of the then outstanding shares of Risk Data
preferred and common stock.
On November 29, 1996, the Company completed an acquisition of all of the
outstanding shares of Retek Distribution Corporation ("Retek"). Retek develops,
markets and supports inventory management system software primarily for
customers in the retail industry. Under the terms of the acquisition, accounted
for as a pooling of interests, the Company exchanged 1,367 shares of common
stock for all of the then outstanding shares of Retek common stock.
On November 28, 1997, the Company completed an acquisition of all of the
outstanding shares of CompReview, Inc. ("CompReview"). CompReview develops,
markets and supports cost containment software for workers' compensation
insurance carriers and for insurers that handle automobile accident personal
injury claims. Under the terms of the acquisition, accounted for as a pooling of
interests, the Company exchanged 4,886 shares of common stock for all of the
then outstanding shares of CompReview common stock.
The consolidated financial statements and related notes give retroactive
effect to all three acquisitions for all of the periods presented. The
consolidated balance sheet as of December 31, 1996 and 1997 includes the
accounts of Risk Data, Retek and CompReview as of December 31, 1996 and 1997.
The consolidated statements of income, of cash flows and of changes in
stockholders' equity for each of the three years in the period ended December
31, 1997 include the results of Risk Data, Retek and CompReview for each of the
years then ended. The term "Company" as used in these consolidated financial
statements refers to HNC and its subsidiaries, including Risk Data, Retek and
CompReview.
F-7
<PAGE> 80
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
No adjustments to conform the accounting methods of the acquired companies
to the accounting methods of HNC were required. Certain amounts have been
reclassified with regard to presentation of the financial information of the
acquired companies. Revenues and net income (loss) for each of the previously
separate companies for the periods prior to their respective acquisition dates
are as follows:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SIX MONTHS SEPTEMBER 30,
---------------------------- ENDED -----------------
1995 1996 1997 JUNE 30, 1996 1997
------- ------- -------- 1996 ------- -------
----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Revenues:
HNC............... $25,174 $53,833 $113,735 $ 16,478 $31,423 $62,683
Risk Data......... 4,577 -- -- 2,600 -- --
Retek............. 921 -- -- 3,377 5,635 --
CompReview........ 13,032 17,606 -- 8,119 12,631 18,971
------- ------- -------- -------- ------- -------
$43,704 $71,439 $113,735 $ 30,574 $49,689 $81,654
======= ======= ======== ======== ======= =======
Net income (loss):
HNC............... $ 4,457 $ 6,376 $ 17,565 $ 1,780 $ 975 $ 7,597
Risk Data......... (1,952) -- -- (2,184) -- --
Retek............. (382) -- -- 43 93 --
CompReview........ 3,954 5,517 -- 2,123 3,679 6,702
------- ------- -------- -------- ------- -------
$ 6,077 $11,893 $ 17,565 $ 1,762 $ 4,747 $14,299
======= ======= ======== ======== ======= =======
</TABLE>
Transaction costs of $563, $515 and $1,440 were incurred to complete the
acquisitions of Risk Data, Retek and CompReview, respectively. Transaction costs
were deferred and charged to income when the related transactions were
consummated. Transaction costs consisted primarily of investment banker, legal
and accounting fees, and printing, mailing and registration expenses.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany transactions and
balances have been eliminated.
During 1996, the Company established Aptex Software Inc. ("Aptex"), a
majority owned subsidiary, in order to develop, market and support certain text
analysis technology that is being used to develop products for the Internet
market. The minority stockholders' interest in Aptex's financial position and
results of operations is presented as a minority interest in the Company's
consolidated financial statements.
Financial Statement Preparation
The preparation of financial statements, in conformity with generally
accepted accounting principles, requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
F-8
<PAGE> 81
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Cash Equivalents
Cash equivalents are highly liquid investments and consist of investments
in money market accounts and commercial paper purchased with maturities of three
months or less.
Investments
Management determines the appropriate classification of its investments in
marketable debt and equity securities at the time of purchase and re-evaluates
such designation as of each balance sheet date. The Company classifies all
securities as "available for sale" and carries them at fair value with
unrealized gains or losses related to these securities included in stockholders'
equity in the Company's consolidated balance sheet.
Property and Equipment
Property and equipment are recorded at cost. The Company computes
depreciation and amortization using either the straight-line method over the
estimated useful lives of the assets of three to seven years or an accelerated
method over the estimated useful lives of the assets of five to seven years. The
Company amortizes leasehold improvements over the shorter of their estimated
useful lives or the remaining term of the related lease. Repair and maintenance
costs are charged to expense as incurred.
Software Costs
Software costs are recorded at cost and amortized over their estimated
useful lives of 36 to 42 months. Software costs are comprised of purchased
software and other rights that are stated at the lower of cost or net realizable
value. At December 31, 1996 and 1997, software costs of $2,561 and $2,581,
respectively, were included in other assets in the consolidated balance sheet
net of accumulated amortization of $642 and $1,451, respectively.
Development costs for software to be licensed or sold that are incurred
from the time technological feasibility is established until the product is
available for general release to customers are capitalized and reported at the
lower of cost or net realizable value. Through December 31, 1997, no significant
amounts were expended subsequent to reaching technological feasibility.
Long-Lived Assets
The Company investigates potential impairments of long-lived assets,
certain identifiable intangibles and associated goodwill when events or changes
in circumstances have made recovery of an asset's carrying value unlikely. An
impairment loss would be recognized if the sum of the expected future net cash
flows were less than the carrying amount of the asset. No such impairments of
long-lived assets existed through December 31, 1997.
Stock-Based Compensation
The Company measures compensation expense for its stock-based employee
compensation plans using the intrinsic value method and provides pro forma
disclosures of net income and earnings per share as if the fair value-based
method had been applied in measuring compensation expense.
F-9
<PAGE> 82
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Revenue Recognition
The Company's revenue from periodic software license and maintenance
agreements is generally recognized ratably over the respective license periods.
Revenue from certain short-term periodic software license and maintenance
agreements with guaranteed minimum license fees is recognized as related
services are performed. Transactional fees are recognized as revenue based on
system usage or when fees based on system usage exceed the monthly minimum
license fees. Revenue from perpetual licenses of the Company's software for
which there are no significant continuing obligations and collection of the
related receivables is probable is recognized on delivery of the software and
acceptance by the customer. Revenue from hardware product sales, which is
included in contracts and other revenue, is recognized upon shipment to the
customer.
The Company's revenue from software installation and implementation and
from contract services is generally recognized as the services are performed
using the percentage of completion method based on costs incurred to date
compared to total estimated costs at completion. Amounts received under
contracts in advance of performance are recorded as deferred revenue and are
generally recognized within one year from receipt. Contract losses are recorded
as a charge to income in the period such losses are first identified. Unbilled
accounts receivable are stated at estimated realizable value.
Service bureau fees are from review and repricing of customers' medical
bills and are assessed to customers on the basis of volume of bills processed
and are recognized as revenue when the processing services are performed.
Income Taxes
The Company's current income tax expense is the amount of income taxes
expected to be payable for the current year. A deferred income tax asset or
liability is computed for the expected future impact of differences between the
financial reporting and tax bases of assets and liabilities as well as the
expected future tax benefit to be derived from tax loss and tax credit
carryforwards. Valuation allowances are established, when necessary, to reduce
deferred tax assets to the amount "more likely than not" to be realized in
future tax returns. Tax rate changes are reflected in income during the period
such changes are enacted.
Net Income Per Common Share
The Company adopted Statement of Financial Accounting Standard No. 128
("FAS 128"), "Earnings per Share," for fiscal 1997 and retroactively restated
all prior periods to conform with FAS 128 as required. Basic net income per
common share is computed as net income less accretion of dividends on
mandatorily redeemable convertible preferred stock divided by the weighted
average number of common shares outstanding during the period. Diluted net
income per common share is computed as net income divided by the weighted
average number of common shares and potential common shares, using the treasury
stock method, outstanding during the period and assumes conversion into common
stock at the beginning of each period of all outstanding shares of convertible
preferred stock (Note 8).
Unaudited Pro Forma Data
Prior to the acquisition of CompReview by HNC on November 28, 1997,
CompReview had elected subchapter S corporation status for income tax purposes;
therefore, its income was included in the tax returns of its stockholders, and
no income tax provision was recorded for
F-10
<PAGE> 83
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CompReview other than certain minimum state taxes on subchapter S corporations.
As a result of the acquisition, beginning November 29, 1997, CompReview became
subject to corporate income taxes on its taxable income. For comparative
purposes, the consolidated statement of income includes unaudited pro forma
adjusted data with respect to the merged companies' income tax provision as if
CompReview had been subject to corporate income taxes on its taxable income for
all periods presented.
Foreign Currency Translation
The financial statements of the Company's international operations are
translated into U.S. dollars using period-end exchange rates for assets and
liabilities and average exchange rates during the period for revenues and
expenses. Cumulative translation gains and losses are excluded from results of
operations and recorded as a separate component of stockholders' equity. Gains
and losses resulting from foreign currency transactions (transactions
denominated in a currency other than the entity's local currency) are included
in the consolidated statement of income and are not material.
Diversification of Credit Risk
The Company's financial instruments that are subject to concentrations of
credit risk consist primarily of cash equivalents, investments available for
sale and accounts receivable, which are generally not collateralized. The
Company's policy is to place its cash, cash equivalents and investments
available for sale with high credit quality financial institutions and
commercial companies and government agencies in order to limit the amount of its
credit exposure. The Company's software license and installation agreements and
commercial development contracts are primarily with large customers in the
healthcare/insurance, financial services and retail industries. The Company
maintains reserves for potential credit losses.
The Company has one major product or product line in each of its three
target markets. In the healthcare/insurance market, revenues from one product
accounted for 29.8%, 24.6% and 23.0% of the Company's total revenues for 1995,
1996 and 1997, respectively. During those same periods, one product in the
retail market accounted for 2.2%, 13.6% and 18.9%, respectively, of the
Company's total revenues, and one product line in the financial services market
accounted for 28.0%, 20.9% and 16.0%, respectively, of the Company's total
revenues. Revenues from international operations and export sales, primarily to
Western Europe and Canada, represented approximately 12.6%, 17.7% and 16.8% of
total revenues in 1995, 1996 and 1997, respectively. Export sales were $4,595,
$7,310 and $7,896 in 1995, 1996 and 1997, respectively.
Disclosures About Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents and accrued liabilities
approximate fair value because of the short-term maturities of these financial
instruments. The carrying amounts of capital lease obligations approximate their
fair values based on interest rates currently available to the Company for
borrowings with similar terms and maturities.
Reincorporation and Stock Split
In May 1995, the Company's stockholders approved an Agreement and Plan of
Merger whereby the Company merged with and into a newly incorporated Delaware
corporation ("HNC Delaware"), which is the surviving corporation. In conjunction
with the merger, each share of the
F-11
<PAGE> 84
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Company's common stock, preferred stock and options and warrants to purchase the
Company's common stock was exchanged for one-half share of HNC Delaware's common
stock, preferred stock and options and warrants to purchase HNC Delaware's
common stock, at twice the exercise price for options and warrants. In April
1996, the Company consummated a two-for-one stock split effected in the form of
a common stock dividend. All references to share and per share amounts of common
and preferred stock and other data in these financial statements have been
retroactively restated to reflect the reincorporation and stock split.
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130 ("FAS 130"), "Reporting
Comprehensive Income," which the Company is required to adopt for 1998. This
statement will require the Company to report in the financial statements, in
addition to net income, comprehensive income and its components including
foreign currency items and unrealized gains and losses on certain investments in
debt and equity securities. Upon adoption of FAS 130, the Company is also
required to reclassify financial statements for earlier periods provided for
comparative purposes. The adoption of FAS 130 will not have a significant impact
on the Company's consolidated financial statement disclosures.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and Related
Information," which the Company is required to adopt for its 1998 annual
financial statements. This statement establishes standards for reporting
information about operating segments in annual financial statements and requires
selected information about operating segments in interim financial reports
issued to stockholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. Under FAS
131, operating segments are to be determined consistent with the way that
management organizes and evaluates financial information internally for making
operating decisions and assessing performance. The Company has not determined
the impact of the adoption of this new accounting standard on its consolidated
financial statement disclosures.
In November 1997, the American Institute of Certified Public Accountants
issued Statement of Position No. 97-2 ("SOP 97-2"), "Software Revenue
Recognition," which the Company is required to adopt for agreements entered into
with customers beginning in 1998. This statement provides guidance for
recognizing revenue related to sales by software vendors. The adoption of SOP
97-2 will not have a significant impact on the timing of the Company's revenue
recognition.
F-12
<PAGE> 85
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Reclassifications
Certain prior year balances have been reclassified to conform to the
current year presentation.
NOTE 2 -- COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
------- -------
<S> <C> <C>
Accounts receivable, net:
Billed............................................. $13,266 $27,812
Unbilled........................................... 9,299 8,368
------- -------
22,565 36,180
Less allowance for doubtful accounts................. (709) (3,200)
------- -------
$21,856 $32,980
======= =======
</TABLE>
Unbilled accounts receivable represent revenue recorded in excess of
amounts billable pursuant to contract provisions and generally become billable
at contractually specified dates or upon the attainment of milestones. Unbilled
amounts are expected to be realized within one year.
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
------- -------
<S> <C> <C>
Property and equipment, net:
Computer equipment................................. $ 9,302 $15,611
Furniture and fixtures............................. 2,210 4,632
Leasehold improvements............................. 273 1,012
------- -------
11,785 21,255
Less accumulated depreciation and amortization....... (5,446) (9,153)
------- -------
$ 6,339 $12,102
======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
------- -------
<S> <C> <C>
Accrued liabilities:
Payroll and related benefits....................... $ 1,645 $ 3,456
Vacation........................................... 860 927
Other.............................................. 1,928 1,550
------- -------
$ 4,433 $ 5,933
======= =======
</TABLE>
F-13
<PAGE> 86
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 3 -- INVESTMENTS
At December 31, 1996 and 1997, the amortized cost and estimated fair value
of investments available for sale were as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
---------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
U.S. government and federal
agencies........................ $ 18,212 $ -- $ (38) $18,174
Foreign government debt........... 1,006 -- (2) 1,004
U.S. corporate debt............... 4,851 -- (14) 4,837
Foreign corporate debt............ 2,718 -- (5) 2,713
------- ------- ------- -------
$ 26,787 $ -- $ (59) $26,728
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
---------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
U.S. government and federal
agencies........................ $ 20,682 $ -- $ (1) $20,681
U.S. corporate debt............... 1,894 -- (1) 1,893
Foreign corporate debt............ 2,304 -- -- 2,304
------- ------- ------- -------
$ 24,880 $ -- $ (2) $24,878
======= ======= ======= =======
</TABLE>
No significant gains or losses were realized during the years ended
December 31, 1996 and 1997. The cost of securities sold is determined by the
specific identification method.
NOTE 4 -- NOTES PAYABLE
The Company has a Credit Agreement with a bank which provides for a $15,000
revolving line of credit through July 11, 1999. The agreement requires that the
Company maintain certain financial ratios and levels of working capital,
tangible net worth and profitability, and also restricts the Company's ability
to pay cash dividends and make loans, advances or investments without the bank's
consent. At December 31, 1997, the Company had no amounts outstanding under the
revolving line of credit. Interest is payable monthly at the bank's prime rate
or LIBOR rate plus 1.5%. The applicable interest rate was 7.22% at December 31,
1997.
The Risk Data credit facilities were comprised of a revolving line of
credit secured by eligible accounts receivable, as well as a bridge loan that
was secured by the guarantees of certain stockholders. The revolving line of
credit matured on January 5, 1997. The bridge loan matured on September 5, 1996.
All outstanding amounts were repaid during 1996, and neither credit facility was
renewed.
During 1995, the preferred stockholders of Risk Data loaned the Company
$1,000 under subordinated note agreements (secured by the assets of Risk Data
but subordinated to borrowings under the Risk Data line of credit) bearing
interest at 9%. All outstanding amounts were repaid during 1996.
F-14
<PAGE> 87
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 5 -- LEASES
At December 31, 1997, the Company was obligated through 2004 under
noncancelable operating leases for its facilities and certain equipment as
follows:
<TABLE>
<CAPTION>
NET FUTURE
FUTURE MINIMUM LESS SUBLEASE MINIMUM LEASE
LEASE PAYMENTS INCOME PAYMENTS
-------------- ------------- -------------
<S> <C> <C> <C>
1998............................. $2,984 $ 127 $ 2,857
1999............................. 3,047 -- 3,047
2000............................. 3,043 -- 3,043
2001............................. 2,994 -- 2,994
2002............................. 2,884 -- 2,884
thereafter....................... 1,535 -- 1,535
</TABLE>
The lease for the Company's corporate headquarters provides for scheduled
rent increases and an option to extend the lease for five years with certain
changes to the terms of the lease agreement and a refurbishment allowance. Rent
expense under operating leases for the years ended December 31, 1995, 1996 and
1997 was approximately $1,503, $1,623 and $2,687, respectively, net of sublease
income of $83, $125 and $477, respectively.
Risk Data maintains a lease line of credit with a leasing company for the
acquisition of equipment under capital lease arrangements. Future minimum
payments are $222 for 1998 and $66 for 1999 with a total of $34 of such amounts
representing interest.
The gross value of assets under capital leases at December 31, 1996 and
1997 was $1,481 and $714, and accumulated amortization was $599 and $556,
respectively. Amortization expense for assets acquired under capital leases is
included in depreciation expense.
NOTE 6 -- CAPITAL STOCK
During June 1995, the Company completed its initial public offering of
5,176 shares of common stock (of which 2,376 shares were sold by the Company and
2,800 shares were sold by certain selling stockholders) at a price to the public
of $7.00 per share, which resulted in net proceeds to the Company of $15,461
after the payment of underwriters' commissions but before the deduction of
offering expenses. Upon the closing of the Company's initial public offering,
all outstanding shares of Series A, B, C, D and E convertible preferred stock
were automatically converted into shares of common stock at their then effective
conversion prices. Upon conversion, the preferred stockholders were no longer
entitled to any undeclared cumulative dividends and all class voting rights
terminated.
During December 1995, the Company completed a follow-on public offering of
3,000 shares of common stock (of which 1,116 shares were sold by the Company and
1,884 shares were sold by certain selling stockholders) at a price to the public
of $18.50 per share, which resulted in net proceeds to the Company of $19,606
after the payment of underwriters' commissions but before the deduction of
offering expenses.
The Company's Board of Directors is authorized to issue up to 4,000 shares
of preferred stock and to determine the price, rights, preferences, privileges
and restrictions, including voting rights, of those shares without any further
vote or action by the stockholders. The rights of the holders of common stock
will be subject to the rights of the holders of any preferred stock that may be
issued in the future.
F-15
<PAGE> 88
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 7 -- INCOME TAXES
Income (loss) before income tax (benefit) provision was taxed under the
following jurisdictions:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1995 1996 1997
------ ------- -------
<S> <C> <C> <C>
Domestic.................................. $5,764 $ 8,599 $23,907
Foreign................................... (198) 2,760 1,012
------ ------- -------
$5,566 $11,359 $24,919
====== ======= =======
</TABLE>
The income tax (benefit) provision is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1995 1996 1997
------ ------- -------
<S> <C> <C> <C>
CURRENT:
Federal................................. $ 97 $ 1,132 $ 2,257
State................................... 143 204 537
Foreign................................. -- 51 233
DEFERRED:
Federal................................. (521) (1,569) 3,197
State................................... (186) (56) 985
Foreign................................. (44) (296) 145
------ ------- -----
$ (511) $ (534) $ 7,354
====== ======= =====
</TABLE>
Deferred tax assets are summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-------------------
1996 1997
------- -------
<S> <C> <C>
Taxable pooling basis difference..................... $18,397 $16,955
Net operating loss carryforwards..................... 8,587 7,404
Tax credit carryforwards............................. 1,878 2,059
Other................................................ 487 214
------- -------
Gross deferred tax assets............................ 29,349 26,632
Deferred tax asset valuation allowance............... -- --
------- -------
Net deferred tax asset..................... $29,349 $26,632
======= =======
</TABLE>
During 1995, the Company released the valuation allowance related to its
deferred tax assets based on management's assessment that it was more likely
than not that the Company would realize a portion of those assets in future
periods due to improvements in the Company's operating results. During 1996, the
Company released the valuation allowances related to Risk Data's and Retek's
deferred tax assets based on management's assessment that it was more likely
than not that the Company would realize those assets in future periods due to
improvements in the operating results of those subsidiaries.
During 1995, 1996 and 1997, the Company realized certain tax benefits
related to stock option transactions in the amount of $800, $7,889 and $4,192,
respectively. The benefit from the stock option tax deduction is credited
directly to paid-in capital.
F-16
<PAGE> 89
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
During 1996, in connection with the acquisition of Retek, the Company made
an Internal Revenue Code Section 338 election for federal and state tax
purposes, resulting in the treatment of the acquisition as a taxable
transaction, whereby the tax bases of the acquired assets and liabilities were
adjusted to their fair values as of the date of the acquisition. As the purchase
price exceeded the carrying value of the net assets acquired by approximately
$46,000, the Company recorded a deferred tax asset in the amount of $18,397.
A reconciliation of the income tax (benefit) provision to the amount
computed by applying the statutory federal income tax rate to income before
income tax provision is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Amounts computed at statutory federal
rate................................... $ 1,892 $ 3,862 $ 8,472
State income taxes.................. 465 554 1,407
Subchapter S corporation earnings... (1,366) (1,901) (2,888)
Change in tax status of S
corporation....................... -- -- 869
Tax credit carryforwards
generated......................... (68) (334) (284)
Release of valuation allowance...... (2,223) (2,717) --
Foreign income taxes................ (44) (296) 27
Losses without tax benefit.......... 794 -- --
Other............................... 39 298 (249)
------- ------- -------
Income tax (benefit) provision........... $ (511) $ (534) $ 7,354
======= ======= =======
</TABLE>
Prior to the acquisition of CompReview by the Company on November 28, 1997,
CompReview had elected subchapter S corporation status and the cash basis of
accounting for income tax purposes; therefore, its cash basis income was
included in the tax returns of its stockholders, and no income tax provision was
recorded for CompReview other than certain minimum state taxes on subchapter S
corporations. As of the date of CompReview's acquisition, its tax status was
changed to C corporation status with the accrual basis of accounting. As a
result of this change in tax status, the Company recorded a deferred tax
liability in the amount of $869 based on the cumulative income recognition
differences as of the date of acquisition between CompReview's former and
prospective tax accounting methods.
At December 31, 1997, the Company had federal, state and foreign net
operating loss carryforwards of approximately $19,992, $7,785 and $352,
respectively. The net operating loss carryforwards expire as follows:
<TABLE>
<S> <C>
2001...................................... $ 6,982
2003...................................... 84
2005...................................... 123
2006...................................... 1,670
2007...................................... 17
2008...................................... 1,692
2009...................................... 1,370
2010...................................... 1,840
2011...................................... 14,086
</TABLE>
The Company also has approximately $1,295 of federal research and
development credit carryforwards, which expire from 2000 to 2012, $711 of state
research and development credit
F-17
<PAGE> 90
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
carryforwards, which have no expiration date, and $53 of foreign tax credit
carryforwards, which expire from 1999 to 2002. Certain of these net operating
loss and research and development credit carryforwards generated by Risk Data,
Retek and CompReview prior to their acquisitions by HNC are subject to annual
limitations on their utilization and also are limited to utilization solely by
the company that generated them. Should a substantial change in HNC's ownership
occur, as defined by the Tax Reform Act of 1986, there will be an annual
limitation on its utilization of net operating loss and research and development
credit carryforwards.
NOTE 8 -- RECONCILIATION OF NET INCOME AND SHARES USED IN PER SHARE COMPUTATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
NET INCOME USED:
Net income used in computing basic net income per common share..... $ 5,729 $11,893 $17,565
Add back accretion of dividends on mandatorily redeemable
convertible preferred stock...................................... 348 -- --
------- ------- -------
Net income used in computing diluted net income per common share... $ 6,077 $11,893 $17,565
======= ======= =======
SHARES USED:
Weighted average common shares outstanding used in computing basic
net income per common share...................................... 15,195 23,552 24,275
Weighted average options and warrants to purchase common stock as
determined by application of the treasury stock method......... 1,995 1,796 1,383
Incremental shares for assumed conversion of convertible
preferred stock................................................ 4,265 -- --
Purchase Plan common stock equivalents........................... 55 15 23
------- ------- -------
Shares used in computing diluted net income per common share....... 21,510 25,363 25,681
======= ======= =======
</TABLE>
All outstanding shares of the Company's preferred stock automatically
converted into shares of common stock upon the closing of the Company's initial
public offering on June 26, 1995. Shares used in computing diluted net income
per common share for 1995 assume conversion of all outstanding shares of
convertible preferred stock were converted at the beginning of that year.
NOTE 9 -- EMPLOYEE BENEFIT PLANS
During 1987, the Company adopted the 1987 Stock Option Plan and reserved
2,500 shares of the Company's common stock for issuance pursuant to nonqualified
and incentive stock options to its officers, directors, key employees and
consultants. The plan, as amended, is administered by the Board of Directors or
its designees and provides generally that, for incentive stock options and
nonqualified stock options, the exercise price must not be less than the fair
market value of the shares as determined by the Board of Directors at the date
of grant. The options expire no later than ten years from the date of grant and
may be exercised in installments based upon stipulated timetables (not in excess
of seven years). At December 31, 1997, options to purchase 490 shares were
exercisable.
During 1995, the Company adopted the 1995 Directors Stock Option Plan (the
"Directors Plan"), the 1995 Equity Incentive Plan (the "Incentive Plan") and the
1995 Employee Stock Purchase Plan (the "Purchase Plan"). For purposes of the
discussion contained in the three paragraphs below, "fair market value" means
the closing price of the Company's common stock on the Nasdaq National Market on
the grant date.
F-18
<PAGE> 91
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The Directors Plan provides for the issuance of up to 300 nonqualified
stock options to the Company's outside directors. Under the provisions of the
Directors Plan, options to purchase 25 shares of the Company's common stock are
granted to outside directors upon their respective dates of becoming members of
the Board of Directors and options to purchase ten shares of such stock will be
granted on each anniversary of such dates. Options under the Directors Plan are
granted at the fair market value of the stock at the grant date and vest at
specific times over a four-year period. At December 31, 1997, options to
purchase 72 shares were exercisable.
The Incentive Plan provides for the issuance of up to 3,550 shares of the
Company's common stock in the form of nonqualified or incentive stock options,
restricted stock or stock bonuses. In addition, all shares that remained
unissued under the 1987 Stock Option Plan on the effective date of the Incentive
Plan, and all shares issuable upon exercise of options granted pursuant to the
1987 Stock Option Plan that expire or become unexercisable for any reason
without having been exercised in full are available for issuance under the
Incentive Plan. Nonqualified stock options and restricted stock may be awarded
at a price not less than 85% of the fair market value of the stock at the date
of the award. Incentive stock options must be awarded at a price not less than
100% of the fair market value of the stock at the date of the award. Options
granted under the Incentive Plan may have a term of up to ten years. The Company
has the discretion to provide for restrictions and the lapse thereof in respect
of restricted stock awards. Options typically vest at the rate of 25% of the
total grant per year over a four-year period; however, the Company may, at its
discretion, implement a different vesting schedule with respect to any new stock
option grant. At December 31, 1997, 316 shares were exercisable.
The Purchase Plan provides for the issuance of a maximum of 400 shares of
common stock. Each purchase period, eligible employees may designate between 2%
and 10% of their cash compensation, subject to certain limitations, to be
deducted from their compensation for the purchase of common stock under the
Purchase Plan. The purchase price of the shares under the Purchase Plan is equal
to 85% of the lesser of the fair market value per share on the first day of the
twelve-month offering period or the last day of each six-month purchase period.
Approximately 60% of eligible employees have participated in the Purchase Plan
in the last two years.
Risk Data's stock option plan is administered by HNC's Board of Directors.
All outstanding Risk Data options were converted into options to purchase HNC
common stock and adjusted to give effect to the acquisition exchange ratio in
the Risk Data acquisition. No changes were made to the terms of the Risk Data
options in connection with the exchange. Options granted under the Risk Data
stock option plan generally vest at the rate of 25% of the total grant per year
and expire ten years after the date of grant. At December 31, 1997, 30 shares
were exercisable under the Risk Data plan.
Retek's stock options are administered by HNC's Board of Directors. All
outstanding Retek options were converted into options to purchase the Company's
common stock and adjusted to give effect to the acquisition exchange ratio in
the Retek acquisition. No changes were made to the terms of the Retek options in
connection with the exchange. Options granted vest ratably over periods from one
to four years and have a term of up to ten years. At December 31, 1997, options
to purchase 32 shares were exercisable.
The CompReview 1995 Stock Option Plan is administered by HNC's Board of
Directors. All outstanding CompReview stock options were converted into options
to purchase HNC common stock in the CompReview acquisition and adjusted to give
effect to the acquisition exchange ratio. No changes were made to the terms of
the CompReview options in connection with the exchange. Options granted under
the CompReview Stock Option Plan generally vest ratably over periods from
F-19
<PAGE> 92
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
two to four years and expire ten years after the date of grant. At December 31,
1997, options to purchase 156 shares were exercisable.
Transactions under the Company's stock option and purchase plans during the
years ended December 31, 1995, 1996 and 1997, including options under the Risk
Data stock option plan, options under the Retek stock option plan and options
under the CompReview Stock Option Plan, but excluding options to purchase stock
of Aptex, a subsidiary of the Company, are summarized as follows.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------
1995 1996 1997
------------------------ ------------------------ ------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------ ---------------- ------ ---------------- ------ ----------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year.... 2,080 $ 0.49 2,868 $ 2.84 3,215 $15.65
Options granted...... 1,272 6.08 1,645 27.98 2,177 32.61
Options exercised.... (207) 0.52 (1,140) 0.96 (475) 6.16
Options canceled..... (277) 1.80 (158) 17.62 (326) 26.33
------ ------
Outstanding at end of
year................. 2,868 2.84 3,215 15.65 4,591 23.92
====== ======
Options exercisable at
end of year.......... 1,437 841 1,096
Weighted average fair
value of options
granted during the
year................. $ 3.10 $14.50 $19.79
</TABLE>
The following table summarizes information about employee stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED -------------------------
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING AT REMAINING AVERAGE OUTSTANDING AT AVERAGE
RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICES 1997 LIFE (IN YEARS) PRICE 1997 PRICE
---------------------- -------------- --------------- -------- -------------- --------
<S> <C> <C> <C> <C> <C>
$ 0.02 to $ 3.00...... 1,002 5.90 $ 1.90 702 $ 1.60
4.50 25.38...... 793 8.21 19.22 188 15.69
25.60 30.75...... 791 8.86 29.39 147 30.33
30.81 31.50...... 944 9.57 31.40 1 30.94
31.88 39.00...... 774 9.42 36.03 32 34.24
39.09 49.50...... 287 9.27 41.42 26 42.64
----- -----
0.02 49.50...... 4,591 8.37 23.92 1,096 9.82
===== =====
</TABLE>
During 1996, Aptex adopted the 1996 Equity Incentive Plan (the "Aptex
Plan") whereby 2,000 shares of Aptex common stock were reserved for issuance
pursuant to nonqualified and incentive stock options and restricted stock
awards. The plan is administered by the Board of Directors of Aptex or its
designees and provides generally that nonqualified stock options and restricted
stock may be awarded at a price not less than 85% of the fair market value, as
determined by the Board of Directors, of the stock at the date of the award.
Incentive stock options must be awarded at a price not less than 100% of the
fair market value of the stock at the date of the award, or 110% of fair market
value for awards to more than 10% stockholders. Options granted under the
Incentive Plan may have a term of up to ten years. The Company has the
F-20
<PAGE> 93
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
discretion to provide for restrictions and the lapse thereof in respect of
restricted stock awards, and options typically vest at the rate of 25% of the
total grant per year. However, the Company may, at its discretion, implement a
different vesting schedule with respect to any new stock option grant. During
1996, Aptex issued 1,000 shares of common stock at fair market value under the
Aptex Plan for cash consideration of $0.03 per share. At December 31, 1997,
options to purchase 79 shares were exercisable under the Aptex Plan.
The Company applies Accounting Principles Board Opinion No. 25 and related
Interpretations in accounting for its stock-based compensation. No compensation
expense has been recognized for its employee stock option grants, which are
fixed in nature, as the options have been granted at fair market value. No
compensation expense has been recognized for the Purchase Plan. Had compensation
cost for the Company's stock-based compensation awards issued during 1997 and
1996 been determined based on the fair value at the grant dates of awards
consistent with the method of Financial Accounting Standards Board Statement No.
123 ("FAS 123"), the Company's net income and basic and diluted pro forma net
income per common share would have been reduced to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1995 1996 1997
------ ------- -------
<S> <C> <C> <C>
Net income:
As reported................................. $6,077 $11,893 $17,565
Pro forma................................... 5,126 6,122 2,232
Basic net income per common share:
As reported................................. 0.38 0.50 0.72
Pro forma................................... 0.31 0.26 0.09
Diluted net income per common share:
As reported................................. 0.28 0.47 0.68
Pro forma................................... 0.24 0.24 0.09
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions used for grants during the years ended December 31, 1995, 1996 and
1997, respectively: dividend yield of 0.0% for all three years, risk-free
interest rates of 6.29%, 6.03% and 6.10%, expected volatilities of 75%, 70% and
65% (0% for 1995 and 1996 options granted by Risk Data, Retek and CompReview
prior to their acquisition by HNC), and expected lives of 3.5, 3.5 and 3.0
years. The fair value of the employees' purchase rights pursuant to the Purchase
Plan is estimated using the Black-Scholes model with the following assumptions:
dividend yield of 0.0% for all three years, risk-free interest rates of 5.66%,
5.36% and 5.32%, expected volatilities of 75%, 70% and 65%, and an expected life
of 6 months for all three years. The weighted average fair value of those
purchase rights granted in 1995, 1996 and 1997 was $2.75, $9.61 and $14.10,
respectively.
The fair value of each option granted under the Aptex Plan is estimated on
the date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions used for grants during the years ended
December 31, 1996 and 1997: dividend yield of 0.0% for both years, risk-free
interest rates of 6.42% and 6.33%, expected volatility of 90% for both years,
and expected lives of 9.25 and 8.0 years. Options to purchase 704 shares and 214
shares were granted during 1996 and 1997, with weighted average exercise prices
per share of $0.03 and $0.08, respectively. During 1997, options to purchase 173
shares with a weighted average exercise price of $0.03 per share were exercised.
During 1997, options to purchase 58 shares
F-21
<PAGE> 94
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
with a weighted average exercise price of $0.03 per share were cancelled. The
weighted average fair value per share of options granted during 1996 and 1997
was $0.03 and $0.07, respectively.
The following table summarizes information about Aptex employee stock
options outstanding at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED -------------------------
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING AT REMAINING AVERAGE OUTSTANDING AT AVERAGE
RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICES 1997 LIFE (IN YEARS) PRICE 1997 PRICE
------------------- -------------- --------------- -------- -------------- --------
<S> <C> <C> <C> <C> <C>
$0.03 to $0.03 497 8.75 $ 0.03 79 $ 0.03
0.05 0.05 39 9.40 0.05 -- --
0.10 0.10 151 9.82 0.10 -- --
----- ---
0.03 0.10 687 9.03 0.05 79 0.03
========== ==========
</TABLE>
NOTE 10 -- CONTINGENCIES
Various claims arising in the course of business, seeking monetary damages
and other relief, are pending. The amount of the liability, if any, from such
claims cannot be determined with certainty; however, in the opinion of
management, the ultimate liability for such claims will not have a material
adverse effect on the Company's consolidated financial position, results of
operations or cash flows.
NOTE 11 -- SUBSEQUENT EVENTS
On January 30, 1998, the Company signed a definitive agreement to acquire
Practical Control Systems Technologies, Inc. ("PCS"), a distribution center
management software vendor based in Cincinnati, Ohio, subject to the
satisfaction of certain closing conditions and the approval of PCS'
shareholders. If consummated, the acquisition of PCS will be accounted for under
the purchase method and will not be considered a "significant" acquisition
pursuant to regulations set forth by the Securities and Exchange Commission.
On February 13, 1998, the Company adopted the 1998 Stock Option Plan (the
"1998 Plan"), under which 1,000,000 shares of HNC Common Stock were reserved for
issuance pursuant to nonqualified stock options. The 1998 Plan is administered
by the Board of Directors of HNC or a committee appointed by the Board and
provides that nonqualified stock options granted under the plan must be awarded
at an exercise price of not less than 100% of the fair market value of the stock
at the date of grant. Options granted under the 1998 Plan may have a term of up
to ten years. No options have been granted under the 1998 Plan to date.
F-22
<PAGE> 95
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN OR
INCORPORATED BY REFERENCE IN THIS PROSPECTUS. IF GIVEN OR MADE, SUCH INFORMATION
OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
COMPANY OR BY ANY OF THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN
OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, SUCH SECURITIES BY ANYONE
IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL TO MAKE SUCH
OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATES AS OF WHICH
INFORMATION IS GIVEN IN THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information.................. 2
Incorporation of Certain Documents by
Reference............................ 2
Prospectus Summary..................... 3
Risk Factors........................... 5
Use of Proceeds........................ 17
Price Range of Common Stock............ 17
Dividend Policy........................ 17
Capitalization......................... 18
Selected Consolidated Financial Data... 19
Management's Discussion and Analysis of
Financial Condition and Results of
Operations........................... 21
Business............................... 31
Management............................. 47
Description of Notes................... 49
Description of Capital Stock........... 60
Certain United States Federal Income
Tax Considerations................... 63
Underwriting........................... 69
Legal Matters.......................... 70
Experts................................ 70
Index to Consolidated Financial
Statements........................... F-1
</TABLE>
- ------------------------------------------------------------
LOGO
U.S. $75,000,000
% CONVERTIBLE
SUBORDINATED NOTES DUE 2003
DEUTSCHE MORGAN GRENFELL
BANCAMERICA
ROBERTSON STEPHENS
SALOMON SMITH BARNEY
PROSPECTUS
, 1998
<PAGE> 96
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any jurisdiction in which such offer, solicitation or sale would be unlawful
prior to registration or qualification under the securities laws of any such
jurisdiction.
SUBJECT TO COMPLETION, DATED FEBRUARY 17, 1998
LOGO
- --------------------------------------------------------------------------------
1,500,000 SHARES
COMMON STOCK
- --------------------------------------------------------------------------------
Of the 1,500,000 shares of Common Stock, par value $0.001 per share ("Common
Stock") offered hereby, 1,480,000 are being sold by certain stockholders (the
"Selling Stockholders") of HNC Software Inc. ("HNC" or the "Company") and 20,000
are being issued and sold by the Company. The Company will not receive any of
the proceeds from the sale of shares by the Selling Stockholders. See "Selling
Stockholders." The Common Stock is listed on the Nasdaq National Market under
the symbol "HNCS." The last reported sale price of the Common Stock on the
Nasdaq National Market on February 13, 1998 was $36.00 per share. See "Price
Range of Common Stock."
FOR INFORMATION CONCERNING CERTAIN RISK FACTORS THAT SHOULD BE CONSIDERED BY
PROSPECTIVE INVESTORS, SEE "RISK FACTORS" COMMENCING ON PAGE 4.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PROCEEDS PROCEEDS TO
PRICE TO UNDERWRITING TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) STOCKHOLDERS
<S> <C> <C> <C> <C>
Per Share $ $ $ $
Total(3) $ $ $ $
</TABLE>
(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended. See "Underwriting."
(2) Before deducting expenses estimated at $700,000, payable by the Company.
(3) Certain of the Selling Stockholders have granted to the Underwriters an
option for 30 days to purchase up to an additional 225,000 shares of Common
Stock solely to cover over-allotments, if any. If such option is exercised
in full, the total Price to Public, Underwriting Discount and Proceeds to
Selling Stockholders will be $ , $ and $ ,
respectively. See "Underwriting."
The shares of Common Stock offered hereby are offered by the Underwriters
subject to prior sale, when, as and if delivered to and accepted by them, and
subject to approval of certain legal matters by counsel and certain other
conditions. The Underwriters reserve the right to withdraw, cancel or modify
such offer and to reject orders in whole or in part. Delivery of the shares of
Common Stock offered hereby to the Underwriters is expected to be made in New
York, New York on or about , 1998.
DEUTSCHE MORGAN GRENFELL
BANCAMERICA ROBERTSON STEPHENS
SALOMON SMITH BARNEY
The date of this Prospectus is , 1998.
<PAGE> 97
AVAILABLE INFORMATION
HNC Software Inc. is subject to the information reporting requirements of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and, in
accordance therewith, files reports, proxy statements and other information with
the Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information can be inspected and copied at the public
reference facilities maintained by the Commission at Room 1024, 450 Fifth
Street, N.W., Judiciary Plaza, Washington, D.C. 20549, and at the Commission's
following Regional Offices: 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661 and Seven World Trade Center, 13th Floor, New York, New York
10048. Copies of such material can be obtained at prescribed rates from the
Public Reference Section of the Commission at 450 Fifth Street, N.W., Judiciary
Plaza, Washington, D.C. 20549. The Commission maintains a World Wide Web site
that contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission. The address
of the site is http://www.sec.gov. The Company's Common Stock is quoted on the
Nasdaq National Market and reports, proxy statements and other information
concerning the Company also may be inspected at the offices of Nasdaq
Operations, 1735 K Street, N.W., Washington, D.C. 20006.
The Company has filed with the Commission a Registration Statement on Form
S-3 (the "Registration Statement") under the Securities Act of 1933, as amended
(the "Securities Act"), with respect to the securities offered by this
Prospectus. This Prospectus, which forms a part of the Registration Statement,
does not contain all of the information set forth in the Registration Statement,
certain parts of which have been omitted in accordance with the rules and
regulations of the Commission. For further information with respect to the
Company and the securities offered hereby, reference is made to the Registration
Statement, including the exhibits filed or incorporated by reference in the
Registration Statement. Statements made in this Prospectus about any contract or
other document are not necessarily complete and in each instance in which a copy
of such contract is filed with, or incorporated by reference in, the
Registration Statement as an exhibit, reference is made to such copy, and each
such statement shall be deemed qualified in all respects by such reference.
Copies of the Registration Statement may be inspected, without charge, at the
offices of the Commission, or obtained at prescribed rates from the Public
Reference Section of the Commission at the address set forth above.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents that HNC has previously filed with the Commission
are hereby incorporated herein by reference:
(a) The Company's Annual Report on Form 10-K for the year ended December
31, 1997; and
(b) The description of the Company's Common Stock contained in the
Company's registration statement on Form 8-A filed with the Commission on
May 26, 1995.
All documents filed by the Company pursuant to Sections 13(a), 13(c), 14 or
15(d) of the Exchange Act after the date of this Prospectus and prior to the
termination of the offering covered by this Prospectus shall be deemed to be
incorporated by reference in this Prospectus and to be a part hereof from the
date of filing of such documents. Any statement contained in any document
incorporated by reference herein shall be deemed to be modified or superseded
for purposes of this Prospectus to the extent that a statement contained herein
or in any other subsequently filed document that also is or is deemed to be
incorporated by reference herein, modifies or supersedes such statement. Any
statement so modified or superseded shall not be deemed, except as so modified
or superseded, to constitute a part of this Prospectus.
The Company will provide without charge, upon written or oral request of any
person to whom this Prospectus is delivered, a copy of any or all of the
documents that have been or may be incorporated by reference in this Prospectus
(other than exhibits to such documents that are not specifically incorporated by
reference into such documents). Requests for such copies should be directed to
HNC at 5930 Cornerstone Court West, San Diego, California 92121-3728, Attention:
Raymond V. Thomas (telephone number (619) 546-8877).
------------------------
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING BY ENTERING STABILIZING BIDS, IMPOSING PENALTY BIDS, OR OTHERWISE.
SUCH ACTIVITIES, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. FOR A DISCUSSION
OF THESE ACTIVITIES, SEE "UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS (AND SELLING GROUP
MEMBERS, IF ANY) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON
STOCK ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M.
SEE "UNDERWRITING."
2
<PAGE> 98
PROSPECTUS SUMMARY
The following summary should be read in conjunction with and is qualified in
its entirety by the more detailed information, including "Risk Factors" and the
consolidated financial statements and notes thereto, appearing elsewhere in this
Prospectus or incorporated by reference in this Prospectus.
THE COMPANY
HNC develops, markets and supports predictive software solutions for leading
service industries. These predictive software solutions employ proprietary
neural-network predictive decision engines, profiles, traditional statistical
modeling, business models, expert rules and context vectors to convert existing
data and business experiences into meaningful recommendations and actions. Just
as manufacturing organizations have implemented manufacturing resource planning
software to automate routine transactions, leading service industries such as
the healthcare/insurance, financial services and retail industries are using
predictive software solutions to improve profitability, competitiveness and
customer satisfaction.
The Company's objective is to be the leading supplier of predictive software
solutions by leveraging its core computational intelligence technology across a
series of product lines targeted at specific service industries. In the
healthcare/insurance industry, the Company's products are used to automate
workers' compensation bill review and loss reserving, detect and prevent
workers' compensation fraud and increase workers' compensation payor and
provider effectiveness. In the financial services industry, the Company's
products are used to detect and prevent credit card fraud, manage the
profitability of credit card portfolios and automate lending decisions and
residential property valuations. In the retail industry, the Company's products
address inventory control, merchandise management, demand forecasting and
private label credit card fraud. The Company markets most of its predictive
software solutions as an ongoing service that includes software licenses,
decision model updates, application consulting and on-line or on-site support
and maintenance. The Company's customers include many of the leading companies
in each of its target markets, including Concentra Managed Care Inc., CIGNA
Corp. and CNA Financial Corporation in the healthcare/insurance industry, First
Data Resources, Inc., Household International Inc. and MBNA Corp. in the
financial services industry, and the Computer City division of Tandy Corp.,
Caldor Corp. and Hills Department Stores Inc. in the retail industry.
The Company was founded in 1986 under the laws of California and was
reincorporated in June 1995 under the laws of Delaware. The Company's principal
executive offices are located at 5930 Cornerstone Court West, San Diego,
California 92121-3728, and its telephone number is (619) 546-8877. In this
Prospectus, the terms "HNC" and the "Company" each refer to HNC Software Inc., a
Delaware corporation, and its consolidated subsidiaries unless the context
otherwise requires.
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered................................... 1,500,000 shares (including 20,000 shares by the Company
and 1,480,000 shares by Selling Stockholders)
Common Stock outstanding after this offering........... 24,557,550 shares
NASDAQ National Market Symbol.......................... HNCS
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:(1)
Total revenues................................................ $16,167 $29,838 $43,704 $71,439 $113,735
Operating income.............................................. 1,034 2,881 5,082 9,659 23,040
Net income.................................................... 875 3,142 6,077 11,893 17,565
Basic net income per common share(2).......................... 0.02 0.28 0.38 0.50 0.72
Diluted net income per common share(2)........................ 0.02 0.17 0.28 0.47 0.68
Pro forma net income(3)....................................... 641 2,137 4,534 9,731 15,417
Basic pro forma net income per common share(3)................ 0.64
Diluted pro forma net income per common share(3).............. 0.60
Shares used in computing basic net income per common share and
basic pro forma net income per common share................. 8,591 8,642 15,195 23,552 24,275
Shares used in computing diluted net income per common share
and diluted pro forma net income per common share........... 9,289 18,142 21,510 25,363 25,681
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997(4)
-------------------------
<S> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and investments available for sale........................... $ 42,946
Working capital..................................................................... 74,303
Total assets........................................................................ 119,877
Total stockholders' equity.......................................................... 103,860
</TABLE>
- ---------------
(1) The summary consolidated financial information gives retroactive effect to
the acquisitions of Risk Data Corporation ("Risk Data"), Retek Distribution
Corporation, now known as Retek Information Systems("Retek") and CompReview,
Inc. ("CompReview") for all periods presented, accounted for as poolings of
interests.
(2) The computations of basic net income per common share for 1993, 1994 and
1995 include reductions of consolidated net income in the amounts of
$717,000, $717,000 and $348,000, respectively, related to the accretion of
dividends on mandatorily redeemable convertible Preferred Stock, which
converted into Common Stock upon the closing of the Company's initial public
offering on June 26, 1995. The computation of diluted net income per common
share for 1993 does not include the assumed conversion of all outstanding
shares of mandatorily redeemable convertible Preferred Stock into 7,675,000
shares of Common Stock or an increase to net income per common share related
to the elimination of dividend accretion on such Preferred Stock as the
impact would be antidilutive.
(3) Pro forma net income and net income per common share reflect a provision for
taxes on the income of CompReview, which was a subchapter S corporation
prior to its acquisition by HNC, as if CompReview had been subject to
corporate income taxes as a C corporation for all periods presented.
(4) The net proceeds to the Company from this offering will not result in a
material change in the December 31, 1997 balance sheet data. The
Underwriters are concurrently offering $75.0 million of the Company's %
Convertible Subordinated Notes due 2003 ("Notes"), which if sold will result
in an increase of $72.7 million in each of the balance sheet data items.
3
<PAGE> 99
RISK FACTORS
This Prospectus (including without limitation the following Risk Factors)
contains forward-looking statements (within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act) regarding the Company and
its business, financial condition, results of operations and prospects. Words
such as "expects," "anticipates," "intends," "plans," "believes," "seeks,"
"estimates" and similar expressions or variations of such words are intended to
identify forward-looking statements, but are not the exclusive means of
identifying forward-looking statements in this Prospectus. Additionally,
statements concerning future matters such as the development of new products,
enhancements or technologies, possible changes in legislation and other
statements regarding matters that are not historical are forward-looking
statements.
Although forward-looking statements in this Prospectus reflect the good
faith judgment of the Company's management, such statements can only be based on
facts and factors currently known by the Company. Consequently, forward-looking
statements are inherently subject to risks and uncertainties, and actual results
and outcomes may differ materially from the results and outcomes discussed in
the forward-looking statements. Factors that could cause or contribute to such
differences in results and outcomes include without limitation those discussed
below as well as those discussed elsewhere in this Prospectus and in any
documents that are incorporated into this Prospectus by reference. Readers are
urged not to place undue reliance on these forward-looking statements, which
speak only as of the date of this Prospectus. The Company undertakes no
obligation to revise or update any forward-looking statements in order to
reflect any event or circumstance that may arise after the date of this
Prospectus. Readers are urged to carefully review and consider the various
disclosures made by the Company in this Prospectus and in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997 filed with the
Commission, which attempts to advise interested parties of the risks and factors
that may affect the Company's business, financial condition and results of
operations and prospects.
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS. The Company's revenues and
operating results have varied significantly in the past and may do so in the
future. Because the Company's expense levels are based in part on its
expectations regarding future revenues and in the short term are fixed to a
large extent, the Company may be unable to adjust its spending in time to
compensate for any unexpected revenue shortfall. Factors affecting operating
results include market acceptance of the Company's products; the relatively
large size and small number of customer orders that may be received during a
given period; customer cancellation of long-term contracts yielding recurring
revenues or customers' ceasing their use of Company products for which the
Company's fees are usage based; the length of the Company's sales cycle; the
Company's ability to develop, introduce and market new products and product
enhancements; the timing of new product announcements and introductions by the
Company and its competitors; changes in the mix of distribution channels;
changes in the level of operating expenses; the Company's ability to achieve
progress on percentage-of-completion contracts; the Company's success in
completing certain pilot installations for contracted fees; competitive
conditions in the industry; domestic and international economic conditions; and
market conditions in the Company's targeted markets. Furthermore, the Company's
operating results may be affected by factors unique to certain of its product
lines. For example, the Company derives a substantial and increasing portion of
its revenues from its retail products, which are generally priced as "perpetual"
license transactions in which the Company receives a one-time license fee. The
Company recognizes these fees as revenue upon delivery of the software and
acceptance by the customer. Thus, failure to complete a perpetual license
transaction during a fiscal quarter would have a disproportionate adverse impact
on the Company's operating results for that quarter.
The Company expects fluctuations in its operating results to continue for
the foreseeable future. Accordingly, the Company believes that period-to-period
comparisons of its financial results should not be relied upon as an indication
of future performance. The Company may not be able to maintain profitability on
a quarterly or annual basis in the future. Due to all of the foregoing factors,
it is possible that in some future quarter the Company's operating results will
be below the
4
<PAGE> 100
expectations of public market analysts and investors. In that event, the price
of the Company's Common Stock would likely be materially adversely affected. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
LENGTHY AND UNPREDICTABLE SALES CYCLE. Due in part to the mission-critical
nature of certain of the Company's applications, potential customers perceive
high risk in connection with adoption of the Company's products. As a result,
customers have been cautious in making decisions to acquire the Company's
products. In addition, because the purchase of the Company's products typically
involves a significant commitment of capital and may involve shifts by the
customer to a new software and/or hardware platform, delays in completing sales
can arise while customers complete their internal procedures to approve large
capital expenditures and test and accept new technologies that affect key
operations. For these and other reasons, the sales cycle associated with the
purchase of the Company's products is typically lengthy, unpredictable and
subject to a number of significant risks over which the Company has little or no
control, including customers' budgetary constraints and internal acceptance
reviews. The sales cycle associated with the licensing of the Company's products
can typically range from 60 days to 18 months. As a result of the length of the
sales cycle and the typical size of customers' orders, the Company's ability to
forecast the timing and amount of specific sales is limited. A lost or delayed
sale could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and "Business -- Sales and
Marketing."
ACQUISITIONS. Between August 1996 and November 1997, the Company acquired
three businesses. In August 1996, the Company acquired Risk Data, a company that
develops, markets and supports proprietary software decision products for use in
the insurance industry. In November 1996, the Company acquired Retek, a company
that develops, markets and supports management decision software products for
retailers and their vendors. In November 1997, the Company acquired CompReview,
a company that develops, markets and supports a software product and related
services designed to assist in the management and containment of the medical
costs of workers' compensation and automobile accident medical claims. The
Company believes that its future growth depends, in part, upon the success of
these and possible future acquisitions. There can be no assurance that the
Company will successfully identify, acquire on favorable terms or integrate such
businesses, products, services or technologies. The Company may in the future
face increased competition for acquisition opportunities, which may inhibit the
Company's ability to consummate suitable acquisitions and increase the costs of
completing such acquisitions. The acquisitions of Risk Data, Retek and
CompReview, as well as other potential future acquisitions, will require the
Company to successfully manage and integrate such acquired businesses, which may
be located in diverse geographic locations. Acquiring other businesses also
requires the Company to successfully develop and market products to new
industries and markets with which the Company may not be familiar. It also
requires the Company to coordinate (and possibly change) the diverse operating
structures, policies and practices of the acquired companies and to integrate
the employees of the acquired companies into the Company's organization and
culture. Failure of the Company to successfully integrate and manage acquired
businesses, to retain their employees, and to successfully address new
industries and markets associated with such acquired businesses, would have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, although the acquisitions of Risk Data,
Retek and CompReview have been accounted for as poolings of interests, future
acquisitions may be accounted for as purchases, resulting in potential charges
that may adversely affect the Company's earnings. Additional acquisitions may
also involve the issuance of shares of the Company's stock to owners of acquired
businesses, resulting in dilution in the percentage of the Company's stock owned
by other stockholders. See "Business -- HNC's Strategy."
RISKS ASSOCIATED WITH MANAGING GROWTH. In recent years, the Company has
experienced changes in its operations that have placed significant demands on
the Company's administrative,
5
<PAGE> 101
operational and financial resources. The growth in the Company's customer base
and expansion of its product functionality, together with its acquisition of
other businesses and their employees, have challenged and are expected to
continue to challenge the Company's management and operations, including its
sales, marketing, customer support, research and development and finance and
administrative operations. The Company's future performance will depend in part
on its ability to successfully manage change, both in its domestic and
international operations, and to adapt its operational and financial control
systems, if necessary, to respond to changes in its business and to facilitate
the integration of acquired businesses with the Company's operations. The
failure of the Company's management to effectively respond to and manage growth
could have a material adverse effect on the Company's business, financial
condition and results of operations.
DEPENDENCE ON EMERGING TECHNOLOGIES AND MARKETS. The market for predictive
software solutions is still emerging. The rate at which businesses have adopted
the Company's products has varied significantly by market and by product within
each market, and the Company expects to continue to experience such variations
with respect to its target markets and products in the future. The Company has
introduced products for the healthcare/insurance, financial services and retail
markets. The Company has recently announced several new products, including
PMAdvisor, VeriComp, SelectCast, SelectResponse and SelectResource. To date,
none of these products has achieved any significant degree of market acceptance,
and there can be no assurance that such products will ever be widely accepted.
Although businesses in the Company's target markets have recognized the
advantages of using predictive software solutions to automate the
decision-making process, many have developed decision automation systems
internally rather than licensing them from outside vendors. There can be no
assurance that the markets for the Company's products will continue to develop
or that the Company's products will be widely accepted, if at all. If the
markets for the Company's new or existing products fail to develop, or develop
more slowly than anticipated, the Company's sales would be negatively impacted,
which would have a material adverse effect on the Company's business, financial
condition and results of operations. See "Business -- Emerging Market
Opportunities."
RISKS ASSOCIATED WITH TECHNOLOGICAL CHANGE AND DELAYS IN DEVELOPING NEW
PRODUCTS. The market for the Company's predictive software solutions for service
industries is characterized by rapidly changing technology and improvements in
computer hardware, network operating systems, programming tools, programming
languages, operating systems and database technology. The Company's success will
depend upon its ability to continue to develop and maintain competitive
technologies, enhance its current products and develop, in a timely and
cost-effective manner, new products that meet changing market conditions,
including evolving customer needs, new competitive product offerings, emerging
industry standards and changing technology. For example, the rapid growth of the
Internet environment creates new opportunities, risks and uncertainties for
businesses, such as the Company, which develop software solutions that now may
have to be designed to operate in Internet, intranet and other on-line
environments. The Company may not be able to develop and market, on a timely
basis, or at all, product enhancements or new products that respond to changing
technologies. The Company has previously experienced significant delays in the
development and introduction of new products and product enhancements, primarily
due to difficulties with model development, which has in the past required
multiple iterations, as well as difficulties with acquiring data and adapting to
particular operating environments. The length of these delays has varied
depending upon the size and scope of the project and the nature of the problems
encountered. Any significant delay in the completion of new products, or the
failure of such products, if and when installed, to achieve any significant
degree of market acceptance, would have a material adverse effect on the
Company's business, financial condition and results of operations. Any failure
by the Company to anticipate or to respond adequately to changing technologies,
or any significant delays in product development or introduction, could cause
customers to delay or decide against purchases of the Company's products and
6
<PAGE> 102
would have a material adverse effect on the Company's business, financial
condition and results of operations. See "Business -- Technology" and
"-- Research and Development."
PRODUCT CONCENTRATION. The Company currently has one product or product
line in each of its three target markets that accounts for a majority of the
Company's total revenues from that market. These products in the aggregate
accounted for 60.0%, 59.1% and 57.9% of the Company's total revenues in 1995,
1996 and 1997, respectively. In the healthcare/insurance market, the Company's
revenues from its CRLink product accounted for 29.8%, 24.6% and 23.0% of the
Company's total revenues in 1995, 1996 and 1997, respectively, and are expected
to account for a substantial portion of the Company's total revenues for the
foreseeable future. Continued market acceptance of CRLink will be affected by
future product enhancements and competition. Decline in demand for, or use of,
CRLink, whether as a result of competition, simplification of state workers'
compensation fee schedules, changes in the overall payment system or regulatory
structure for workers' compensation claims, technological change, an inability
to obtain or use state fee schedule or claims data, saturation of market demand,
industry consolidation or otherwise, could result in decreased revenues from
CRLink, which could have a material adverse effect on the Company's business,
financial condition and results of operations. Further, revenues from the Retek
Merchandising System ("RMS"), a retail management product, accounted for 2.2%,
13.6% and 18.9% of the Company's total revenues in 1995, 1996 and 1997,
respectively, and are expected to continue to account for a substantial portion
of the Company's revenues in the foreseeable future. Continued market acceptance
of RMS will be affected by the quality and timely introduction of future product
enhancements and competition. Decline in demand for, or use of, RMS as a result
of continued entry into the retail inventory management market by vendors that
may have significantly greater resources and a broader customer base than the
Company could result in decreased revenues from RMS, which could have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, decline in demand for RMS, as a result of technological
change, saturation of market demand, industry consolidation or otherwise would
have a material adverse effect on the Company's business, financial condition
and results of operations. Revenues from the Company's Falcon product line for
credit card fraud detection for financial institutions accounted for 28.0%,
20.9% and 16.0% of the Company's total revenues in 1995, 1996 and 1997,
respectively, and are expected to continue to account for a substantial portion
of the Company's total revenues in the foreseeable future. Continued market
acceptance of the Falcon product line will be affected by the quality and timely
introduction of future product enhancements and competition. In addition, it is
possible that patterns of credit card fraud may change in a manner that the
Falcon product line would not detect and that other methods of credit card fraud
prevention may reduce customers' needs for the Falcon product line. As a result
of increasing saturation of market demand for the Falcon product line, the
Company may also need to rely increasingly on international sales to maintain or
increase Falcon revenue levels. Furthermore, Falcon customers are banks and
related financial institutions. Accordingly, the Company's future success
depends upon the capital expenditure budgets of such customers and the continued
demand by such customers for Falcon products. The financial services industry
tends to be cyclical in nature, which may result in variations in demand for the
Company's products. In addition, there has been and continues to be
consolidation in the financial services industry, which in some cases has
lengthened the sales cycle and may lead to reduced demand for the Company's
products. Decline in demand for, or use of, Falcon, whether as a result of
competition, technological change, change in fraud patterns, the cyclical nature
of the financial services industry, saturation of market demand, fluctuations in
interest rates, industry consolidation, reduction in capital spending or
otherwise, could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business -- Markets and
Products."
DEPENDENCE ON DATA. The development, installation and support of the
Company's credit card fraud control and profitability management, loan
underwriting, home valuation and certain healthcare/insurance products require
periodic model updates. The Company must develop or
7
<PAGE> 103
obtain a reliable source of sufficient amounts of current and statistically
relevant data to analyze transactions and update its models. For example, in the
electronic payments market, the data required by the Company are collected
privately and maintained in proprietary databases. As a result, the Company and
its Falcon and ProfitMax customers enter into agreements pursuant to and build
new fraud detection and profitability models. For its AREAS home valuation
product, the Company obtains data from commercial databases on available terms
and conditions. Many of the Company's healthcare/insurance products use
historical workers' compensation claims data obtained from customers. CRLink
also uses data from state workers' compensation fee schedules adopted by state
regulatory agencies, and certain third parties have asserted copyright interests
in such data. In most cases, such data must be periodically updated and
refreshed to enable the Company's predictive software products to continue to
work effectively. In addition, the development of new and enhanced products also
depends to a significant extent on the availability of sufficient amounts of
statistically relevant data to enable the Company to develop models. For
example, to expand the geographic coverage of its AREAS product, the Company
would be required to develop or obtain data on home sales in each county for
which AREAS is marketed. There can be no assurance that the Company will be able
to continue to obtain adequate amounts of statistically relevant data on a
timely basis, in the required formats or on reasonable terms and conditions,
whether from customers or commercial suppliers. Any such failure by the Company
to obtain required data when it is needed, for a reasonable price and on
reasonable terms, could have a significant negative impact on existing product
performance, new product development and product pricing which could in turn
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Business -- Customer Service and Support."
COMPETITION. The market for predictive software solutions for service
industries is intensely competitive and subject to rapid change. Competitors,
many of which have substantially greater financial resources than the Company,
vary in size and in the scope of the products and services they offer. The
Company encounters competition from a number of sources, including (i) other
application software companies, (ii) management information systems departments
of customers and potential customers, including banks, insurance companies and
retailers, (iii) third-party professional services organizations, including
without limitation, consulting divisions of public accounting firms, (iv)
hardware suppliers that bundle or develop complementary software, (v) network
and service providers that seek to enhance their value-added services, (vi)
neural-network tool suppliers and (vii) managed care organizations. In the
healthcare/insurance market, the Company has experienced competition primarily
from National Council on Compensation Insurance ("NCCI"), Corporate Systems and
CSC Incorporated. In the workers' compensation and medical cost administration
market, the Company has experienced competition from MediCode, Inc.
("MediCode"), Medata, Inc. and Embassy Software with regard to software
licensing, and Intracorp and Corvel Corporation in the service bureau operations
market. Additionally, the Company has faced competition from Automatic Data
Processing, Inc. ("ADP") in the automobile accident medical claims market. In
the financial services market, the Company has experienced competition from
Fair, Isaac & Co., Inc., Cogensys (a subsidiary of Policy Management Systems
Corporation), Federal National Mortgage Association ("Fannie Mae"), Federal Home
Loan Mortgage Corporation ("Freddie Mac"), International Business Machines
Corporation ("IBM"), Nestor, Inc., NeuralTech Inc., Neuralware Inc., PMI
Mortgage Services Co., VISA International and others. In the retail market, the
Company has experienced competition from JDA Software Group, Inc., SAP AG,
PeopleSoft, Inc., IBM, Manugistics Group, Inc. and others. The Company expects
to experience additional competition from other established and emerging
companies, as well as other technologies. For example, the Company's Falcon
product competes against other methods of preventing credit card fraud, such as
card activation programs, credit cards that contain the cardholder's photograph,
smart cards and other card authorization techniques. Increased competition,
whether from other products or new technologies, could result in price
reductions, fewer customer orders, reduced gross margins and loss of market
share, any of
8
<PAGE> 104
which could materially adversely affect the Company's business, financial
condition and results of operations.
The Company believes that most of its products are currently priced at a
premium when compared to its competitors' products. The market for the Company's
products is highly competitive, and the Company expects that it will face
increasing pricing pressures from its current competitors and new market
entrants. In particular, increased competition could reduce or eliminate such
premiums and cause further price reductions. In addition, such competition could
adversely affect the Company's ability to obtain new long-term contracts and
renewals of existing long-term contracts on terms favorable to the Company. Any
reduction in the price of the Company's products could materially adversely
affect the Company's business, financial condition and results of operations.
Some of the Company's current, and many of the Company's potential,
competitors have significantly greater financial, technical, marketing and other
resources than the Company. As a result, they may be able to respond more
quickly to new or emerging technologies and changes in customer requirements or
to devote greater resources to the development, promotion and sale of their
products than the Company. In addition, current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties to increase the ability of their products to address the needs of
the Company's prospective customers. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly gain
significant market share. Also, the Company relies upon its customers to provide
data, expertise and other support for the ongoing updating of the Company's
models. The Company's customers, most of which have significantly greater
financial and marketing resources than the Company, may compete with the Company
in the future or otherwise discontinue their relationships with or support of
the Company. There can be no assurance that the Company will be able to compete
successfully against current and future competitors or that competitive
pressures faced by the Company will not materially adversely affect its
business, financial condition and results of operations. See
"Business -- Competition."
RISKS ASSOCIATED WITH RECRUITING AND RETAINING QUALIFIED PERSONNEL. The
Company's success depends to a significant degree upon the continued service of
members of the Company's senior management and other key research, development,
sales and marketing personnel. Accordingly, the loss of any such personnel could
have a material adverse effect on the Company's business, financial condition
and results of operations. Only a small number of employees have employment
agreements with the Company, and there can be no assurance that such agreements
will result in the retention of these employees for any significant period of
time. In addition, the untimely loss of a member of the management team or a key
employee of a business acquired by the Company could have a material adverse
effect on the Company's business, financial condition and results of operations,
particularly if such loss occurred before the Company has had adequate time to
familiarize itself with the operating details of that business. In the past, the
Company has experienced difficulty in recruiting a sufficient number of
qualified sales and technical employees. In addition, competitors may attempt to
recruit the Company's key employees. There can be no assurance that the Company
will be successful in attracting, assimilating and retaining such personnel. The
failure to attract, assimilate and retain key personnel could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Business -- Employees" and "Management."
CUSTOMER CONCENTRATION. Product licenses to First Data Resources, Inc.
("First Data"), the largest provider of credit card charge receipt processing
services to banks, accounted for 8.7%, 8.6% and 7.6% of the Company's total
revenues in 1995, 1996 and 1997, respectively. The Company has licensed First
Data to provide its customers with access to the Company's ProfitMax product
pursuant to a license agreement entered into in January 1996 (the "ProfitMax
Contract"). The Company's revenues under the ProfitMax Contract represented
approximately one-quarter of the Company's revenues from First Data in 1997. In
late January 1998, First Data
9
<PAGE> 105
asserted that certain restrictive covenants under the ProfitMax Contract
violated certain intellectual property laws. First Data also asserted that the
existence of such restrictions made the ProfitMax Contract at least temporarily
unenforceable and that First Data is therefore not obligated to pay the Company
license fees due under the ProfitMax Contract. The Company disputed First Data's
claim, released and waived the above-mentioned restrictive covenants in the
ProfitMax Contract and gave First Data written notice that the Company intended
to terminate the ProfitMax Contract pursuant to its terms unless First Data
cured its failure to pay the delinquent license fees in a timely manner.
Currently, First Data and the Company are working to resolve their dispute
regarding the ProfitMax Contract by negotiating a new agreement; however, there
can be no assurance that such an agreement will be reached or that the terms of
such an agreement would be as favorable to HNC as its existing contractual
arrangements with First Data. If no such agreement can be reached and First Data
maintains its current position, it is possible that litigation or arbitration
could ensue, which would likely result in a loss of anticipated revenue to the
Company under the ProfitMax Agreement and possibly other agreements between the
Company and First Data, which could have a material adverse affect on the
Company's business, financial condition and results of operation. See
"Business -- Sales and Marketing."
RISKS ASSOCIATED WITH INTERNATIONAL SALES. In 1995, 1996 and 1997,
international operations and export sales (including sales in Canada)
represented 12.6%, 17.7% and 16.8% of the Company's total revenues,
respectively. The Company intends to continue to expand its operations outside
the United States and to enter additional international markets, including by
adding sales and support offices in Europe and Japan, which will require
significant management attention and financial resources. For certain more
mature products, such as Falcon, the Company may need to increase international
sales in order to continue to expand the product's customer base. The Company
has committed and continues to commit significant time and development resources
to customizing certain of its products for selected international markets and to
developing international sales and support channels. There can be no assurance
that the Company's efforts to develop products, databases and models for
targeted international markets or to develop additional international sales and
support channels will be successful. The failure of such efforts, which can
entail considerable expense, could have a material adverse effect on the
Company's business, financial condition and results of operations.
International sales are subject to additional inherent risks, including
longer payment cycles, unexpected changes in regulatory requirements, import and
export restrictions and tariffs, difficulties in staffing and managing foreign
operations, the burdens of complying with a variety of foreign laws, greater
difficulty or delay in accounts receivable collection, potentially adverse tax
consequences and political and economic instability. The Company's international
sales are currently denominated predominantly in United States dollars and a
small portion are denominated in British pounds sterling. An increase in the
value of the United States dollar relative to foreign currencies could make the
Company's products more expensive, and therefore potentially less competitive,
in foreign markets. In the future, to the extent the Company's international
sales are denominated in local currencies, foreign currency translations may
contribute to significant fluctuations in the Company's business, financial
condition and results of operations. If for any reason exchange or price
controls or other restrictions on foreign currencies are imposed, the Company's
business, financial condition and results of operations could be materially
adversely affected. See "Business -- Sales and Marketing."
RISKS ASSOCIATED WITH CHANGING REGULATORY ENVIRONMENT. The Company's
customers are subject to a number of government regulations and certain other
industry standards with which the Company's products must comply. For example,
the Company's financial services products are affected by Regulation B
promulgated under the Equal Credit Opportunity Act, by regulations governing the
extension of credit to consumers and by Regulation E promulgated under the
Electronic Fund Transfers Act governing the transfer of funds from and to
consumer deposit accounts, as well as VISA and MasterCard electronic payment
standards. In the mortgage services
10
<PAGE> 106
market, the Company's products are affected by regulations such as Fannie Mae
and Freddie Mac regulations for conforming loans, Uniform Standards of
Professional Appraisal Practice and appraisal standards for federally insured
institutions under the Financial Institutions Reform, Recovery and Enforcement
Act. In addition, recent regulatory initiatives have restricted the availability
of bank and credit bureau data, reflecting a consumer privacy trend that could
limit the Company's ability to obtain or use certain credit-related information.
It is also possible that insurance-related regulations may in the future apply
to the Company's healthcare/insurance products. In many states, including
California, there have been periodic legislative efforts to reform workers'
compensation laws in order to reduce the cost of workers' compensation insurance
and to curb abuses of the workers' compensation system, and such changes, if
adopted, might adversely affect the Company's healthcare/insurance business. In
addition, if state-mandated workers' compensation laws or regulations or state
workers' compensation fee schedules are simplified, such changes would diminish
the need for, and the benefit provided by, the CRLink product. Changes in
workers' compensation laws or regulations could also adversely affect the
Company's healthcare/insurance products by making them obsolete, or by requiring
extensive changes in these products to reflect new workers' compensation rules.
To the extent that the Company sells new products targeted to markets that
include regulated industries and businesses, the Company's products will need to
comply with these additional regulations. Any failure of the Company's products
to comply with existing or new regulations and standards could result in legal
action against the Company or its customers by regulatory authorities or by
third parties, including actions seeking civil or criminal penalties,
injunctions against the Company's use of data or civil damages, any of which
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company may also be liable to its
customers for failure of its products to comply with such regulatory
requirements. Furthermore, changes to these regulations and standards or the
adoption of new regulations or standards that affect the Company's products
could affect the performance of such products and have a material adverse effect
on the Company's business, financial condition and results of operations.
PROTECTION OF INTELLECTUAL PROPERTY. The Company relies on a combination of
patent, copyright, trademark and trade secret laws and confidentiality
procedures to protect its proprietary rights. The Company currently owns seven
issued United States patents and has four United States patent applications
pending. The Company has applied for additional patents for its Falcon
technology in Canada, Europe and Japan and its MIRA product in Australia, Canada
and Europe. There can be no assurance that patents will be issued with respect
to pending or future patent applications or that the Company's patents will be
upheld as valid or will prevent the development of competitive products. The
Company seeks to protect its software, documentation and other written materials
under trade secret and copyright laws, which afford only limited protection. As
part of its confidentiality procedures, the Company generally enters into
invention assignment and proprietary information agreements with its employees
and independent contractors and nondisclosure agreements with its distributors,
corporate partners and licensees, and limits access to and distribution of its
software, documentation and other proprietary information. Despite these
precautions, it may be possible for a third party to copy or otherwise to obtain
and use the Company's products or technology without authorization, or to
develop similar technology independently. In addition, to ensure that customers
will not be adversely affected by an interruption in the Company's business, the
Company places source code for certain of its products into escrow, which may
increase the likelihood of misappropriation or other misuse of the Company's
intellectual property. Moreover, effective protection of intellectual property
rights may be unavailable or limited in certain foreign countries in which the
Company has done and may do business. Also, the Company has developed
technologies under research projects conducted under agreements with various
United States Government agencies or subcontractors to such agencies. Although
the Company has acquired certain commercial rights to such technologies, the
United States Government typically retains ownership of certain intellectual
property rights and licenses in the technologies developed by the Company under
such contracts, and in some cases
11
<PAGE> 107
can terminate the Company's rights in such technologies if the Company fails to
commercialize them on a timely basis. In addition, under certain United States
Government contracts, the results of the Company's research may be made public
by the government, which could limit the Company's competitive advantage with
respect to future products based on such research. See "Business -- Intellectual
Property and Other Proprietary Rights."
INFRINGEMENT OF PROPRIETARY RIGHTS. In the past, the Company has received
communications from third parties asserting that Company trademarks infringed
such other parties' trademarks, none of which have resulted in litigation or
losses to the Company. Given the Company's ongoing efforts to develop and market
new technologies and products, the Company may receive communications from third
parties asserting that the Company's products infringe, or may infringe, their
intellectual property rights. If as a result of any such claims the Company were
precluded from using certain technologies or intellectual property rights,
licenses to such disputed third-party technology or intellectual property rights
might not be available on reasonable commercial terms, if at all. Furthermore,
the Company may initiate claims or litigation against third parties for
infringement of the Company's proprietary rights or to establish the validity of
the Company's proprietary rights. Litigation, either as plaintiff or defendant,
could result in significant expense to the Company and divert the efforts of the
Company's technical and management personnel from productive tasks, whether or
not such litigation is resolved in favor of the Company. In the event of an
adverse ruling in any such litigation, the Company might be required to pay
substantial damages, discontinue the use and sale of infringing products, expend
significant resources to develop non-infringing technology or obtain licenses to
infringing technology, and the court might invalidate the Company's patents,
trademarks or other proprietary rights. In the event of a successful claim
against the Company and the failure of the Company to develop or license a
substitute technology, the Company's business, financial condition and results
of operations would be materially and adversely affected. As the number of
software products increases and the functionality of these products further
overlaps, the Company believes that software developers may become increasingly
subject to infringement claims. Any such claims, with or without merit, can be
time consuming and expensive to defend and could materially and adversely affect
the Company's business, financial condition and results of operations. See
"Business -- Intellectual Property and Other Proprietary Rights."
RISK OF PRODUCT DEFECTS AND PRODUCT LIABILITY. Software products as complex
as those offered by the Company often contain undetected errors or failures when
first introduced or as new versions are released. In addition, to the extent
that the Company may have to develop new products that operate in new
environments, such as the Internet, the possibility for program errors and
failures may increase due to factors such as the use of new technologies or the
need for more rapid product development that is characteristic of the Internet
market. Despite pre-release testing by the Company and by current and potential
customers, there still may be errors in new products, even after commencement of
commercial shipments. The occurrence of such errors could result in delay in, or
failure to achieve, market acceptance of the Company's products, which could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Although the Company's license agreements with its customers typically
contain provisions designed to limit the Company's exposure to potential product
liability claims, it is possible that such limitation of liability provisions
may not be effective as a result of existing or future laws or unfavorable
judicial decisions. Because the Company's products are used in business-critical
applications, any errors or failures in such products may give rise to
substantial product liability claims, which could have a material adverse effect
on the Company's business, financial condition and results of operations.
VOLATILITY OF COMMON STOCK PRICE. The Company's Common Stock has
experienced significant price volatility and such volatility may recur in the
future. Factors such as announcements of the introduction of new products by the
Company or its competitors, acquisitions of businesses or products by the
Company, quarter-to-quarter variations in the Company's operating results and
12
<PAGE> 108
the gain or loss of significant orders, as well as market conditions in the
technology and emerging growth company sectors, may have a significant impact on
the market price of the Company's Common Stock. Further, the stock market has
experienced extreme volatility that has particularly affected the market prices
of securities of many technology companies and that often has been unrelated or
disproportionate to the operating performance of such companies. These market
fluctuations may adversely affect the price of the Common Stock. The trading
prices of many technology companies' stocks, including the Company's Common
Stock, reflect price/earnings ratios substantially above historical norms. The
trading price of the Company's Common Stock may not remain at or near its
current level. See "Price Range of Common Stock."
YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. These date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, in less
than two years, computer systems and/or software used by many companies may need
to be upgraded to comply with such "Year 2000" requirements. Significant
uncertainty exists in the software industry concerning the potential effects
associated with such compliance. The Company anticipates that it will need to
devote resources in the next two years to modify its CRLink product to properly
process dates beyond December 31, 1999. The Company expects that the cost of
making these modifications and distributing the modified product to existing
customers will be approximately $500,000. These modifications and the resources
that the Company expects to devote to such modifications may divert management
and engineering attention from, or delay the development and introduction of,
new products and enhancements to existing products. The inability of the Company
to complete such modifications successfully and on a timely basis, or the
inability of the Company to devote sufficient resources to continuing updates
and enhancements to the CRLink product, could have a material adverse effect on
the Company's business, financial condition and results of operations. In
addition, the Company believes that the purchasing patterns of customers and
potential customers may be affected by Year 2000 issues as companies expend
significant resources to correct or patch their current software systems for
Year 2000 compliance. These expenditures may result in reduced funds available
to purchase software products such as those offered by the Company, which could
result in a material adverse effect on the Company's business, financial
condition and results of operations.
FACTORS INHIBITING TAKEOVER. The Board of Directors is authorized to issue
up to 4,000,000 shares of Preferred Stock and to determine the price, rights,
preferences, privileges and restrictions, including voting rights, of those
shares without any further vote or action by the stockholders. The rights of the
holders of Common Stock will be subject to, and may be adversely affected by,
the rights of the holders of any Preferred Stock that may be issued in the
future. The issuance of Preferred Stock, while providing desirable flexibility
in connection with possible acquisitions and other corporate purposes, could
have the effect of making it more difficult for a third party to acquire a
majority of the outstanding voting stock of the Company. The Company has no
current plans to issue shares of Preferred Stock. In addition, Section 203 of
the Delaware General Corporation Law restricts certain business combinations
with any "interested stockholder" as defined by such statute. The statute may
have the effect of delaying, deferring or preventing a change in control of the
Company.
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USE OF PROCEEDS
The net proceeds to the Company from the sale of the 20,000 shares of
Common Stock offered by the Company hereby will not be material. The Company
will not receive any proceeds from the sale of Common Stock by the Selling
Stockholders.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock has been traded on the Nasdaq National Market
since June 1995 under the symbol "HNCS." The following table sets forth for the
periods indicated the high and low sales prices of the Common Stock. Prior to
June 1995, there was no established public trading market for the Common Stock.
All prices have been adjusted to give effect to a two-for-one stock split
effected in the form of a stock dividend paid in April 1996.
<TABLE>
<CAPTION>
HIGH LOW
------ ----
<S> <C> <C>
1996:
First Quarter..................................... $ 38 3/4 $18 1/4
Second Quarter.................................... 51 31 1/4
Third Quarter..................................... 47 1/2 20 3/4
Fourth Quarter.................................... 45 1/4 26 1/4
1997:
First Quarter..................................... $ 36 3/4 $23 1/4
Second Quarter.................................... 42 3/8 18 1/4
Third Quarter..................................... 43 5/8 33 3/4
Fourth Quarter.................................... 43 1/2 30
1998:
First Quarter (through February 13, 1998)......... $ 43 $33
</TABLE>
On February 13, 1998, the last reported sale price of the Common Stock on
the Nasdaq National Market was $36.00 per share. As of February 13, 1998, there
were approximately 186 holders of record of the Common Stock.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its capital
stock. The Company currently anticipates that it will retain all future earnings
for use in its business and does not anticipate paying any cash dividends in the
foreseeable future. The Company's bank credit agreement prohibits the Company
from declaring or paying any cash dividends without the bank's consent.
14
<PAGE> 110
CAPITALIZATION
The following table sets forth the capitalization of HNC at December 31,
1997. The net proceeds to the Company from this offering will not result in a
material change to the Company's capitalization as of December 31, 1997.
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------
(IN THOUSANDS)
<S> <C>
Stockholders' equity:
Preferred stock, $0.001 par value -- 4,000,000 shares authorized: no
shares issued or outstanding........................................ $ --
Common stock, $0.001 par value -- 50,000,000 shares authorized:
24,537,550 shares issued and outstanding(1)......................... 25
Paid-in capital........................................................ 95,919
Unrealized loss on investments available for sale...................... (2)
Foreign currency translation adjustment................................ (111)
Retained earnings...................................................... 8,029
--------
Total stockholders' equity.......................................... 103,860
--------
Total capitalization........................................... $ 103,860
========
</TABLE>
- ---------------
(1) Excludes the shares reserved for issuance upon conversion of the
Notes, 4,591,133 shares of Common Stock subject to stock options outstanding
at December 31, 1997 at a weighted average exercise price of $23.92 per
share and an additional 393,075 shares of Common Stock reserved for issuance
under the Company's stock option and stock purchase plans at such date. In
February 1998, the Company adopted a nonqualified stock option plan and
reserved 1,000,000 shares of Common Stock for issuance thereunder.
The Underwriters are concurrently offering $75.0 million of convertible
subordinated notes, which if sold will result in an increase of $72.7 million in
the total capitalization of the Company.
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<PAGE> 111
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data as of December 31, 1996 and 1997
and for each of the years in the three-year period ended December 31, 1997 have
been derived from HNC's Consolidated Financial Statements included elsewhere in
this Prospectus, which have been audited by Price Waterhouse LLP, independent
accountants, as indicated in their report thereon appearing elsewhere herein.
The selected consolidated financial data as of December 31, 1994 and 1995 and
for the year ended December 31, 1994 have been derived from separate audited
financial statements for HNC and CompReview not included herein. The selected
consolidated financial data as of and for the year ended December 31, 1993 have
been derived from separate financial data for HNC and CompReview not included
herein. The data set forth below are qualified in their entirety by reference
to, and should be read in conjunction with, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Consolidated
Financial Statements and related notes thereto included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
------- ------- -------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C> <C>
STATEMENT OF INCOME DATA(1):
Revenues:
License and maintenance..................................................... $24,561 $48,890 $89,643
Installation and implementation............................................. 4,648 6,691 10,702
Contracts and other......................................................... 9,146 11,128 7,772
Service bureau.............................................................. 5,349 4,730 5,618
-------- ------- -------
Total revenues....................................................... 43,704 71,439 113,735
-------- ------- -------
Operating expenses:
License and maintenance..................................................... 7,903 13,725 19,937
Installation and implementation............................................. 1,425 2,714 5,174
Contracts and other......................................................... 6,894 7,694 5,438
Service bureau.............................................................. 3,025 3,365 4,320
Research and development.................................................... 6,998 13,808 21,151
Sales and marketing......................................................... 7,276 11,923 22,049
General and administrative.................................................. 5,101 8,551 12,626
-------- ------- -------
Total operating expenses............................................. 38,622 61,780 90,695
-------- ------- -------
Operating income.............................................................. 5,082 9,659 23,040
Interest and other income..................................................... 912 2,178 2,003
Interest expense.............................................................. (428) (478) (81)
Minority interest in income of consolidated subsidiary........................ -- -- (43)
-------- ------- -------
Income before income tax (benefit) provision......................... 5,566 11,359 24,919
Income tax (benefit) provision................................................ (511) (534) 7,354
-------- ------- -------
Net income........................................................... $ 6,077 $11,893 $17,565
======== ======= =======
Earnings per share:
Basic net income per common share(2)........................................ $ 0.38 $ 0.50 $ 0.72
======== ======= =======
Diluted net income per common share(2)...................................... $ 0.28 $ 0.47 $ 0.68
======== ======= =======
Unaudited pro forma data(3):
Income before income tax provision.......................................... $ 5,566 $11,359 $24,919
Income tax provision........................................................ 1,032 1,628 9,502
-------- ------- -------
Net income........................................................... $ 4,534 $ 9,731 $15,417
======== ======= =======
Basic pro forma net income per common share(3).............................. $ 0.64
=======
Diluted pro forma net income per common share(3)............................ $ 0.60
=======
Shares used in computing basic net income per common share and unaudited basic
pro forma net income per common share....................................... 15,195 23,552 24,275
======== ======= =======
Shares used in computing diluted net income per common share and unaudited
diluted pro forma net income per common share............................... 21,510 25,363 25,681
======== ======= =======
</TABLE>
16
<PAGE> 112
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT RATIO AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
ADDITIONAL STATEMENT OF INCOME DATA:(1)
Total revenues............................... $16,167 $29,838 $43,704 $71,439 $113,735
Operating income............................. 1,034 2,881 5,082 9,659 23,040
Net income................................... 875 3,142 6,077 11,893 17,565
Basic net income per common share(2)......... 0.02 0.28 0.38 0.50 0.72
Diluted net income per common share(2)....... 0.02 0.17 0.28 0.47 0.68
Pro forma net income(3)...................... 641 2,137 4,534 9,731 15,417
Basic pro forma net income per common
share(3)................................... 0.64
Diluted pro forma net income per common
share(3)................................... 0.60
Shares used in computing unaudited basic net
income per common share and basic pro forma
net income per common share................ 8,591 8,642 15,195 23,552 24,275
Shares used in computing unaudited diluted
net income per common share and diluted pro
forma net income per common share.......... 9,289 18,142 21,510 25,363 25,681
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and investments
available for sale......................... $ 4,679 $ 7,827 $44,975 $34,849 $ 42,946
Total assets................................. 10,944 20,663 63,113 98,293 119,877
Long-term obligations, less current
portion.................................... 367 931 1,373 264 63
Mandatorily redeemable convertible preferred
stock...................................... 12,452 13,169 -- -- --
</TABLE>
- ---------------
(1) The selected consolidated financial data gives retroactive effect to the
acquisitions of Risk Data, Retek and CompReview for all periods presented,
accounted for as poolings of interests.
(2) The computations of basic net income per common share for 1993, 1994 and
1995 include reductions of consolidated net income in the amounts of
$717,000, $717,000 and $348,000, respectively, related to the accretion of
dividends on mandatorily redeemable convertible Preferred Stock, which
converted into Common Stock upon the closing of the Company's initial public
offering on June 26, 1995. The computation of diluted net income per common
share for 1993 does not include the assumed conversion of all outstanding
shares of mandatorily redeemable convertible Preferred Stock into 7,675,000
shares of Common Stock or an increase to net income per common share related
to the elimination of dividend accretion on such Preferred Stock as the
impact would be antidilutive.
(3) Pro forma net income and net income per common share reflect a provision for
taxes on the income of CompReview, which was a subchapter S corporation
prior to its acquisition by HNC, as if CompReview had been subject to
corporate income taxes as a C corporation for all periods presented.
17
<PAGE> 113
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Prospectus (including without limitation the following section
regarding Management's Discussion and Analysis of Financial Condition and
Results of Operations) contains forward-looking statements (within the meaning
of Section 27A of the Securities Act and Section 21E of the Exchange Act)
regarding the Company and its business, financial condition, results of
operations and prospects. Words such as "expects," "anticipates," "intends,"
"plans," "believes," "seeks," "estimates" and similar expressions or variations
of such words are intended to identify forward-looking statements, but are not
the exclusive means of identifying forward-looking statements in this
Prospectus. Additionally, statements concerning future matters such as the
development of new products, enhancements or technologies, possible changes in
legislation and other statements regarding matters that are not historical are
forward-looking statements.
Although forward-looking statements in this Prospectus reflect the good
faith judgment of the Company's management, such statements can only be based on
facts and factors currently known by the Company. Consequently, forward-looking
statements are inherently subject to risks and uncertainties and actual results
and outcomes may differ materially from the results and outcomes discussed in
the forward-looking statements. Factors that could cause or contribute to such
differences in results and outcomes include without limitation those discussed
in "Risk Factors" as well as those discussed elsewhere in this Prospectus and in
any documents that are incorporated into this Prospectus by reference. Readers
are urged not to place undue reliance on these forward-looking statements, which
speak only as of the date of this Prospectus. The Company undertakes no
obligation to revise or update any forward-looking statements in order to
reflect any event or circumstance that may arise after the date of this
Prospectus. Readers are urged to carefully review and consider the various
disclosures made by the Company in this Prospectus and in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997 filed with the
Commission, which attempts to advise interested parties of the risks and factors
that may affect the Company's business, financial condition, results of
operations and prospects.
OVERVIEW
HNC develops, markets and supports predictive software solutions for
leading service industries. These predictive software solutions employ
proprietary neural-network predictive decision engines, profiles, traditional
statistical modeling, business models, expert rules and context vectors to
convert existing data and business experiences into meaningful recommendations
and actions. HNC was founded in 1986 to provide software tools and contracted
technology services using neural-network technology.
In August 1996, HNC completed its acquisition of Risk Data in a transaction
accounted for as a pooling of interests. Risk Data is based in Irvine,
California and develops, markets and supports proprietary software decision
products for use in the insurance industry. In 1996, HNC formed Aptex Software
Inc. ("Aptex"), a majority-owned subsidiary located in San Diego, California
that develops, markets and supports electronic text analysis technology in
products designed for the Internet and other environments. In November 1996, HNC
completed its acquisition of Retek in a transaction accounted for as a pooling
of interests. Retek is based in Minneapolis, Minnesota and develops, markets and
supports software products that provide merchandise management and other
management tools to retailers and their vendors. In November 1997, the Company
completed its acquisition of CompReview, in a transaction accounted for as a
pooling of interests. CompReview is located in Costa Mesa, California and
develops, markets and supports a software product and related services designed
to assist in the management and containment of the medical costs of workers'
compensation and automobile accident medical claims. CompReview provides its
product and services primarily to insurance companies, managed care
organizations, third party administrators and large self-insured employers. The
Company anticipates that from time to time it
18
<PAGE> 114
will consider acquisitions of other businesses in order to expand the markets
served by the Company and to acquire complementary technologies, products and
personnel. See "Risk Factors -- Acquisitions" and "Business -- HNC's Strategy."
After giving retroactive effect to the Company's acquisitions of Risk Data,
Retek and CompReview, HNC experienced compound annual growth in total revenues
of 63% from 1993 through 1997. See "Risk Factors -- Risks Associated with
Managing Growth." This revenue growth resulted primarily from increased license
fees for the Retek Merchandising System, CRLink, Falcon, MIRA and ProfitMax
products and, to a lesser extent, from increased license fees for the Active
Retail Intelligence, Retek Data Warehouse, PMAdvisor, CompCompare, Capstone and
AREAS products. Because of the long sales and development cycle associated with
the Company's products, the Company has not received significant revenues to
date from the SelectCast, SelectResponse, SelectResource, VeriComp or PMAdvisor
products. See "Risk Factors -- Lengthy and Unpredictable Sales Cycle."
The Company markets most of its predictive software solutions as an ongoing
service that includes software licenses, decision model updates, application
consulting and on-line or on-site support and maintenance. The Company's pricing
for the CRLink, the Falcon products, MIRA, ProfitMax, AREAS, PMAdvisor,
CompCompare and ProviderCompare products typically includes an annual or monthly
usage fee and a one to seven year contract commitment. In 1995, 1996 and 1997,
annual license and maintenance revenues from these contracts represented 61.2%,
56.1% and 55.2% of the Company's total revenues, respectively.
The Company's revenues and operating results have varied significantly in
the past and may do so in the future. Because the Company's expense levels are
based in part on its expectations regarding future revenues and in the short
term are fixed to a large extent, the Company may be unable to adjust its
spending in time to compensate for any unexpected revenue shortfall. Factors
affecting operating results include market acceptance of the Company's products;
the relatively large size and small number of customer orders that may be
received during a given period; customer cancellation of long-term contracts
yielding recurring revenues or customers' ceasing their use of Company products
for which the Company's fees are usage based; the length of the Company's sales
cycle; the Company's ability to develop, introduce and market new products and
product enhancements; the timing of new product announcements and introductions
by the Company and its competitors; changes in the mix of distribution channels;
changes in the level of operating expenses; the Company's ability to achieve
progress on percentage-of-completion contracts; the Company's success in
completing certain pilot installations for contracted fees; competitive
conditions in the industry; domestic and international economic conditions; and
market conditions in the Company's targeted markets. Furthermore, the Company's
operating results may be affected by factors unique to certain of its product
lines. For example, the Company derives a substantial and increasing portion of
its revenues from its retail products, which are generally priced as "perpetual"
license transactions in which the Company receives a one-time license fee. The
Company recognizes these fees as revenue upon delivery of the software and
acceptance by the customer. Thus, failure to complete a perpetual license
transaction during a fiscal quarter could have a disproportionate adverse impact
on the Company's operating results for that quarter.
The Company expects fluctuations in its operating results to continue for
the foreseeable future. Accordingly, the Company believes that period-to-period
comparisons of its financial results should not be relied upon as an indication
of future performance. The Company may not be able to maintain profitability on
a quarterly or annual basis in the future. Due to all of the foregoing factors,
it is possible that in some future quarter the Company's operating results will
be below the expectations of public market analysts and investors. In that
event, the price of the Company's Common Stock and, in turn, the market price of
the Notes, would likely be materially adversely affected.
19
<PAGE> 115
RESULTS OF OPERATIONS
The Company's statements of income for all periods presented give
retroactive effect to the acquisitions of Risk Data, Retek and CompReview in
August 1996, November 1996 and November 1997, respectively, each of which was
accounted for as a pooling of interests.
Total Revenues
The Company's revenues are comprised of license and maintenance revenues,
installation and implementation revenues, contracts and other revenues and
service bureau revenues. Total revenues increased by 63.5% to $71.4 million in
1996 and by 59.2% to $113.7 million in 1997. International operations and export
sales represented 12.6%, 17.7% and 18.5% of total revenues in 1995, 1996 and
1997, respectively. The retail product line currently has more sales in
international markets than the healthcare/insurance and financial services
product lines combined. The Company believes that international sales represent
a significant opportunity for revenue growth and expects international sales to
increase as a percent of total revenue.
License and Maintenance Revenues. The Company's license and
maintenance revenues are derived from annual license fees, monthly license
fees, perpetual license fees and annual maintenance fees. The Company
typically licenses many of its products for an annual or monthly usage fee
under long-term contracts that include software licenses, decision model
updates, application consulting, and on-line or on-site support and
maintenance. The Company's revenue from periodic software license and
maintenance agreements is generally recognized ratably over the respective
license or agreement periods. Revenue from certain short-term periodic
software license and maintenance agreements with guaranteed minimum license
fees is recognized as related services are performed. Transactional fees
are recognized as revenue based on system usage or when fees based on
system usage exceed the monthly minimum license fees. Revenue from
perpetual licenses of the Company's software for which there are no
significant continuing obligations and collection of the related
receivables is probable is recognized on delivery of the software and
acceptance by the customer.
License and maintenance revenues increased by 99.1% to $48.9 million
in 1996 and by 83.4% to $89.6 million in 1997. The increase from 1995 to
1996 was due primarily to the growth of license fees in all markets,
particularly from the Retek Merchandising System, CRLink and Falcon, and,
to a lesser extent, MIRA and CompCompare. The increase from 1996 to 1997
was due primarily to the growth of license fee revenues from the Retek
Merchandising System and CRLink. Also contributing to the increase were
increased license fees from other retail products, such as ARI and Retek
Data Warehouse, financial services products such as Falcon, ProfitMax and
Capstone, and other healthcare/insurance products, such as PMAdvisor and
MIRA.
Installation and Implementation Revenues. Revenues from software
installations and implementations are generally recognized as the services
are performed using the percentage of completion method based on costs
incurred to date compared to total estimated costs at completion. Amounts
received in advance of performance under the contracts are recorded as
deferred revenue and are generally recognized within one year from receipt.
Installation and implementation revenues increased by 44.0% to $6.7
million in 1996 and by 59.9% to $10.7 million in 1997. Substantially all of
the increase from 1995 to 1996 was due primarily to growth in the
installations of Retek Data Forecasting as this product moved from
development into production. The increase from 1996 to 1997 was due
primarily to growth in the installations of Capstone and ProfitMax.
20
<PAGE> 116
Contracts and Other Revenues. Contracts and other revenues are derived
primarily from new product development contracts with commercial customers
and research contracts with the United States Government. The Company
typically contracts with one or two commercial partners for pilot
development and installation of its new products and with the United States
Government for additional research funds. Revenues from contract services
are generally recognized as the services are performed using the percentage
of completion method based on costs incurred to date compared to total
estimated costs at completion. Revenue from hardware product sales, which
is included in contracts and other revenue, is recognized upon shipment to
the customer.
Contracts and other revenues increased by 21.7% to $11.1 million in
1996 and decreased by 30.2% to $7.8 million in 1997. The increase in 1996
was primarily the result of greater revenues from commercial new product
pilot installation contracts with customers in support of the Company's
development of ProfitMax, SelectCast, Falcon Sentry and Capstone. The
decrease in 1997 was primarily the result of products such as ProfitMax,
Retek Data Forecasting and Capstone moving from development into
production.
During 1997, the Company had fewer new product development projects
and new product pilot installations than during 1996. There can be no
assurance that any of these product development projects or pilot
installations will be successful or be completed within anticipated time
schedules or that the customers who serve as pilot installation sites will
be satisfied with these products or agree to license them. If the Company's
new product development efforts are unsuccessful, are not completed on a
timely basis or are not well received by pilot customers, the Company may
be compelled to delay or discontinue the release of production versions of
these products or bear increased expense to bring these pilot products to
market, either of which would have a material adverse effect on the
Company's business, financial condition and results of operations.
Service Bureau Revenues. Service bureau revenues are derived from the
Company's service bureau operations, which provide CRLink's functionality
to customers that do not wish to obtain a license, that use this service
until they can implement their own internal CRLink operation or that use
this service when their volumes peak to high levels. Service bureau
customers typically subscribe for services under month-to-month agreements.
Service bureau fees are recognized as revenue when the processing services
are performed.
Service bureau revenues decreased by 11.6% to $4.7 million in 1996 and
increased by 18.8% to $5.6 million in 1997. The decrease in 1996 was
primarily a result of the significant increase in license revenues as the
Company's sales efforts were focused on licensing CRLink to customers
rather than marketing service bureau services. The increase in 1997 was
primarily due to an increase in the number of customers utilizing service
bureau operations.
Gross Margin
The following table sets forth the gross margin for each of the Company's
revenue categories for each of the comparison periods.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
License and maintenance........................... 67.8% 71.9% 77.8%
Installation and implementation................... 69.3 59.4 51.7
Contracts and other............................... 24.6 30.9 30.0
Service bureau.................................... 43.4 28.9 23.1
</TABLE>
21
<PAGE> 117
License and Maintenance Gross Margin. License and maintenance costs
primarily represent the Company's expenses for personnel engaged in
customer support, travel to customer sites and documentation materials. The
Company's gross margin on licenses and maintenance revenues was 67.8%,
71.9% and 77.8% in 1995, 1996 and 1997, respectively. In 1996, the
improvement in gross margin was the result of the Company's ability to move
from price discounts for early adopters of its products to full pricing for
products sold to subsequent customers as well as a higher volume of
international licenses, which generate relatively higher margins than
domestic operations due, in part, to lower overhead expenses as a result of
less corporate infrastructure. Gross margin improved in 1997 due primarily
to license fees increasing at a higher rate than the costs associated with
providing these licenses. This increase was primarily attributable to
increased pricing producing higher margins in the retail and
healthcare/insurance markets.
Installation and Implementation Gross Margin. Installation and
implementation costs consist primarily of personnel-related costs, travel
and equipment. The Company's gross margin on installation and
implementation revenues was 69.3%, 59.4% and 51.7% in 1995, 1996 and 1997,
respectively. In 1996, the improved margin was due primarily to new
installations of Retek Data Forecasting, which have substantially lower
margins than installations of Falcon products, which represented a majority
of installations in 1995. Gross margin improved in 1997 due primarily to an
increase in Capstone implementations, which have substantially lower
margins than implementations of Falcon products.
Contracts and Other Gross Margin. Contracts and other costs consist
primarily of personnel-related costs. The Company's gross margin on
contracts and other revenues was 24.6%, 30.9% and 30.0% in 1995, 1996 and
1997, respectively. The improvement in gross margin during 1996 was due
primarily to the Company's increased ability to better price its new pilot
projects. The slight decrease in gross margin for 1997 was due to the
decrease in new product development contracts, while government projects
with substantially lower margins remained relatively constant in absolute
dollars.
Service Bureau Gross Margin. Service bureau costs consist primarily of
the personnel and facilities costs of operating the service bureaus. The
Company's gross margin on service bureau revenues was 43.4%, 28.9% and
23.1% in 1995, 1996 and 1997. The decrease in 1996 was a result of the loss
of a customer in early 1996 for which the Company was able to recognize
higher than usual margins during 1995. The decrease in 1997 was
attributable to an increase in fixed costs and in labor costs required to
support the service bureau business that outpaced the increase in revenue.
This was the result of a more static customer base and higher fixed costs
associated with the infrastructure necessary to run the service bureau
operation.
Other Operating Expenses
Research and Development Expenses. Research and development expenses
consist primarily of salaries and other personnel-related expenses,
subcontracted development services, depreciation for development equipment
and supplies. Research and development expenses increased from $7.0 million
in 1995 to $13.8 million in 1996 and to $21.2 million in 1997, representing
16.0%, 19.3% and 18.6% of total revenues in 1995, 1996 and 1997,
respectively. Research and development expenses increased in absolute
dollars due to the development costs associated with new releases of
several products in the retail and financial services product lines. The
increased research and development expenses in absolute dollars and as a
percentage of revenues in 1996 was primarily the result of greater staffing
to support more new product development programs, primarily for ProfitMax,
Capstone, CompCompare, ProviderCompare and the Retek Merchandising System.
The 1996 costs also included the initial product development costs of the
Company's Aptex business unit, which did not have a significant impact on
revenues. Statement of Financial Accounting Standards No. 86, "Ac-
22
<PAGE> 118
counting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed," requires capitalization of certain software development costs
subsequent to the establishment of technological feasibility. Based on the
Company's product development process, technological feasibility is not
established until completion of a working model. Costs incurred by the
Company between completion of the working model and the point at which a
product is ready for general release have been insignificant. As a result,
no significant software development costs were capitalized through December
31, 1997. The Company anticipates that research and development expenses
will increase in dollar amount and could increase as a percentage of total
revenues for the foreseeable future.
Sales and Marketing Expenses. Sales and marketing expenses consist
primarily of salaries and benefits, commissions, travel, entertainment and
promotional expenses. Sales and marketing expenses increased from $7.3
million in 1995 to $11.9 million in 1996 and to $22.0 million in 1997,
representing 16.6%, 16.7% and 19.4% of total revenues in 1995, 1996 and
1997, respectively. The increases were primarily a result of increased
staffing as the Company built its direct sales and marketing staff, opened
sales offices in Japan and in several locations in Europe, and increased
expenses for trade shows, advertising and other marketing programs. The
Company expects sales and marketing expenses to continue to increase for
the foreseeable future. Such expenses could also increase as a percentage
of total revenues as the Company continues to develop a direct sales force
in Europe and other international markets, expand its domestic sales and
marketing organization and increase the breadth of its product lines.
General and Administrative Expenses. General and administrative
expenses consist primarily of personnel costs for finance, contract
administration, human resources and general management, as well as
acquisition, insurance and professional services expenses. General and
administrative expenses increased from $5.1 million in 1995 to $8.6 million
in 1996 and $12.6 million in 1997, representing 11.7%, 10.3% and 9.8% of
total revenues, respectively. General and administrative expenses included
$1.2 million of acquisition expenses related to the acquisitions of Risk
Data and Retek in 1996 and $1.4 million of acquisition expenses primarily
related to the acquisition of CompReview in 1997. Excluding acquisition
expenses, general and administrative expenses were $5.1 million, $7.4
million and $11.2 million in 1995, 1996 and 1997, respectively. The primary
reason for these increases in absolute dollars was increased staffing to
support the Company's growth and additional expenses associated with being
a public company.
Operating Income
The above factors resulted in operating income of $5.1 million,
constituting 11.6% of total revenues in 1995, $9.7 million, constituting 13.5%
of total revenues in 1996, and $23.0 million, constituting 20.3% of total
revenues in 1997. The Company does not expect that operating income will
continue to increase significantly as a percentage of total revenues.
Other Income (Expense) Net
Interest and other income, net of interest expense, increased from $484,000
in 1995 to $1.7 million in 1996 and to $1.9 million in 1997. The increase in
1996 was primarily attributable to increased interest income in 1996 from higher
cash and investment balances, which consisted primarily of the proceeds from the
Company's initial public offering in June 1995 and secondary public offering in
December 1995. The increase in 1997 was primarily due to a decrease in interest
expense of approximately $397,000 primarily related to the repayment of Risk
Data's bank notes payable during the third quarter of 1996, offset by a decrease
in interest income of approximately $165,000.
23
<PAGE> 119
Income Tax (Benefit) Provision
The income tax benefit of $511,000 in 1995 was primarily attributable to
the recognition of a $2.2 million deferred tax asset based on anticipated future
utilization of all of the Company's remaining net operating loss carryforwards
and research and development credit carryforwards. The income tax benefit of
$534,000 in 1996 was primarily attributable to the recognition of a $2.7 million
deferred tax asset based on anticipated future utilization of all of the
remaining net operating loss carryforwards and research and development credit
carryforwards relating to Risk Data and Retek. That deferred tax asset had
previously been offset by a valuation allowance. The Company released the
valuation allowance during the fourth quarter of 1996, based upon management's
assessment that it was more likely than not that the Company would realize the
asset in future periods.
The 1997 income tax provision of $7.4 million, or 29.5% of pre-tax income,
was lower than 1997 taxes at statutory rates primarily as a result of
CompReview's subchapter S corporation status prior to the acquisition, which
resulted in most of CompReview's tax liability being borne by its former
shareholders. As of the date of the acquisition, CompReview's tax status was
changed to C corporation. In the future, the Company expects that the effective
tax rate will be reflective of the tax rate of other California-based companies.
24
<PAGE> 120
SELECTED PRO FORMA QUARTERLY OPERATING RESULTS
The following table presents unaudited pro forma quarterly financial
information for each of the eight quarters in the period ended December 31,
1997. This information has been derived from the Company's unaudited financial
statements. Pro forma net (loss) income reflects a provision for taxes on the
income of CompReview, which was a subchapter S corporation prior to its
acquisition by HNC, as if CompReview had been subject to corporate income taxes
as a C corporation for all periods presented. In the opinion of management, all
adjustments, consisting only of normal recurring adjustments, have been included
to present fairly the quarterly results. See "Risk Factors -- Potential
Fluctuations in Operating Results" and "-- Lengthy and Unpredictable Sales
Cycle."
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------------------------------
1996 1997
--------------------------------------- --------------------------------------
MAR. 31 JUN. 30 SEPT. 30 DEC. 31 MAR. 31 JUN. 30 SEPT. 30 DEC. 31
------- ------- -------- ------- ------- ------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:(1)
Revenues:
License and maintenance................... $ 8,479 $11,163 $ 13,831 $15,417 $18,331 $22,311 $ 23,705 $25,296
Installation and implementation........... 1,200 1,214 1,399 2,878 1,946 2,188 3,069 3,499
Contracts and other....................... 2,979 3,051 2,784 2,314 2,726 1,805 1,671 1,570
Service bureau............................ 1,219 1,269 1,101 1,141 1,069 1,289 1,544 1,716
------- ------- ------- ------- ------- ------- ------- -------
Total revenues...................... 13,877 16,697 19,115 21,750 24,072 27,593 29,989 32,081
------- ------- ------- ------- ------- ------- ------- -------
Operating expenses:
License and maintenance................... 3,180 3,120 3,689 3,736 3,994 5,036 4,957 5,950
Installation and implementation........... 589 597 560 968 801 1,251 1,499 1,623
Contracts and other....................... 2,071 1,938 1,860 1,825 1,850 1,454 1,111 1,023
Service bureau............................ 932 947 749 737 864 919 1,203 1,334
Research and development.................. 2,440 3,352 3,748 4,268 4,431 4,930 6,015 5,775
Sales and marketing....................... 2,485 2,981 3,041 3,416 4,553 5,233 5,691 6,572
General and administrative................ 1,829 1,961 2,351 2,410 2,459 2,768 3,142 4,257
------- ------- ------- ------- ------- ------- ------- -------
Total operating expense............. 13,526 14,896 15,998 17,360 18,952 21,591 23,618 26,534
------- ------- ------- ------- ------- ------- ------- -------
Operating income............................ 351 1,801 3,117 4,390 5,120 6,002 6,371 5,547
Interest income, net........................ 452 406 384 458 429 481 538 431
------- ------- ------- ------- ------- ------- ------- -------
Income before pro forma income tax
provision (benefit)..................... 803 2,207 3,501 4,848 5,549 6,483 6,909 5,978
Pro forma income tax provision (benefit).... 934 1,119 1,138 (1,563) 2,115 2,475 2,623 2,289
------- ------- ------- ------- ------- ------- ------- -------
Pro forma net (loss) income............... $ (131) $ 1,088 $ 2,363 $ 6,411 $ 3,434 $ 4,008 $ 4,286 $ 3,689
======= ======= ======= ======= ======= ======= ======= =======
AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
License and maintenance................... 61.1% 66.8% 72.3% 70.9% 76.2% 80.9% 79.1% 78.9%
Installation and implementation........... 8.6 7.3 7.3 13.2 8.1 7.9 10.2 10.9
Contracts and other....................... 21.5 18.3 14.6 10.6 11.3 6.5 5.6 4.9
Service bureau............................ 8.8 7.6 5.8 5.3 4.4 4.7 5.1 5.3
------- ------- ------- ------- ------- ------- ------- -------
Total revenues...................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
------- ------- ------- ------- ------- ------- ------- -------
Operating expenses:
License and maintenance................... 22.9 18.7 19.3 17.2 16.6 18.2 16.5 18.5
Installation and implementation........... 4.3 3.6 3.0 4.4 3.3 4.5 5.0 5.0
Contracts and other....................... 14.9 11.6 9.7 8.4 7.7 5.3 3.7 3.2
Service bureau............................ 6.7 5.7 3.9 3.4 3.6 3.3 4.0 4.2
Research and development.................. 17.6 20.1 19.6 19.6 18.4 17.9 20.1 18.0
Sales and marketing....................... 17.9 17.8 15.9 15.7 18.9 19.0 19.0 20.5
General and administrative................ 13.2 11.7 12.3 11.1 10.2 10.0 10.5 13.3
------- ------- ------- ------- ------- ------- ------- -------
Total operating expense............. 97.5 89.2 83.7 79.8 78.7 78.2 78.8 82.7
------- ------- ------- ------- ------- ------- ------- -------
Operating income............................ 2.5 10.8 16.3 20.2 21.3 21.8 21.2 17.3
Interest income, net........................ 3.3 2.4 2.0 2.1 1.8 1.7 1.8 1.3
------- ------- ------- ------- ------- ------- ------- -------
Income before pro forma income tax
provision (benefit)..................... 5.8 13.2 18.3 22.3 23.1 23.5 23.0 18.6
Pro forma income tax provision (benefit).... 6.7 6.7 5.9 (7.2) 8.8 9.0 8.7 7.1
------- ------- ------- ------- ------- ------- ------- -------
Pro forma net (loss) income............... (0.9)% 6.5% 12.4% 29.5% 14.3% 14.5% 14.3% 11.5%
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
- ---------------
(1) The above table gives retroactive effect to the acquisitions of Risk Data,
Retek and CompReview for all periods presented, accounted for as poolings of
interests.
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<PAGE> 121
LIQUIDITY AND CAPITAL RESOURCES
The $21.0 million of net cash provided by operating activities in 1997
represented net income before depreciation and amortization of approximately
$22.4 million, further increased by a decrease in deferred income taxes of $6.9
million and offset by an increase in accounts receivable of $11.1 million. Net
cash used in investing activities was $7.7 million in 1997 primarily due to $9.6
million expended for property and equipment during 1997, including $6.0 million
for computer equipment to support the increased staffing across the Company, and
$1.9 million for furniture and fixtures primarily related to the relocation of
the Company's Minneapolis facility, offset by approximately $1.9 million of net
proceeds from the sale and maturity of investments. Net cash used in financing
activities was $3.2 million in 1997 primarily due to $6.8 million in
distributions to the former CompReview stockholders offset by $4.0 million in
net proceeds from issuances of common stock.
As of December 31, 1997, the Company had $42.9 million in cash, cash
equivalents and investments. The Company believes that its current cash, cash
equivalents and investments available for sale balances, together with the net
proceeds from the sale of the Notes, borrowings under its credit facility and
net cash provided by operating activities, will be sufficient to meet its
working capital and capital expenditure requirements for at least the next 12
months. The credit facility will not be available following issuance of the
Notes unless the Company obtains an appropriate consent or amendment from the
bank. A portion of the Company's cash could be used to repurchase shares of the
Company's Common Stock from time to time in the open market. Management intends
to invest the Company's cash in excess of current operating requirements in
short-term, interest-bearing, investment-grade securities. A portion of the
Company's cash could also be used to acquire or invest in complementary
businesses or products or otherwise to obtain the right to use complementary
technologies or data. From time to time, in the ordinary course of business, the
Company evaluates potential acquisitions of such businesses, products,
technologies or data. The Company has no present understandings, commitments or
agreements with respect to any material acquisitions of other businesses,
products or technologies.
YEAR 2000 COMPLIANCE
The Company anticipates that it will need to devote resources in the next
two years to modify its CRLink product to properly process dates beyond December
31, 1999. The Company expects that the cost of making these modifications and
distributing the modified product to existing customers will be approximately
$500,000. These modifications and the resources that the Company expects to
devote to such modifications may divert management and engineering attention
from, or delay the development and introduction of, new products and
enhancements to existing products. The inability of the Company to complete such
modifications successfully and on a timely basis, or the inability of the
Company to devote sufficient resources to continuing updates and enhancements to
the CRLink product, could have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, the
Company believes that the purchasing patterns of customers and potential
customers may be affected by Year 2000 issues as companies expend significant
resources to correct or patch their current software systems for Year 2000
compliance. These expenditures may result in reduced funds available to purchase
software products such as those offered by the Company, which could result in a
material adverse effect on the Company's business, financial condition and
results of operations.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130 ("FAS 130"), "Reporting
Comprehensive Income," which the Company is required to adopt for 1998. This
statement will require the Company to report in the financial statements, in
addition to net income, comprehensive income and its
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<PAGE> 122
components including foreign currency items and unrealized gains and losses on
certain investments in debt and equity securities. Upon adoption of FAS 130, the
Company is also required to reclassify financial statements for earlier periods
provided for comparative purposes. The adoption of FAS 130 will not have a
significant impact on the Company's consolidated financial statement
disclosures.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and Related
Information," which the Company is required to adopt for its 1998 annual
financial statements. This statement establishes standards for reporting
information about operating segments in annual financial statements and requires
selected information about operating segments in interim financial reports
issued to stockholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. Under FAS
131, operating segments are to be determined consistent with the way that
management organizes and evaluates financial information internally for making
operating decisions and assessing performance. The Company has not determined
the impact of the adoption of this new accounting standard on its consolidated
financial statement disclosures.
In November 1997, the American Institute of Certified Public Accountants
issued Statement of Position No. 97-2 ("SOP 97-2"), "Software Revenue
Recognition," which the Company is required to adopt for agreements entered into
with customers beginning in 1998. This statement provides guidance for
recognizing revenue related to sales by software vendors. The adoption of SOP
97-2 will not have a significant impact on the timing of the Company's revenue
recognition.
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<PAGE> 123
BUSINESS
HNC develops, markets and supports predictive software solutions for
leading service industries. These predictive software solutions employ
proprietary neural-network predictive decision engines, profiles, traditional
statistical modeling, business models, expert rules and context vectors to
convert existing data and business experiences into meaningful recommendations
and actions. Just as manufacturing organizations have implemented manufacturing
resource planning ("MRP") software to automate routine transactions, leading
service industries such as the health-care/insurance, financial services and
retail industries are using predictive software solutions to improve
profitability, competitiveness and customer satisfaction.
INDUSTRY BACKGROUND
Today's competitive business environment has forced many service companies
to increase business efficiency while improving their flexibility and
responsiveness to changing market conditions. Businesses continually seek new
ways to make better decisions by collecting and analyzing data. Consequently,
service companies have made, and continue to make, significant investments in
computer systems designed to gather and electronically store ever increasing
amounts of data. In most cases, these computerized systems automate manual tasks
and activities, resulting in the conversion of significant amounts of corporate
data from paper to electronic form. However, these systems generally do not
synthesize data in ways that help businesses make better real-time decisions.
Historically, the development of predictive software solutions was
inhibited by the lack of computing standards and effective computational
intelligence techniques. The emergence of client-server standards, including
relational database management systems, the Windows operating system and network
communications protocols, has fostered the increased transmission and
dissemination of electronically stored data within and among businesses. MRP
software systems were developed to automate production, accounting, human
resources and distribution transactions for primarily manufacturing
organizations. These systems manage and store large amounts of diverse business
information, providing continuous and simultaneous availability of information
to geographically dispersed employees, customers and suppliers. However, MRP
systems generally do not provide businesses with the functionality and
flexibility needed to utilize this data to simulate operations and make
real-time decisions and recommendations in diverse and rapidly changing business
environments.
Several service industries have a particular need to leverage large volumes
of real-time transactional and operational data in order to address systemic
issues that have historically affected profitability, competitiveness and
customer satisfaction. These industries and issues include:
- HEALTHCARE/INSURANCE INDUSTRY. Workers' compensation fraud and abuse is
currently receiving widespread attention in the healthcare/insurance
industry. Conning & Co. recently estimated that 10%-25% of the dollar
amount of filed workers' compensation claims in the United States are
fraudulent. This translates to more than $5 billion lost each year to
workers' compensation fraud.
- FINANCIAL SERVICES INDUSTRY. Based on reports from Visa and Mastercard,
Faulkner & Gray estimates that United States credit card credit losses
and chargeoffs were $18 billion in 1996.
- RETAIL INDUSTRY. Rapid changes in consumer buying patterns have caused
merchants to place increased emphasis on predicting consumer demand and
managing retail inventories. The change from mass to individual retail
marketing has multiplied the number of promotional offers and
stock-keeping units ("SKUs") required to address market opportunities.
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<PAGE> 124
The U.S. Department of Commerce estimates that the inventory carrying
costs for retail inventories nationwide were $316 billion at the end of
March 1997.
Historically, many companies in the healthcare/insurance, financial
services and retail industries have developed specialized in-house applications
to address these issues. Such applications are generally designed to access
large volumes of operational and transactional data stored on mainframe
computers. However, such systems are expensive, costly to support and maintain,
and do not offer flexible and enterprise-wide access to data. Furthermore, most
of these systems are not designed to meet the need for real-time recommendations
and actions. The widespread adoption of distributed client-server computing has
provided organizations with a much greater ability to access and manipulate
stored information but also has created the need for third-party vendors of
packaged applications software solutions that provide the same degree of
functionality and reliability as traditional in-house applications. These
vendors are able to provide a higher degree of functionality and reliability
than traditional in-house applications by combining the domain knowledge from
their customers and partners with expertise in computational intelligence and
client-server technologies.
THE HNC SOLUTION
HNC's predictive software solutions enable leading service industries, such
as the healthcare/insurance, financial services and retail industries, to
analyze and act upon operational and transactional data in real time. The
Company's products provide the following benefits:
Core predictive software technology. The Company's software includes a
variety of computational intelligence technologies such as proprietary
neural-network predictive decision engines, profiles, expert rules, context
vectors, traditional statistical modeling and business models that can be
customized to specific business applications. Neural networks can be adapted to
changing environments and applications quickly and have proven to be accurate
and effective in real-time operating environments. The Company's decision engine
also includes a user-defined rule-based technology. The neural networks and
rulebases are delivered through software that allows the Company's products to
adapt to many customer-specific business needs without extensive custom
programming. Adaptable functions include workflow queuing management, policy and
procedure guidelines, input data modification, flexible graphical user interface
("GUI") display, decision criteria and report formats.
Quick payback for customers. The Company's software solutions are designed
for quick customer payback. The Company typically installs its products in two
to six months, and customer payback periods for installation and first year
usage fees are typically less than one year. Payback is rapid because the
software products address applications that have a significant profit impact.
HNC personnel focus not only on the technical integration, but also on
delivering direct benefits to the customer throughout the service contract
period.
Transaction-based, real-time decision capability. HNC's software can
operate in real time, providing an immediate, situation-specific response to
each customer transaction. For example, the Falcon system for credit/debit card
fraud can monitor millions of transactions each day, identify fraudulent
transactions in progress and permit the card issuing bank to withhold an
authorization before the perpetrator completes a purchase. The Falcon system
differs from traditional modeling implementations, which operate in a batch or
off-line mode on a collection of historical transactions.
Flexible client-server solutions. HNC's solutions can be integrated into a
customer's existing environment or architecture. The Company's products are
available on industry-standard, client-server platforms, including Windows and
UNIX clients, NetWare, Windows NT, UNIX and CICS servers and IBM, Oracle, Sybase
and Informix databases. HNC's application products represent a complete software
solution, including decision models, deployment software, communications
interfaces and GUIs. The Company also supplies systems integration, ongoing
performance
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<PAGE> 125
analysis, model rebuilding and application consulting services to help ensure
ongoing success for the customer. The Company believes that this flexible
combination of products, services and deployment platforms represents an advance
that enables successful predictive software system deployment in many
mission-critical applications.
Turnkey, customized and user-developed model options. The choice of data
source is important to customers because data are the fundamental building
blocks used to create accurate predictive models. HNC provides various models
built on industry-specific or customer-specific data to meet individual
application requirements. Customers and data suppliers provide the Company with
historical transaction data for turnkey models, trend analyses and product
updates. This combination of proprietary turnkey (from data and individual
consumer profiles), customized and user-developed models allows the Company to
offer products that solve a broad range of predictive application problems.
HNC'S STRATEGY
HNC's objective is to be the leading supplier of predictive software
solutions by leveraging its core computational intelligence technology across a
series of product families targeted at specific service industries. The
Company's strategy for achieving this objective contains the following key
elements:
Maintain and strengthen HNC's position at the core of its customers'
applications infrastructure. Customers rely heavily on HNC's predictive software
solutions to anticipate and react to rapidly changing business conditions. The
Company's core computational intelligence technology serves as a platform upon
which services businesses can deploy and combine the Company's products to
manage and respond to operational and transactional data in real time.
Therefore, HNC attempts to establish a strong position within the applications
infrastructure of its customers. For example, the Company's first predictive
solution product, Falcon, is a credit/debit card fraud detection system for
monitoring individual credit card accounts. By adapting the core technology
developed for Falcon, the Company later introduced ProfitMax, a
transaction-based, real-time credit authorization system that manages the
profitability of credit card portfolios. The Company believes that the
opportunity exists for similar penetration within each of its core vertical
markets, including opportunities such as retail banking within the financial
services industry. As another example, the Company's context vectoring
technology could profile visitors to a financial institution's Web site and send
proactive direct e-mails regarding financial products.
Leverage core predictive technologies to enter new market segments.
Historically, the Company has applied its core predictive technology to the
domain knowledge of companies it has acquired to introduce new products. For
example, in August 1996, HNC acquired Risk Data, a developer of decision systems
in the workers' compensation industry. By combining Risk Data's industry
expertise with HNC's fraud detection technology, HNC is developing a VeriComp
module that applies predictive technology to employer fraud in the workers'
compensation industry. In addition, the Company is evaluating opportunities in
other data-intensive industries, such as telecommunications, where predictive
software may have the ability to improve business performance and profitability.
Earn recurring revenues through long-term contracts. The Company markets
most of its predictive software solutions as an ongoing service that includes
software licenses, decision model updates, application consulting and on-line or
on-site support and maintenance. Since many of the Company's applications are
enhanced by periodic model updates, customers derive significant value from the
Company's ongoing services. In addition, the mission-critical nature of many of
HNC's predictive software solutions creates customer demand for long-term
support commitments. Accordingly, the Company's customers typically pay for this
package of software and service with a monthly usage fee and a three to seven
year contract commitment.
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Use strategic relationships to support direct distribution. In each of its
primary markets, the Company uses strategic relationships with system
integrators and third-party service providers to support its direct distribution
efforts. These partners provide varying levels of distribution support, from
lead generation to resale of the Company's products. The Company maintains such
strategic relation\ships with Electronic Data Systems ("EDS"), Intracorp and
Marsh McLennan, Inc. in healthcare/insurance, First Data and EDS in financial
services, and Andersen Consulting and KPMG Peat Marwick LLP in retail.
Growth Through Acquisitions. The Company acquired First Data, Retek and
CompReview in 1996 and 1997, thereby significantly expanding its product
offerings in its target markets. On January 30, 1998, the Company signed a
definitive agreement to acquire Practical Control Systems Technologies, Inc.
("PCS"), a distribution center management software vendor based in Cincinnati,
Ohio, subject to the satisfaction of certain closing conditions and the approval
of PCS' shareholders. The Company expects to continue to review acquisitions of
businesses, products and technologies as a means to expand its product offerings
for existing and new target markets.
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<PAGE> 127
MARKETS AND PRODUCTS
HNC has a broad family of predictive software products that provide
specific solutions for each of the healthcare/insurance, financial services and
retail markets. Revenues from each of the Company's three product lines
accounted for more than one-quarter of the Company's total revenues in 1997.
Revenues from three products, CRLink, Retek Merchandising System and Falcon,
accounted for 57.9% of the Company's total revenues in 1997. See "Risk
Factors -- Product Concentration."
Healthcare/Insurance
HNC offers and is developing products in the healthcare/insurance market.
These products are targeted to insurance carriers, insurance providers, managed
care organizations, state insurance funds, third-party administrators and large,
self-insured employers. HNC has developed predictive software solutions that
address the containment of the medical costs of workers' compensation and auto
accident insurance claims, workers' compensation loss reserving, workers'
compensation fraud, managed care effectiveness and provider effectiveness. These
solutions, CRLink, MIRA, CompCompare, ProviderCompare, PMAdvisor and VeriComp,
allow users the ability to reduce fraud losses and streamline operations.
HNC HEALTHCARE/INSURANCE INDUSTRY PRODUCTS
================================================================================
<TABLE>
<CAPTION>
PRODUCT PRODUCT DESCRIPTION
<S> <C> <C>
- -------------------------------------------------------------------------------------------------------
CRLink CRLink operates as the bill review engine that links all of the critical
components of an effective cost containment program to help clients control
the cost of workers' compensation, personal injury and other casualty risks.
- -------------------------------------------------------------------------------------------------------
MIRA MIRA uses statistical predictive methods to automatically determine workers'
compensation loss reserves based on historical data gathered from insurance
carriers, third-party administrators and state insurance funds throughout
the United States.
- -------------------------------------------------------------------------------------------------------
CompCompare CompCompare enables clients to compare claims costs or the effectiveness of
managed care programs by using benchmarking data from HNC's proprietary
workers' compensation database.
- -------------------------------------------------------------------------------------------------------
ProviderCompare ProviderCompare is a physician profiling product that provides on-line
access to HNC's proprietary workers' compensation database. ProviderCompare
enables clients to generate a detailed comparative analysis, such as
treatment costs, among providers within the same specialty.
- -------------------------------------------------------------------------------------------------------
PMAdvisor PMAdvisor enables claim payors to verify that the number of visits and type
of treatment for claims involving physical medicine (primarily chiropractic
and physical therapy) are appropriate for the diagnosis and severity of the
injury and to identify chiropractic and physical therapy claims that exceed
appropriate treatment guidelines.
- -------------------------------------------------------------------------------------------------------
VeriComp VeriComp is a workers' compensation claimant system designed to assist in
identifying claimant behavior that is likely to indicate the presence of
fraud or abuse.
- -------------------------------------------------------------------------------------------------------
</TABLE>
Financial Services
The increasing volume of electronic financial transactions requires
mission-critical decision-making in real time for applications such as credit
card charge authorization, that carry a substantial risk of consumer and
merchant fraud. HNC's Falcon and ProfitMax product lines are targeted at bank
and private label card issuers and payment processors. Falcon employs a
client/server architecture that consists of an interface into the customer's
legacy system, a decision engine, a cardholder profile database, a case
management database and a fraud workstation.
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<PAGE> 128
HNC estimates that loan underwriting costs in the United States currently
exceed $2.5 billion each year. Competitive pressures including cost reduction,
rapid loan approval and the growth of on-line banking have compelled lenders to
turn to software solutions that can automate loan origination in order to lower
costs, improve customer service and provide remote access to lending services.
HNC's predictive software solutions for the loan origination markets, Capstone
and AREAS, allow lenders such as banks and private label card issuers, home
equity lenders, auto lenders and mortgage lenders to automate the loan approval
decision process.
HNC FINANCIAL SERVICES INDUSTRY PRODUCTS
================================================================================
<TABLE>
<CAPTION>
PRODUCT PRODUCT DESCRIPTION
<S> <C> <C>
- -------------------------------------------------------------------------------------------------------
Falcon Product Line
- ------------------------
Falcon Falcon products are neural network-based solutions that examine
Falcon Expert transaction, cardholder and merchant data to detect a wide range of
Falcon Select credit and debit card fraud. Using predictive software techniques,
Falcon Debit Falcon captures relationships and patterns that often are missed by
Falcon Retail traditional methods of detecting suspicious transactions.
Falcon Sentry
Eagle
- -------------------------------------------------------------------------------------------------------
Capstone Product Line
- ------------------------
Capstone for Payment Capstone is an intelligent, high-performance new account decision
Cards processing solution. Based on expert rules, Capstone allows users to
Capstone for automate lending decisions and design, test, implement and track
Consumer Lending lending policies.
Capstone for Mortgage
Lending
- -------------------------------------------------------------------------------------------------------
ProfitMax Product Line
- ------------------------
ProfitMax ProfitMax provides transaction-based, real-time authorization and
ProfitMax Bankruptcy action decisions from within a complete infrastructure for managing
the profitability of credit card portfolios. ProfitMax uses neural
networks, expert rules and HNC's cardholder behavior profiling
technology to analyze the expected profitability of each account in an
issuer's portfolio using the issuer's definition of financial profit.
ProfitMax Bankruptcy uses the basic ProfitMax structure to predict the
likelihood of cardholder bankruptcy even before the cardholder is
delinquent.
- -------------------------------------------------------------------------------------------------------
AREAS AREAS automated property valuation software uses neural networks and
other computational intelligence to provide an objective prediction of
the current market value of residential property.
- -------------------------------------------------------------------------------------------------------
</TABLE>
Retail
Although retailers have made significant investments in customer
information, point-of-sale and quick-response ordering systems, these
applications often do not include the forecasting ability required to maximize
profitability and respond to competition through timely "in-store"
replenishment, electronic networking and quick response initiatives. HNC has
developed a group of products that effectively addresses inventory control,
merchandise management and financial control management. These software
solutions allow retailers to build forecasting and marketing models to carry out
day-to-day buying and selling activities, thereby reducing carrying costs for
inventories and improving purchasing, promotion and logistics efficiencies. The
target markets for the Company's retail products are department stores, mass
merchandisers and specialty retail chains in multi-store and multi-warehouse
environments with gross sales in excess of $200 million.
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<PAGE> 129
HNC RETAIL INDUSTRY PRODUCTS
================================================================================
<TABLE>
<CAPTION>
PRODUCT PRODUCT DESCRIPTION
<S> <C> <C>
- -------------------------------------------------------------------------------------------------------
Retek Merchandising The Retek Merchandising System provides inventory control, merchandise
System management and financial control and addresses the definition and
management of merchandise at the SKU level and reporting and financial
control through stock ledgers.
- -------------------------------------------------------------------------------------------------------
Retek Data Warehouse Retek Data Warehouse provides the transaction infrastructure needed
for retailers to plan, buy, move, sell and pay for their merchandise.
- -------------------------------------------------------------------------------------------------------
Active Retail Active Retail Intelligence identifies performance exceptions and
Intelligence recommends the appropriate corrective action.
- -------------------------------------------------------------------------------------------------------
Retek Demand Retek Demand Forecasting provides forecasts to retailers' supply chain
Forecasting planning allocation and replenishment functions and uses predictive
causal techniques with automated forecasting and multi-dimensional
on-line analysis.
- -------------------------------------------------------------------------------------------------------
Falcon Retail Falcon Retail provides proactive detection of private label card
application and transaction fraud.
- -------------------------------------------------------------------------------------------------------
</TABLE>
EMERGING MARKET OPPORTUNITIES
The Company's experience and technology capabilities in the
healthcare/insurance, financial services and retail markets often lead to new
product ideas and concepts. The Company also evaluates new market opportunities
that arise through its commercial and government contract work. As contracts are
completed, the end products are evaluated for commercialization. For example,
contracts for the Advanced Research Projects Agency, United States Army Research
Laboratory, United States Air Force, Office of Naval Research, DataTimes
Corporation and Tracor Applied Sciences, Inc. generated a context-based text
analysis technology called MatchPlus. This core text analysis technology has
been under development at HNC for the last four years for Department of Defense
applications. During 1996, the Company formed Aptex to commercialize HNC's
MatchPlus text analysis technology for emerging markets. Aptex has developed a
strategic partnership with InfoSeek Corporation, an Internet search and
navigation service, to deliver products using this text analysis technology to
the Internet market. To date, three new Internet products have been launched:
SelectCast, SelectResponse and SelectResource.
Substantially all of the Company's revenues in recent years have been
attributable to sales of predictive software solutions and services, and these
products and services are currently expected to continue to account for a
substantial amount of the Company's future revenues. The market for predictive
software solutions is still emerging. The rate at which businesses have adopted
the Company's products has varied significantly by market and by product within
each market, and the Company expects to continue to experience such variations
with respect to its target markets and products in the future. The Company has
introduced products for the healthcare/insurance, financial services and retail
markets. The Company has recently announced several new products, including
PMAdvisor, VeriComp, SelectCast, SelectResponse and SelectResource. To date,
none of these products has achieved any significant degree of market acceptance,
and there can be no assurance that such products will ever be widely accepted.
Although businesses in the Company's target markets have recognized the
advantages of using predictive software solutions to automate the
decision-making process, many have developed decision automation systems
internally rather than licensing them from outside vendors. There can be no
assurance that the markets for the Company's products will continue to develop
or that the Company's products will be widely accepted, if at all. If the
markets for the Company's new or existing products fail to develop, or
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<PAGE> 130
develop more slowly than anticipated, the Company's sales would be negatively
impacted, which would have a material adverse effect on the Company's business,
financial condition and results of operations.
CUSTOMER SERVICE AND SUPPORT
A high level of continuing maintenance, service and support is critical to
maintaining the performance of the Company's predictive software solutions.
Service and support are also essential to the Company's objective of developing
long-term relationships with, and obtaining recurring revenues from, customers.
The Company's service and support activities are related to system installation,
performance validation and ongoing consultation on the optimal use of HNC
products.
Model and Rule Updates. Most HNC product license agreements include
periodic data, model and/or rule updates to maintain system performance. HNC
technical personnel generally assist the customer with installation of updates.
The Company makes commitments to update models and rules at varying intervals,
from fixed times (such as quarterly and annually) to unscheduled times, provided
the customer has met its commitments to provide data to HNC.
Education. The Company offers comprehensive education and training programs
to its customers. The Company provides on-site training services associated with
many of its products. Fees for education and training services are generally
included in usage-priced products, but may be charged separately in other cases.
Consulting. The Company's consultants are available to work with customers'
user application groups and information systems organizations. Customers that
buy consulting services are usually planning large implementations or want to
optimize performance of the Company's products in their operating environments.
Fees for consulting are generally included in usage-priced products, but may be
charged separately in other cases.
PRICING
The Company generally establishes prices in one of two ways: usage-based
fees and fixed-fee licenses with maintenance. The Company generally employs
usage-based pricing for its healthcare/insurance products, Falcon, ProfitMax and
AREAS. Under the usage-based pricing structure, HNC generally provides a
fixed-term software license, software maintenance, model updates (in the case of
HNC-supplied models) and ongoing consulting services in exchange for recurring
revenue based on usage. Usage-based term contracts typically include annual
price index adjustments. In 1995, 1996 and 1997, recurring revenues from these
contracts represented 61.2%, 56.1% and 55.2% of the Company's total revenues,
respectively. The Company generally employs fixed-fee license pricing for
Capstone and all of the Company's retail products except Falcon Retail. Under
the fixed-fee license pricing structure, the Company generally licenses the
product for the customer's internal use on a perpetual basis. In most cases, the
user can separately contract for maintenance services on an annual basis. The
Company typically offers early adopter pricing for its usage-based products to
customers that agree to be part of pilot or other early product life cycle
installations. Early adopter pricing might include reduced-fee perpetual
licenses, reduced-fee services or both.
The Company often contracts for installation services associated with its
predictive software solutions. The Company provides user-specific proposals
priced at either fixed-fee levels or on a time and materials basis. In nearly
all cases, travel expenses are billed separately at cost.
The Company offers contract consulting services. Because of the complexity
associated with predictive software solutions, users often request that HNC help
them to develop models or analyze problems. Also, the Company from time to time
accepts engagements not associated with current product offerings in order to
become more familiar with a new application area and
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determine the potential for new product development. Although consulting
services are included with many of the Company's usage-based products, customers
may request additional consulting, often associated with custom modeling.
SALES AND MARKETING
The Company sells and markets its software and services in North America
and internationally through its direct sales organization, joint marketing and
distribution agreements. The Company's worldwide sales and marketing
organization consisted of 125 employees as of December 31, 1997. The domestic
sales staff is based at the Company's corporate headquarters in San Diego and in
United States field offices in California, Colorado, Connecticut, Georgia,
Minnesota, New York, Pennsylvania, Texas and Virginia. Internationally, the
Company has field sales offices in Australia, Canada, France, Germany, Japan,
Singapore, South Africa and the United Kingdom. To support its sales force, the
Company conducts comprehensive marketing programs, which include direct mail,
public relations, advertising, seminars, trade shows and ongoing customer
communication programs. The sales staff is generally product-based, and each
representative is assigned a geographic territory.
The Company has licensed First Data and EDS to act as service bureaus to
provide an alternate channel of distribution for end-users to utilize the Falcon
product to process credit card receipts for banks and other credit card issuers.
The Company generally assists its service bureau partners in the sales effort,
often employing the Company's direct sales force in the process. Company sales
representatives earn a commission for service bureau sales in their territory.
These service bureaus pay the Company monthly usage fees based on the volume of
transactions processed for such credit card issuers. Product licenses to First
Data, the largest provider of credit card charge receipt processing services to
banks, accounted for 8.7%, 8.6% and 7.6% of the Company's total revenues in
1995, 1996 and 1997, respectively. The Company has licensed First Data to
provide its customers with access to the Company's ProfitMax product pursuant to
a license agreement entered into in January 1996. The Company's revenues under
the ProfitMax Contract represented approximately one-quarter of the Company's
revenues from First Data in 1997. In late January 1998, First Data asserted that
certain restrictive covenants under the ProfitMax Contract violated certain
intellectual property laws. First Data also asserted that the existence of such
restrictions made the ProfitMax Contract at least temporarily unenforceable and
that First Data is therefore not obligated to pay the Company license fees due
under the ProfitMax contract. The Company disputed First Data's claim, released
and waived the above-mentioned restrictive covenants in the ProfitMax Contract
and gave First Data written notice that the Company intended to terminate the
ProfitMax Contract pursuant to its terms unless First Data cured its failure to
pay the delinquent license fees in a timely manner. Currently, First Data and
the Company are working to resolve their dispute regarding the ProfitMax
Contract by negotiating a new agreement. First Data has resumed making license
fee payments on a delayed basis, and HNC has agreed to extend the date for First
Data to pay past due license fees until mid-April 1998. Although HNC expects to
reach a new agreement with First Data that will resolve the pending dispute,
there can be no assurance that such an agreement will be reached or that the
terms of such an agreement would be as favorable to HNC as its existing
contractual arrangements with First Data. If no such agreement can be reached
and First Data maintains its current position, it is possible that litigation or
arbitration could ensue, which would likely result in a loss of anticipated
revenue to the Company under the ProfitMax Agreement and possibly other
agreements between the Company and First Data, which could have a material
adverse affect on the Company's business, financial condition and results of
operation.
The Company also uses representative agents for certain products in certain
territories outside of North America. The Company has agents covering Australia,
Austria, France, Germany, Italy, New Zealand, Spain and Switzerland. In 1995,
1996 and 1997, international operations and export sales (includes sales in
Canada) represented 12.6%, 17.7% and 16.8% of the Company's total revenues,
respectively. International sales result primarily from Falcon product sales and
sales of
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retail products. The Company intends to continue to expand its operations
outside the United States and to enter additional international markets,
including by adding sales and support offices in Europe and Japan, which will
require significant management attention and financial resources. The Company
has committed and continues to commit significant time and development resources
to customizing certain of its products for selected international markets and to
developing international sales and support channels. There can be no assurance
that the Company's efforts to develop products, databases and models for
targeted international markets or to develop additional international sales and
support channels will be successful. The failure of such efforts, which can
entail considerable expense, could have a material adverse effect on the
Company's business, financial condition and results of operations. See "Risk
Factors -- Risks Associated with International Sales."
International sales are subject to additional inherent risks, including
longer payment cycles, unexpected changes in regulatory requirements, import and
export restrictions and tariffs, difficulties in staffing and managing foreign
operations, the burdens of complying with a variety of foreign laws, greater
difficulty or delay in accounts receivable collection, potentially adverse tax
consequences and political and economic instability. The Company's international
sales are currently denominated predominantly in United States dollars and a
small portion are denominated in British pounds sterling. An increase in the
value of the United States dollar relative to foreign currencies could make the
Company's products more expensive, and therefore potentially less competitive,
in foreign markets. In the future, to the extent the Company's international
sales are denominated in local currencies, foreign currency translations may
contribute to significant fluctuations in the Company's business, financial
condition and results of operations. If for any reason exchange or price
controls or other restrictions on foreign currencies are imposed, the Company's
business, financial condition and results of operations could be materially
adversely affected.
Due in part to the mission-critical nature of certain of the Company's
applications, potential customers perceive high risk in connection with adoption
of the Company's products. As a result, customers have been cautious in making
decisions to acquire the Company's products. In addition, because the purchase
of the Company's products typically involves a significant commitment of capital
and may involve shifts by the customer to a new software and/or hardware
platform, delays in completing sales can arise while customers complete their
internal procedures to approve large capital expenditures and test and accept
new technologies that affect key operations. For these and other reasons, the
sales cycle associated with the purchase of the Company's products is typically
lengthy, unpredictable and subject to a number of significant risks over which
the Company has little or no control, including customers' budgetary constraints
and internal acceptance reviews. The sales cycle associated with the licensing
of the Company's products can typically range from 60 days to 18 months. As a
result of the length of the sales cycle and the typical size of customers'
orders, the Company's ability to forecast the timing and amount of specific
sales is limited. A lost or delayed sale could have a material adverse effect on
the Company's business, financial condition and results of operations.
TECHNOLOGY
The Company seeks to develop innovative products by combining industry and
application knowledge with its core neural-network technology to address
specific market needs. The Company's systems also employ rule-based technology
to implement customer strategy, policy and procedures. These technologies are
incorporated in computer software and hardware architectures, including
client-server hardware, relational databases and object-oriented programming.
The Company intends to continue to develop state-of-the-art technologies to
enhance its current products and broaden development opportunities.
Neural-Network Technology. Neural networks have predictive power that can
be improved with experience as the historical database increases in size. The
term "neural network" refers to a family of nonlinear, statistical modeling
techniques, sometimes called "computational intelli-
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gence." These techniques distinguish themselves through a process of automated
"learning" or "training" that replaces the time-consuming manual techniques of
traditional nonlinear, statistical modeling. The neural-network architecture
itself consists of groups of "processing elements," or equations with several
inputs and a single output. The output of each element becomes either the input
to another element or part of the dependent output. Each input receives a
"weight" or value, in the equation, which is adjusted during the training
process. The actual result from each training record is compared with the answer
from the neural network, and the weights are adjusted to reduce the error
between the two. This process can become computationally intensive, as millions
of training data records must be processed hundreds or thousands of times. HNC
has developed proprietary high-speed and parallel-processor boards to accelerate
training and execution of its neural-network software. The Company believes that
the rapid model development afforded by its technology provides a competitive
advantage in the development of predictive software solutions.
Rule-Based Technology. The Company's systems also employ rule-based
technology to implement customer strategy, policy and procedures. The rules are
implemented as part of predictive processes. The Company believes that its
combination of neural networks and rule bases in a single decision engine
represents a significant competitive advantage over more traditional approaches
to decision automation.
Context Vector Technology. Context vector technology that originated at HNC
and is being commercialized at Aptex is a way to explore, analyze and model
unstructured textual data. Context vector technology automatically discovers the
underlying structure of free form symbolic data. This structure enables modeling
from data elements previously considered impossible to include in predictive
software applications. Context vector technology also models behavior. Just as
relationships are discovered in unstructured data, observing electronic
transaction behavior identifies patterns. Compatibility predictions can be made
between information, behavior, people and products. When combined with other HNC
technologies, such as neural networks and rule-based systems, the Company
believes that context vectors can improve the performance of existing
applications while opening new market opportunities. Context vector technology
has been demonstrated to increase banner advertising click rates on the
Internet, automate e-mail responses and discover unknown relationships in credit
card transaction data.
The Company's success depends upon its ability to enter new markets by
successfully developing new products for such markets on a timely and
cost-effective basis. The Company's products often require customer data for
decision model development and system installation. As a result, completion of
new products (particularly new products for markets not previously served by the
Company) may be delayed while the Company extracts sufficient amounts of
statistically relevant data and develops the models. During this development
process, the Company relies on its potential customers in the new market to
provide data and to help train Company personnel in the use and meaning of the
data in the specific industry. These relationships also assist the Company in
establishing a market presence and credibility in the new market. These
potential customers, most of which have significantly greater financial and
marketing resources than the Company, may compete with the Company in the future
or otherwise discontinue their relationships with or support of the Company,
either during development of the Company's products or thereafter. The failure
by the Company to obtain adequate third-party support for new product
development would have a material adverse effect on the Company's ability to
enter new markets and, consequently, on the Company's business, financial
condition and results of operations. See "Risk Factors -- Risks Associated with
Technological Change and Delays in Developing New Products."
RESEARCH AND DEVELOPMENT
The Company believes that its future success depends in part on its ability
to maintain and improve its core technologies, enhance its existing products and
develop new products that meet an expanding range of markets and customer
requirements. The Company intends to expand its
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existing product offerings and to introduce new predictive software solutions.
In the development of new products and enhancements to existing products, the
Company uses its own tools extensively. Until 1996, the Company relied primarily
on internal development of its products. Based on timing and cost
considerations, however, the Company has acquired, and in the future may
consider acquiring, technology or products from third parties. For example, the
Company acquired technology and products in connection with its acquisitions of
Risk Data and Retek in 1996 and CompReview in 1997.
The Company performs all quality assurance and develops documentation
internally. The Company intends to continue to support industry standard
operating environments, client-server architectures and network protocols. The
Company's specialists in neural network model development, software engineering,
user interface design, product documentation and quality improvement are
responsible for maintaining and enhancing the performance, quality and usability
of all HNC predictive software solutions. The marketing services organization is
responsible for authoring and updating all user documentation and other
publications. See "Risk Factors -- Risks Associated with Technological Change
and Delays in Developing New Products."
The Company strategically targets its long-term research projects. In
addition to funds allocated by the Company for research, HNC receives research
contracts from a range of commercial sources and the United States Government.
Government and commercial contract customers have included the Advanced Research
Projects Agency, United States Air Force, Office of Naval Research and Tracor
Applied Sciences, Inc. The Company believes that these contracts augment its
ability to maintain existing technologies and investigate new technologies that
may or may not become part of its products. The United States Government
typically retains certain intellectual property rights and licenses in the
technologies the Company develops under research contracts directly or
indirectly sponsored by the government, and in some cases can terminate the
Company's rights in such technologies if the Company fails to commercialize them
on a timely basis. Historically, these contracts have not resulted in
development of products contributing to the Company's revenues in the fiscal
year in which the research contract is performed, or in the subsequent fiscal
year.
The market for the Company's predictive software solutions for service
industries is characterized by rapidly changing technology and improvements in
computer hardware, network operating systems, programming tools, programming
languages, operating systems and database technology. The Company's success will
depend upon its ability to continue to develop and maintain competitive
technologies, enhance its current products and develop, in a timely and
cost-effective manner, new products that meet changing market conditions,
including evolving customer needs, new competitive product offerings, emerging
industry standards and changing technology. For example, the rapid growth of the
Internet environment creates new opportunities, risks and uncertainties for
businesses, such as the Company, which develop software solutions that now may
have to be designed to operate in Internet, intranet and other on-line
environments. The Company may not be able to develop and market, on a timely
basis, or at all, product enhancements or new products that respond to changing
technologies. The Company has previously experienced significant delays in the
development and introduction of new products and product enhancements, primarily
due to difficulties with model development, which has in the past required
multiple iterations, as well as difficulties with acquiring data and adapting to
particular operating environments. The length of these delays has varied
depending upon the size and scope of the project and the nature of the problems
encountered. Any significant delay in the completion of new products, or the
failure of such products, if and when installed, to achieve any significant
degree of market acceptance, would have a material adverse effect on the
Company's business, financial condition and results of operations. Any failure
by the Company to anticipate or to respond adequately to changing technologies,
or any significant delays in product development or introduction, could cause
customers to delay or decide against purchases of the Company's products and
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would have a material adverse effect on the Company's business, financial
condition and results of operations.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company relies on a combination of patent, copyright, trademark and
trade secret laws and confidentiality procedures to protect its proprietary
rights. The Company currently owns seven issued United States patents and has
four United States patent applications pending. The Company has applied for
additional patents for its Falcon technology in Canada, Europe and Japan and for
its MIRA product in Australia, Canada and Europe. There can be no assurance that
patents will be issued with respect to pending or future patent applications or
that the Company's patents will be upheld as valid or will prevent the
development of competitive products. The Company seeks to protect its software,
documentation and other written materials under trade secret and copyright laws,
which afford only limited protection. As part of its confidentiality procedures,
the Company generally enters into invention assignment and proprietary
information agreements with its employees and independent contractors and
nondisclosure agreements with its distributors, corporate partners and
licensees, and limits access to and distribution of its software, documentation
and other proprietary information. Despite these precautions, it may be possible
for a third party to copy or otherwise to obtain and use the Company's products
or technology without authorization, or to develop similar technology
independently. In addition, to ensure that customers will not be adversely
affected by an interruption in the Company's business, the Company places source
code for certain of its products into escrow, which may increase the likelihood
of misappropriation or other misuse of the Company's intellectual property.
Moreover, effective protection of intellectual property rights may be
unavailable or limited in certain foreign countries in which the Company has
done and may do business. Also, the Company has developed technologies under
research projects conducted under agreements with various United States
Government agencies or subcontractors to such agencies. Although the Company has
acquired certain commercial rights to such technologies, the United States
Government typically retains ownership of certain intellectual property rights
and licenses in the technologies developed by the Company under such contracts,
and in some cases can terminate the Company's rights in such technologies if the
Company fails to commercialize them on a timely basis. In addition, under
certain United States Government contracts, the results of the Company's
research may be made public by the government, which could limit the Company's
competitive advantage with respect to future products based on such research.
In the past, the Company has received communications from third parties
asserting that Company trademarks infringe such other parties' trademarks, none
of which has resulted in litigation or losses to the Company. Given the
Company's ongoing efforts to develop and market new technologies and products,
the Company may receive communications from third parties asserting that the
Company's products infringe, or may infringe, their intellectual property
rights. If as a result of any such claims the Company were precluded from using
certain technologies or intellectual property rights, licenses to such disputed
third-party technology or intellectual property rights might not be available on
reasonable commercial terms, if at all. Furthermore, the Company may initiate
claims or litigation against third parties for infringement of the Company's
proprietary rights or to establish the validity of the Company's proprietary
rights. Litigation, either as plaintiff or defendant, could result in
significant expense to the Company and divert the efforts of the Company's
technical and management personnel from productive tasks, whether or not such
litigation is resolved in favor of the Company. In the event of an adverse
ruling in any such litigation, the Company might be required to pay substantial
damages, discontinue the use and sale of infringing products, expend significant
resources to develop non-infringing technology or obtain licenses to infringing
technology, and the court might invalidate the Company's patents, trademarks or
other proprietary rights. In the event of a successful claim against the Company
and the failure of the Company to develop or license a substitute technology,
the Company's business, financial condition and results of operations would be
materially and adversely affected.
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As the number of software products increases and the functionality of these
products further overlaps, the Company believes that software developers may
become increasingly subject to infringement claims. Any such claims, with or
without merit, can be time consuming and expensive to defend and could
materially and adversely affect the Company's business, financial condition and
results of operations.
COMPETITION
The market for predictive software solutions for service industries is
intensely competitive and subject to rapid change. Competitors, many of which
have substantially greater financial resources than the Company, vary in size
and in the scope of the products and services they offer. The Company encounters
competition from a number of sources, including (i) other application software
companies, (ii) management information systems departments of customers and
potential customers, including banks, insurance companies and retailers, (iii)
third party professional services organizations, including without limitation,
consulting divisions of public accounting firms, (iv) hardware suppliers that
bundle or develop complementary software, (v) network and service providers that
seek to enhance their value-added services, (vi) neural-network tool suppliers,
and (vii) managed care organizations. In the healthcare/insurance market, the
Company has experienced competition primarily from NCCI, Corporate Systems and
CSC Incorporated. In the workers' compensation and medical cost administration
market, the Company has experienced competition from MediCode, Medata, Inc. and
Embassy Software with regard to software licensing, and Intracorp and Corvel
Corporation in the service bureau operations market. Additionally, the Company
has faced competition from ADP in the automobile accident medical claims market.
In the financial services market, the Company has experienced competition from
Fair, Isaac & Co., Inc., Cogensys (a subsidiary of Policy Management Systems
Corporation), Fannie Mae, Freddie Mac, IBM, Nestor, Inc., NeuralTech Inc.,
Neuralware Inc., PMI Mortgage Services Co., VISA International and others. In
the retail market, the Company has experienced competition from JDA Software
Group, Inc., SAP AG, PeopleSoft, Inc., IBM, Manugistics Group, Inc. and others.
The Company expects to experience additional competition from other established
and emerging companies, as well as other technologies. For example, the
Company's Falcon product competes against other methods of preventing credit
card fraud, such as card activation programs, credit cards that contain the
cardholder's photograph, smart cards and other card authorization techniques.
Increased competition, whether from other products or new technologies, could
result in price reductions, fewer customer orders, reduced gross margins and
loss of market share, any of which could materially adversely affect the
Company's business, financial condition and results of operations.
The Company believes that most of its products are currently priced at a
premium when compared to its competitors' products. The market for the Company's
products is highly competitive, and the Company expects that it will face
increasing pricing pressures from its current competitors and new market
entrants. In particular, increased competition could reduce or eliminate such
premiums and cause further price reductions. In addition, such competition could
adversely affect the Company's ability to obtain new long-term contracts and
renewals of existing long-term contracts on terms favorable to the Company. Any
reduction in the price of the Company's products could materially adversely
affect the Company's business, financial condition and results of operations.
The Company believes that the principal competitive factors affecting its
market include technical performance (for example, accuracy in detecting credit
card fraud or evaluating workers' compensation claims), access to unique
proprietary databases and product attributes such as adaptability, scalability,
ability to integrate with products produced by other vendors, functionality,
ease-of-use, product reputation, quality, performance, price, customer service
and support, the effectiveness of sales and marketing efforts and Company
reputation. Although the Company believes that its products currently compete
favorably with respect to such factors, there can be
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no assurance that the Company can maintain its competitive position against
current and potential competitors, especially those with significantly greater
financial, marketing, service, support, technical and other resources.
Some of the Company's current, and many of the Company's potential,
competitors have significantly greater financial, technical, marketing and other
resources than the Company. As a result, they may be able to respond more
quickly to new or emerging technologies and changes in customer requirements or
to devote greater resources to the development, promotion and sale of their
products than the Company. In addition, current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties to increase the ability of their products to address the needs of
the Company's prospective customers. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly gain
significant market share. Also, the Company relies upon its customers to provide
data, expertise and other support for the ongoing updating of the Company's
models. The Company's customers, most of which have significantly greater
financial and marketing resources than the Company, may compete with the Company
in the future or otherwise discontinue their relationships with or support of
the Company. There can be no assurance that the Company will be able to compete
successfully against current and future competitors or that competitive
pressures faced by the Company will not materially adversely affect its
business, financial condition and results of operations.
EMPLOYEES
As of December 31, 1997, the Company had 706 employees, including 316 in
product development and support, 87 in customer service, 125 in sales and
marketing and 178 in finance, administration and MIS. Most of these employees
are located in the United States. None of the Company's employees are
represented by a labor union. The Company has experienced no work stoppages and
believes that its employee relationships are generally good.
The Company's success depends to a significant degree upon the continued
service of members of the Company's senior management and other key research,
development, sales and marketing personnel. Accordingly, the loss of any of the
Company's senior management or key research, development, sales or marketing
personnel could have a material adverse effect on the Company's business,
financial condition and results of operations. Only a small number of employees
have employment agreements with the Company, and there can be no assurance that
such agreements will result in the retention of these employees for any
significant period of time. In addition, the untimely loss of a member of the
management team or a key employee of a business acquired by the Company could
have a material adverse effect on the Company's business, financial condition
and results of operations, particularly if such loss occurred before the Company
has had adequate time to familiarize itself with the operating details of that
business. In the past, the Company has experienced difficulty in recruiting a
sufficient number of qualified sales and technical employees. In addition,
competitors may attempt to recruit the Company's key employees. There can be no
assurance that the Company will be successful in attracting, assimilating and
retaining such personnel. The failure to attract, assimilate and retain key
personnel could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Risk Factors -- Risks
Associated with Managing Growth."
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FACILITIES
The Company's principal administrative, sales, marketing, support, research
and development facilities are located in approximately 85,000 square feet of
space in San Diego, California. The Company and its subsidiaries also lease an
aggregate of approximately 95,000 square feet of additional office space
elsewhere in San Diego and in Atlanta, Georgia; Minneapolis, Minnesota; Costa
Mesa, California; and Irvine, California. The Company and its subsidiaries also
maintain numerous field offices in the United States and in foreign countries.
The Company believes that its current facilities are adequate to meet its needs
for the foreseeable future. The Company believes that suitable additional or
alternative space will be available in the future on commercially reasonable
terms as needed.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The names, ages and positions of the Company's directors and executive
officers as of February 17, 1998 are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
------------------------------------------ --- -----------------------------------------------
<S> <C> <C>
Robert L. North........................... 62 President, Chief Executive Officer and Director
Raymond V. Thomas......................... 55 Vice President, Finance and Administration,
Chief Financial Officer and Secretary
John Mutch................................ 41 Vice President, Marketing
Todd W. Gutschow.......................... 37 Vice President, Technology Development
Michael A. Thiemann....................... 41 President, Aptex Software Inc.
Edward K. Chandler(1)..................... 39 Director
Oliver D. Curme(2)........................ 44 Director
Thomas F. Farb(1)......................... 41 Director
Charles H. Gaylord, Jr.(2)................ 52 Director
</TABLE>
- ---------------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
Mr. North has been President and Chief Executive Officer and a director of
the Company since June 1987. Mr. North is also a director of Peerless Systems
Corporation. Mr. North holds Bachelor of Science and Master of Science degrees
in Electrical Engineering from Stanford University.
Mr. Thomas has been Vice President, Finance and Administration and Chief
Financial Officer of the Company since February 1995 and Secretary of the
Company since May 1995. From May 1993 to February 1995, he served as Executive
Vice President and Chief Financial Officer of Golden Systems, Inc., a power
supply manufacturer, and from September 1994 to February 1995 he also served as
Chief Operating Officer. From April 1991 to May 1993, Mr. Thomas served as
Senior Vice President of Finance and Administration and Chief Financial Officer
of Vitesse Semiconductor Corporation, a semiconductor manufacturer. Mr. Thomas
holds a Bachelor of Science degree in Industrial Management from Purdue
University and attended the Wharton School of Business at the University of
Pennsylvania.
Mr. Mutch joined the Company in July 1997 as Vice President, Marketing. He
was a founder of MVenture Holdings, Inc., a private equity fund that invests in
start-up technology companies, and served as a General Partner from June 1994 to
July 1997. From December 1986 to June 1994, Mr. Mutch held a variety of
positions with Microsoft Corporation, including Director of Organization
Marketing. He holds a Bachelor of Science degree in Applied Economics from
Cornell University and a Masters degree in Business Administration from the
University of Chicago.
Mr. Gutschow is a co-founder of the Company and has been Vice President,
Technology Development of the Company since October 1990. He was also Secretary
of the Company from January 1993 to May 1995. Mr. Gutschow holds a Bachelor of
Arts degree in Physics from Harvard University and attended the University of
California at San Diego.
Mr. Thiemann joined the Company in June 1989. He ran the Company's Aptex
text analysis division from January 1996 to September 1996 and in September 1996
was named President and Chief Executive Officer of Aptex Software Inc. From May
1993 to January 1996, he served as Executive Vice President, Sales and Marketing
of the Company. He has also served as Executive Vice President and General
Manager, Decision Systems of the Company from January 1993 to May 1993, Vice
President and General Manager, Decision Systems of the Company from February
1990 to January 1993 and Vice President, New Business Development of the Company
from June 1989 to February 1990. Mr. Thiemann holds a Bachelor of Arts degree in
Art, a Bachelor of Science degree in Electrical Engineering and a Masters degree
in Electrical
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Engineering from Stanford University and a Masters degree in Business
Administration from Harvard University.
Mr. Chandler has been a director of the Company since August 1991. Since
July 1991, he has been President of Prairie-EKC, Inc., a partner of the general
partner of PCE 1991 Limited Partnership, a venture capital firm. Since November
1996, Mr. Chandler has also been a Managing Director of Graystone Venture
Partners, LLC, a venture capital firm. Mr. Chandler holds a Bachelor of Arts
degree in Economics from Yale University and a Masters degree in Business
Administration from Harvard University.
Mr. Curme has been a director of the Company since June 1987. Since January
1988, he has been a general partner of the general partner of Battery Ventures,
L.P., a national venture capital firm. Mr. Curme also serves as a director of
several privately held technology companies. Mr. Curme is also a director of
InfoSeek Corporation, an Internet search and navigation service company. He
holds a Bachelor of Science degree in Biochemistry from Brown University and a
Masters degree in Business Administration from Harvard University.
Mr. Farb has been a director of the Company since November 1987. Since
April 1994, he has been Senior Vice President, Chief Financial Officer and
Treasurer of Interneuron Pharmaceuticals, Inc., a publicly-held diversified
pharmaceutical company, and an officer of several of its subsidiaries. From
October 1992 to March 1994, Mr. Farb served as Vice President of Corporate
Development, Chief Financial Officer and Controller of Cytyc Corporation, a
medical device and diagnostics company. Mr. Farb also serves as a director of
Redwood Trust, Inc., a California-based publicly-held Real Estate Investment
Trust. He holds a Bachelor of Arts degree in Sociology from Harvard College.
Mr. Gaylord has been a director of the Company since May 1995. He is
currently a private technology investor and a director of Stac Inc., a
publicly-held software company. From December 1993 to September 1994, Mr.
Gaylord served as Executive Vice President of Intuit Inc., a publicly-held
personal and small business finance software company, following Intuit's
acquisition of ChipSoft, Inc., a tax preparation software company. Prior to that
acquisition, from June 1990 to December 1993, he served first as President and
Chief Executive Officer and a director of ChipSoft and then as Chairman of the
Board of Directors and Chief Executive Officer. He holds Bachelor of Science and
Master of Science degrees in Aerospace Engineering from Georgia Institute of
Technology and a Masters degree in Business Administration from Harvard
University.
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SELLING STOCKHOLDERS
The following table sets forth certain information known to the Company
regarding beneficial ownership of the Company's Common Stock by each Selling
Stockholder as of December 31, 1997, and as adjusted to reflect the sale of
shares offered pursuant to this Prospectus.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY NUMBER OF SHARES BENEFICIALLY
OWNED PRIOR TO SHARES BEING OWNED AFTER
OFFERING(1) OFFERED OFFERING(1)(2)
-------------------- ------------ --------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT NUMBER PERCENT
- ---------------------------------- --------- ------- --------- -------
<S> <C> <C> <C> <C> <C>
Robert L. Kaaren(3)............... 2,442,780 9.9% 735,000 1,707,780 7.0%
Michael E. Munayyer, Trustee of
the Michael Munayyer Trust dated
August 11, 1995(4).............. 2,442,780 9.9 735,000 1,707,780 7.0%
Oliver D. Curme(5)................ 18,936 * 10,000 8,936 *
</TABLE>
- ---------------
* Less than 1.0%.
(1) Based upon a total of 24,537,550 shares of Common Stock outstanding as of
December 31, 1997. Unless otherwise indicated below, the persons and
entities named in the table have sole voting and sole investment power with
respect to all shares beneficially owned, subject to community property laws
where applicable. Shares of Common Stock subject to options that are
currently exercisable or exercisable within 60 days of December 31, 1997 are
deemed to be outstanding and to be beneficially owned by the person holding
such options for the purpose of computing the percentage ownership of such
person but are not treated as outstanding for the purpose of computing the
percentage ownership of any other person.
(2) Assumes that the Underwriters' over-allotment option to purchase up to an
aggregate of 225,000 shares is not exercised. If the over-allotment option
is exercised, Messrs. Kaaren and the Michael Munayyer Trust will each sell
847,500 shares, and own 1,595,280 shares or 6.5% of the Company's
outstanding Common Stock following this offering.
(3) Dr. Kaaren is the Chairman and Chief Executive Officer of CompReview. The
address of Dr. Kaaren is c/o CompReview, Inc., 3200 Park Center Drive, 5th
Floor, Costa Mesa, CA 92626.
(4) Mr. Munayyer is the Chief Technical Officer of CompReview. The address of
Mr. Munayyer and the Michael Munayyer Trust is c/o CompReview, Inc., 3200
Park Center Drive, 5th Floor, Costa Mesa, CA 92626.
(5) Includes 10,000 shares of Common Stock subject to options exercisable within
60 days of December 31, 1997. Mr. Curme is a director of the Company.
46
<PAGE> 142
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 50,000,000 shares
of Common Stock and 4,000,000 shares of Preferred Stock. As of December 31,
1997, there were 24,537,550 outstanding shares of Common Stock held of record by
approximately 186 stockholders and options to purchase 4,591,133 shares of
Common Stock.
COMMON STOCK
Subject to preferences that may apply to any Preferred Stock outstanding at
the time, the holders of outstanding shares of Common Stock are entitled to
receive dividends out of assets legally available therefor at such times and in
such amounts as the Board of Directors may from time to time determine. Each
stockholder is entitled to one vote for each share of Common Stock held on all
matters submitted to a vote of stockholders. Cumulative voting for the election
of directors is not provided for in the Company's Certificate of Incorporation,
which means that the holders of a majority of the shares voted can elect all of
the directors then standing for election. The Common Stock is not entitled to
preemptive rights and is not subject to conversion or redemption. Upon
liquidation, dissolution or winding-up of the Company, the assets legally
available for distribution to stockholders are distributable ratably among the
holders of the Common Stock and any participating Preferred Stock outstanding at
that time after payment of liquidation preferences, if any, on any outstanding
Preferred Stock and payment of other claims of creditors. Each outstanding share
of Common Stock is fully paid and nonassessable. The Company's Common Stock is
traded on the Nasdaq National Market under the symbol "HNCS."
PREFERRED STOCK
The Board of Directors is authorized, subject to any limitations prescribed
by Delaware law, to provide for the issuance of additional shares of Preferred
Stock in one or more series, to establish from time to time the number of shares
to be included in each such series, to fix the powers, designations, preferences
and rights of the shares of each wholly unissued series and any qualifications,
limitations or restrictions thereon, and to increase or decrease the number of
shares of any such series (but not below the number of shares of such series
then outstanding), without any further vote or action by the stockholders. The
Board of Directors may authorize the issuance of Preferred Stock with voting or
conversion rights that could adversely affect the voting power of other rights
of the holders of Common Stock. Thus, the issuance of Preferred Stock could have
the effect of delaying, deferring or preventing a change in control of the
Company. The Company has no current plan to issue any shares of Preferred Stock.
DELAWARE GENERAL CORPORATION LAW SECTION 203
As a corporation organized under the laws of the State of Delaware, the
Company is subject to Section 203 of the Delaware General Corporation Law (the
"DGCL"), which restricts certain business combinations between the Company and
an "interested stockholder" (in general, a stockholder owning 15% or more of the
Company's outstanding voting stock) or its affiliates or associates for a period
of three years following the date on which the stockholder becomes an
"interested stockholder." The restrictions do not apply if (i) prior to an
interested stockholder becoming such, the Board of Directors approves either the
business combination or the transaction in which the stockholder becomes an
interested stockholder, (ii) upon consummation of the transaction in which the
stockholder becomes an interested stockholder, such interested stockholder owns
at least 85% of the voting stock of the Company outstanding at the time the
transaction commences (excluding shares owned by certain employee stock
ownership plans and persons who are both directors and officers of the Company)
or (iii) on or subsequent to the date an interested stockholder becomes such,
the business combination is both approved by the Board of Directors and
authorized at an annual or special meeting of the Company's stockholders, not by
47
<PAGE> 143
written consent, but by the affirmative vote of at least 66 2/3% of the
outstanding voting stock not owned by the interested stockholder.
REGISTRATION RIGHTS; EXISTING SHELF REGISTRATION
1994 Registration Rights Agreement. Certain holders of outstanding shares
of Common Stock who are parties to the Company's Third Amended Registration
Rights Agreement dated April 26, 1994 (the "1994 Registration Rights Agreement")
have contractual rights to have certain shares of the Company's Common Stock
registered under the Securities Act. To the Company's best knowledge, based
solely on its review of its current stockholders of record, parties to the 1994
Registration Rights Agreement together own approximately 412,666 shares of
Common Stock that may be registered pursuant to the 1994 Registration Rights
Agreement (the "Registrable Shares"). If requested by holders of at least 50% of
the outstanding Registrable Shares, the Company must file a registration
statement under the Securities Act covering all Registrable Shares requested to
be included by all holders thereof. For purposes of exercising such demand
registration rights, the Registrable Shares do not include any shares of Common
Stock that were issued upon the conversion of formerly outstanding shares of the
Company's Series A Preferred Stock. The Company may be required to effect up to
four such demand registrations of Registrable Shares, plus one additional such
registration for each registration that does not include at least 80% of the
Registrable Shares requested to be included. All expenses incurred in connection
with such registrations (other than underwriters' discounts and commissions)
will be borne by the Company until there have been two such registrations that
include at least 80% of the Registrable Shares requested to be included. In
addition, if the Company proposes to register any of its securities under the
Securities Act (other than in connection with a Company employee benefit plan or
a business combination), the holder of Registrable Shares may require the
Company to include all or a portion of such shares in such registration,
although the managing underwriter of any such offering has certain rights to
limit the number of shares in such registration. All expenses incurred in
connection with such registrations (other than underwriters' discounts and
commissions) will be borne by the Company. If the Company is eligible to use
Form S-3 to register its shares, any holder or holders of Registrable Shares who
hold at least 10% of the Registrable Shares originally issued may request the
Company to register such shares on a Form S-3 registration statement, provided
the reasonably anticipated aggregate offering price of such shares exceeds
$500,000. The Company is not obligated to effect more than two such Form S-3
registrations in any calendar year. All expenses of such Form S-3 registrations
must be borne by the selling stockholders. The registration rights under the
1994 Registration Rights Agreement expire in July 2000.
Risk Data Registration Rights. Pursuant to a Registration Rights Agreement
dated August 30, 1996, former stockholders of Risk Data who hold at least 30% of
the shares of the Company's Common Stock that were issued in the Risk Data
acquisition and have not been publicly resold ("Risk Data Shares") may request
the Company to register such shares under the Securities Act on a Form S-3
registration statement, provided the aggregate public offering price of such
shares is at least $2,000,000. The Company is not obligated to register any
holder's Risk Data Shares if all such shares may be resold within a three-month
period under Rule 144 or Rule 145(d) of the Securities Act. The Company may be
required to effect up to two such Form S-3 registrations and will bear all
expenses incurred in connection with such registrations. These registration
rights expire on August 31, 1998.
CompReview Registration Rights. Pursuant to a Registration Rights Agreement
dated November 28, 1997, the former stockholders of CompReview are entitled to
have the shares of the Company's Common Stock that were issued to them in the
CompReview acquisition ("CompReview Shares") registered, at the Company's
expense, on a shelf registration statement on Form S-3 pursuant to Rule 415
under the Securities Act (the "CompReview Shelf Registration"). The Company
expects to file the CompReview Shelf Registration in the near future. Under
48
<PAGE> 144
the CompReview Registration Rights Agreement, once the former CompReview
stockholders have together sold an aggregate combined total of 1,250,000
CompReview Shares, sales of CompReview Shares may be made pursuant to the
CompReview Shelf Registration only during certain time periods after advance
notice to the Company. The Company is not obligated to maintain the
effectiveness of the CompReview Shelf Registration after November 28, 1998
unless, pursuant to the CompReview registration rights agreement, the Company
exercises its rights to defer a requested sale of CompReview Shares, in which
case the time period during which the CompReview Shelf Registration must be kept
effective must be extended by a period of time equal to the period of deferral.
Retek Shelf Registration. Pursuant to a Registration Rights Agreement dated
October 25, 1996, as amended, the Company has filed a Form S-3 registration
statement pursuant to Rule 415 under the Securities Act (the "Retek Shelf
Registration"), covering the sale of the shares of the Company's Common Stock
issued in the Retek acquisition (the "Retek Shares"). Sales of Retek Shares may
be made pursuant to the Retek Shelf Registration only during certain time
periods after advance notice to the Company. The Company is not obligated to
maintain the effectiveness of the Retek Shelf Registration after November 29,
1998 unless, pursuant to the Retek registration rights agreement, the Company
exercises its rights to defer a requested sale of Retek Shares, in which case
the time period during which the Retek Shelf Registration must be kept effective
must be extended by a period of time equal to the period of deferral.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Company's Common Stock is
BancBoston, N.A.
49
<PAGE> 145
UNDERWRITING
The Underwriters named below have severally agreed, subject to the terms
and conditions contained in the Underwriting Agreement (the form of which will
be filed as an exhibit to the Company's Registration Statement, of which this
Prospectus is a part), to purchase from the Company and the Selling Stockholders
the respective number of shares of Common Stock indicated below opposite their
respective names. The Underwriters are committed to purchase all of the shares
(other than those covered by the Underwriters' over-allotment option described
below), if they purchase any.
<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES
------------------------------------------------------- ---------
<S> <C>
Deutsche Morgan Grenfell Inc...........................
BancAmerica Robertson Stephens.........................
Smith Barney Inc.......................................
---------
Total........................................ 1,500,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters thereunder are subject to approval of certain legal matters by
counsel and to various other conditions.
The Underwriters have advised the Company that the Underwriters propose
initially to offer the Common Stock to the public on the terms set forth on the
cover page of this Prospectus. The Underwriters may allow to selected dealers
(who may include the Underwriters) a concession of not more than $ per
share. The selected dealers may reallow a concession of not more than $ per
share to certain other dealers. After the initial offering of the shares, the
price and concessions and re-allowances to dealers and other selling terms may
be changed by the Underwriters. The Common Stock is offered subject to receipt
and acceptance by the Underwriters, and to certain other conditions, including
the right to reject orders in whole or in part. The Underwriters do not intend
to sell any of the shares of Common Stock offered hereby to accounts for which
they exercise discretionary authority.
Certain of the Selling Stockholders have granted an option to the
Underwriters to purchase up to a maximum of 225,000 additional shares of Common
Stock to cover over-allotments, if any, at the public offering price, less the
underwriting discount set forth on the cover page of this Prospectus. Such
option may be exercised at any time until 30 days after the date of the
Underwriting Agreement. To the extent the Underwriters exercise this option,
each of the Underwriters will be committed, subject to certain conditions, to
purchase such additional shares in approximately the same proportion as set
forth in the above table. The Underwriters may purchase such shares only to
cover over-allotments made in connection with this offering.
In connection with this offering, the Company, the directors and executive
officers of the Company and the Selling Stockholders have agreed, during the
period ending 90 days after the date of this Prospectus, not to (i) offer,
pledge, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant to
purchase, or otherwise transfer, lend or dispose of, directly or indirectly, any
shares of Common Stock or any securities convertible into or exercisable or
exchangeable for Common Stock or (ii) enter into any swap or other arrangement
that transfers to another, in whole or in part, any of the economic consequences
of ownership of the Common Stock, whether any such transaction described in
clause (i) or (ii) above is to be settled by delivery of Common Stock or such
other securities, in cash or otherwise, except under certain limited
circumstances or without the prior written consent of Deutsche Morgan Grenfell
Inc.
The Underwriters are also currently offering $75.0 million of the Company's
Notes and intend to enter into an Underwriting Agreement (the form of which will
be filed as an exhibit to the Company's Registration Statement, of which this
Prospectus is a part) for that purpose. Pursuant
50
<PAGE> 146
to that agreement, the Underwriters will be entitled to exercise an
over-allotment option for $11.3 million of the Notes, will receive customary
underwriters' compensation for an offering of that size and type and will be
indemnified by the Company.
The Underwriting Agreement provides that the Company and the Selling
Stockholders will indemnify the several Underwriters against certain
liabilities, including civil liabilities under the Securities Act, as amended,
or will contribute to payments the Underwriters may be required to make in
respect thereof.
Certain persons participating in this offering may over-allot or effect
transactions which stabilize, maintain or otherwise affect the market price of
the Common Stock at levels above those which might otherwise prevail in the open
market, including by entering stabilizing bids, imposing penalty bids or
otherwise. A stabilizing bid means the placing of any bid or effecting of any
purchase for the purpose of pegging, fixing or maintaining the price of the
Common Stock. A syndicate covering transaction means the placing of any bid on
behalf of the underwriting syndicate or the effecting of any purchase to reduce
a short position created in connection with this offering. A penalty bid means
an arrangement that permits the Underwriters to reclaim a selling concession
from an Underwriter when shares of Common Stock sold by the Underwriter are
purchased in stabilization transactions. Such transactions may be effected on
the Nasdaq Stock Market, in the over-the-counter market, or otherwise. Such
stabilizing, if commenced, may be discontinued at any time.
The Underwriters and dealers may engage in passive market making
transactions in the Common Stock in accordance with Rule 103 of Regulation M
promulgated by the Commission. In general, a passive market maker may not bid
for, or purchase, the Common Stock at a price that exceeds the highest
independent bid. In addition, the net daily purchases made by any passive market
maker generally may not exceed 30% of its average daily trading volume in the
Common Stock during a specified two month prior period, or 200 shares, whichever
is greater. A passive market maker must identify passive market making bids as
such on the Nasdaq electronic inter-dealer reporting system. Passive market
making may stabilize or maintain the market price of the Common Stock above
independent market levels. Underwriters and dealers are not required to engage
in passive market making and may end passive market making activities at any
time.
LEGAL MATTERS
The validity of the issuance of the shares of Common Stock offered hereby
will be passed upon for the Company and the Selling Stockholders by Fenwick &
West LLP, Palo Alto, California. Certain legal matters will be passed upon for
the Underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation,
Palo Alto, California.
EXPERTS
The consolidated financial statements as of December 31, 1996 and 1997 and
for each of the three years in the period ended December 31, 1997 included in
this Prospectus have been so included in reliance on the report of Price
Waterhouse LLP, independent accountants, given on the authority of said firm as
experts in auditing and accounting.
51
<PAGE> 147
HNC SOFTWARE INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants..................................................... F-2
Consolidated Balance Sheet............................................................ F-3
Consolidated Statement of Income...................................................... F-4
Consolidated Statement of Cash Flows.................................................. F-5
Consolidated Statement of Changes in Stockholders' Equity............................. F-6
Notes to Consolidated Financial Statements............................................ F-7
</TABLE>
F-1
<PAGE> 148
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of HNC Software Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of cash flows and of changes in stockholders'
equity present fairly, in all material respects, the financial position of HNC
Software Inc. and its subsidiaries at December 31, 1996 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
San Diego, California
January 29, 1998,
except as to Note 11
which is as of February 13, 1998
F-2
<PAGE> 149
HNC SOFTWARE INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1997
------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents......................................... $ 8,121 $ 18,068
Investments available for sale.................................... 26,728 24,878
Accounts receivable, net.......................................... 21,856 32,980
Current portion of deferred income taxes.......................... 6,383 11,310
Other current assets.............................................. 2,553 2,802
------- --------
Total current assets...................................... 65,641 90,038
Deferred income taxes, less current portion......................... 22,966 15,322
Property and equipment, net......................................... 6,339 12,102
Other assets........................................................ 3,330 2,415
------- --------
$98,276 $119,877
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................................. $ 4,368 $ 5,728
Accrued liabilities............................................... 4,433 5,933
Deferred revenue.................................................. 3,377 3,883
Other current liabilities......................................... 445 191
------- --------
Total current liabilities................................. 12,623 15,735
Non-current liabilities............................................. 683 239
Minority interest in consolidated subsidiary........................ -- 43
Commitments and contingencies (Notes 5 and 10)
Stockholders' equity:
Preferred stock, $0.001 par value -- 4,000 shares authorized:
no shares issued or outstanding................................ -- --
Common stock, $0.001 par value -- 50,000 shares authorized:
24,012 and 24,538 shares issued and outstanding,
respectively.................................................. 24 25
Paid-in capital................................................... 83,991 95,919
Unrealized loss on investments available for sale................. (59) (2)
Foreign currency translation adjustment........................... 54 (111)
Retained earnings................................................. 960 8,029
------- --------
Total stockholders' equity................................ 84,970 103,860
------- --------
$98,276 $119,877
======= ========
</TABLE>
See accompanying notes to consolidated financial statements
F-3
<PAGE> 150
HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1995 1996 1997
-------- ------- -------
<S> <C> <C> <C>
Revenues:
License and maintenance.............................. $ 24,561 $48,890 $89,643
Installation and implementation...................... 4,648 6,691 10,702
Contracts and other.................................. 9,146 11,128 7,772
Service bureau....................................... 5,349 4,730 5,618
-------- ------- -------
Total revenues............................... 43,704 71,439 113,735
-------- ------- -------
Operating expenses:
License and maintenance.............................. 7,903 13,725 19,937
Installation and implementation...................... 1,425 2,714 5,174
Contracts and other.................................. 6,894 7,694 5,438
Service bureau....................................... 3,025 3,365 4,320
Research and development............................. 6,998 13,808 21,151
Sales and marketing.................................. 7,276 11,923 22,049
General and administrative........................... 5,101 8,551 12,626
-------- ------- -------
Total operating expenses..................... 38,622 61,780 90,695
-------- ------- -------
Operating income....................................... 5,082 9,659 23,040
Interest and other income.............................. 912 2,178 2,003
Interest expense....................................... (428) (478) (81)
Minority interest in income of consolidated
subsidiary........................................... -- -- (43)
-------- ------- -------
Income before income tax (benefit)
provision.................................. 5,566 11,359 24,919
Income tax (benefit) provision......................... (511) (534) 7,354
-------- ------- -------
Net income................................... $ 6,077 $11,893 $17,565
======== ======= =======
Earnings per share:
Basic net income per common share.................... $ 0.38 $ 0.50 $ 0.72
======== ======= =======
Diluted net income per common share.................. $ 0.28 $ 0.47 $ 0.68
======== ======= =======
Unaudited pro forma data (Note 1):
Income before income tax provision................... $ 5,566 $11,359 $24,919
Income tax provision................................. 1,032 1,628 9,502
-------- ------- -------
Net income................................... $ 4,534 $ 9,731 $15,417
======== ======= =======
Basic pro forma net income per common share.......... $ 0.64
=======
Diluted pro forma net income per common share........ $ 0.60
=======
Shares used in computing basic net income per common
share and unaudited basic pro forma net income per
common share (Notes 1 and 8)......................... 15,195 23,552 24,275
======== ======= =======
Shares used in computing diluted net income per common
share and unaudited diluted pro forma net income per
common share (Notes 1 and 8)......................... 21,510 25,363 25,681
======== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 151
HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income....................................................... $ 6,077 $ 11,893 $ 17,565
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization.................................. 1,874 3,605 4,833
Tax benefit from stock option transactions..................... 800 896 3,848
Changes in assets and liabilities:
Accounts receivable, net..................................... (1,658) (10,978) (11,124)
Other assets................................................. (674) (1,207) (295)
Deferred income taxes........................................ (1,551) (1,324) 6,909
Accounts payable............................................. 1,172 2,167 1,360
Accrued liabilities.......................................... 1,756 625 (2,348)
Deferred revenue............................................. 1,337 1,472 375
Other liabilities............................................ 22 (441) (116)
-------- -------- --------
Net cash provided by operating activities................. 9,155 6,708 21,007
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investments available for sale....................... (28,666) (26,113) (26,517)
Maturities of investments available for sale..................... 4,182 18,125 24,666
Proceeds from sales of investments available for sale............ 2,467 3,707 3,716
Acquisitions of property and equipment........................... (2,246) (3,978) (9,593)
-------- -------- --------
Net cash used in investing activities..................... (24,263) (8,259) (7,728)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuances of common stock...................... 33,726 1,935 4,039
Proceeds from issuances of notes payable to stockholders......... 1,000 -- --
Repayments of notes payable to stockholders...................... -- (1,000) --
Proceeds from bank line of credit................................ 1,085 309 --
Repayments of bank line of credit................................ (265) (2,504) --
Repayments of debt from asset purchases.......................... -- (4,710) --
Capital lease payments........................................... (502) (553) (408)
Proceeds from issuances of bank notes payable.................... -- 1,999 --
Repayments of bank notes payable................................. (687) (1,999) --
Distributions to CompReview stockholders......................... (3,845) (5,908) (6,798)
-------- -------- --------
Net cash provided by (used in) financing activities....... 30,512 (12,431) (3,167)
-------- -------- --------
Effect of exchange rate changes on cash............................ -- 54 (165)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents............... 15,404 (13,928) 9,947
Cash and cash equivalents at beginning of period................... 6,645 22,049 8,121
-------- -------- --------
Cash and cash equivalents at end of period......................... $ 22,049 $ 8,121 $ 18,068
======== ======== ========
SIGNIFICANT NON-CASH INVESTING AND FINANCING ACTIVITIES:
Assets purchased through issuance of debt........................ $ -- $ 4,710 $ --
======== ======== ========
Acquisitions of property and equipment under capital leases...... $ 411 $ 344 $ --
======== ======== ========
Conversion of preferred stock.................................... $ 13,518 $ -- $ --
======== ======== ========
Accretion of dividends on mandatorily redeemable convertible
preferred stock................................................ $ 348 $ -- $ --
======== ======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Interest paid.................................................... $ 390 $ 448 $ 101
======== ======== ========
Income taxes paid................................................ $ 190 $ 165 $ 547
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements
F-5
<PAGE> 152
HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED STOCK
---------------------------------
SERIES A SERIES E COMMON STOCK
--------------- --------------- ---------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1994......... 380 $ -- 1,282 $ 1 8,656 $ 9
Common stock options exercised....... 207
Accretion of dividends...............
Issuance of common stock in initial
public offering, net of issuance
costs............................... 2,376 2
Conversion of convertible preferred
stock into common stock............. (380) -- (1,282) (1) 8,956 9
Issuance of common stock in follow-on
public offering, net of issuance
costs............................... 1,116 2
Issuance of common stock at inception
of Retek (Note 1)................... 1,367 1
Tax benefit from stock option
transactions........................
Unrealized gain on investments.......
Stock warrant exercised.............. 100
Distributions to CompReview
stockholders........................
Net income...........................
---- ----- ------ --- ------ ---
BALANCE AT DECEMBER 31, 1995......... -- -- -- -- 22,778 23
Common stock options exercised....... 1,140 1
Common stock issued under Employee
Stock Purchase Plan................. 94
Tax benefit from stock option
transactions........................
Tax benefit from Retek taxable
pooling (Note 7)....................
Unrealized loss on investments.......
Foreign currency translation
adjustment..........................
Distributions to CompReview
stockholders........................
Net income...........................
---- ----- ------ --- ------ ---
BALANCE AT DECEMBER 31, 1996......... -- -- -- -- 24,012 24
Common stock options exercised....... 475 1
Common stock issued under Employee
Stock Purchase Plan................. 51
Tax benefit from stock option
transactions........................
Unrealized gain on investments.......
Foreign currency translation
adjustment..........................
Distributions to CompReview
stockholders........................
CompReview contribution to capital...
Net income...........................
---- ----- ------ --- ------ ---
BALANCE AT DECEMBER 31, 1997......... -- $ -- -- $ -- 24,538 $ 25
==== ===== ====== === ====== ===
<CAPTION>
UNREALIZED
GAIN (LOSS) ON FOREIGN (ACCUMULATED
INVESTMENTS CURRENCY DEFICIT) TOTAL
PAID-IN AVAILABLE TRANSLATION RETAINED STOCKHOLDERS'
CAPITAL FOR SALE ADJUSTMENT EARNINGS EQUITY
-------- -------------- ----------- ------------ -------------
<S> <<C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1994.........$ 10,980 $ -- $ -- $(10,149) $ 841
Common stock options exercised....... 85 85
Accretion of dividends............... (348) (348)
Issuance of common stock in initial
public offering, net of issuance
costs............................... 14,329 14,331
Conversion of convertible preferred
stock into common stock............. 10,618 2,892 13,518
Issuance of common stock in follow-on
public offering, net of issuance
costs............................... 19,184 19,186
Issuance of common stock at inception
of Retek (Note 1)................... (1) --
Tax benefit from stock option
transactions........................ 800 800
Unrealized gain on investments....... 92 92
Stock warrant exercised.............. 124 124
Distributions to CompReview
stockholders........................ (3,845) (3,845)
Net income........................... 6,077 6,077
------- ----- ----- -------- --------
BALANCE AT DECEMBER 31, 1995......... 55,771 92 -- (5,025) 50,861
Common stock options exercised....... 1,095 1,096
Common stock issued under Employee
Stock Purchase Plan................. 839 839
Tax benefit from stock option
transactions........................ 7,889 7,889
Tax benefit from Retek taxable
pooling (Note 7).................... 18,397 18,397
Unrealized loss on investments....... (151) (151)
Foreign currency translation
adjustment.......................... 54 54
Distributions to CompReview
stockholders........................ (5,908) (5,908)
Net income........................... 11,893 11,893
------- ----- ----- -------- --------
BALANCE AT DECEMBER 31, 1996......... 83,991 (59) 54 960 84,970
Common stock options exercised....... 2,845 2,846
Common stock issued under Employee
Stock Purchase Plan................. 1,193 1,193
Tax benefit from stock option
transactions........................ 4,192 4,192
Unrealized gain on investments....... 57 57
Foreign currency translation
adjustment.......................... (165) (165)
Distributions to CompReview
stockholders........................ (6,798) (6,798)
CompReview contribution to capital... 3,698 (3,698) --
Net income........................... 17,565 17,565
------- ----- ----- -------- --------
BALANCE AT DECEMBER 31, 1997.........$ 95,919 $ (2) $(111) $ 8,029 $ 103,860
======= ===== ===== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements
F-6
<PAGE> 153
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 1 -- THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES
The Company
Headquartered in San Diego, California, HNC Software Inc. (the "Company" or
"HNC") develops, markets and supports predictive software solutions in
client/server environments. HNC provides innovative predictive software systems
in the healthcare/insurance, financial services and retail markets.
Acquisitions
On August 30, 1996, the Company completed an acquisition of all of the
outstanding shares of Risk Data Corporation ("Risk Data"). Risk Data is an
insurance information technology services firm that develops, markets and
supports analytical benchmarking and risk management software products primarily
for insurance carriers, state insurance funds and third party administrators
primarily in the workers' compensation insurance field. Under the terms of the
acquisition, accounted for as a pooling of interests, the Company exchanged
1,891 shares of common stock for all of the then outstanding shares of Risk Data
preferred and common stock.
On November 29, 1996, the Company completed an acquisition of all of the
outstanding shares of Retek Distribution Corporation ("Retek"). Retek develops,
markets and supports inventory management system software primarily for
customers in the retail industry. Under the terms of the acquisition, accounted
for as a pooling of interests, the Company exchanged 1,367 shares of common
stock for all of the then outstanding shares of Retek common stock.
On November 28, 1997, the Company completed an acquisition of all of the
outstanding shares of CompReview, Inc. ("CompReview"). CompReview develops,
markets and supports cost containment software for workers' compensation
insurance carriers and for insurers that handle automobile accident personal
injury claims. Under the terms of the acquisition, accounted for as a pooling of
interests, the Company exchanged 4,886 shares of common stock for all of the
then outstanding shares of CompReview common stock.
The consolidated financial statements and related notes give retroactive
effect to all three acquisitions for all of the periods presented. The
consolidated balance sheet as of December 31, 1996 and 1997 includes the
accounts of Risk Data, Retek and CompReview as of December 31, 1996 and 1997.
The consolidated statements of income, of cash flows and of changes in
stockholders' equity for each of the three years in the period ended December
31, 1997 include the results of Risk Data, Retek and CompReview for each of the
years then ended. The term "Company" as used in these consolidated financial
statements refers to HNC and its subsidiaries, including Risk Data, Retek and
CompReview.
F-7
<PAGE> 154
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
No adjustments to conform the accounting methods of the acquired companies
to the accounting methods of HNC were required. Certain amounts have been
reclassified with regard to presentation of the financial information of the
acquired companies. Revenues and net income (loss) for each of the previously
separate companies for the periods prior to their respective acquisition dates
are as follows:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SIX MONTHS SEPTEMBER 30,
---------------------------- ENDED -----------------
1995 1996 1997 JUNE 30, 1996 1997
------- ------- -------- 1996 ------- -------
----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Revenues:
HNC............... $25,174 $53,833 $113,735 $ 16,478 $31,423 $62,683
Risk Data......... 4,577 -- -- 2,600 -- --
Retek............. 921 -- -- 3,377 5,635 --
CompReview........ 13,032 17,606 -- 8,119 12,631 18,971
-------- -------- --------- -------- -------- --------
$43,704 $71,439 $113,735 $ 30,574 $49,689 $81,654
======== ======== ========= ======== ======== ========
Net income (loss):
HNC............... $ 4,457 $ 6,376 $ 17,565 $ 1,780 $ 975 $ 7,597
Risk Data......... (1,952) -- -- (2,184) -- --
Retek............. (382) -- -- 43 93 --
CompReview........ 3,954 5,517 -- 2,123 3,679 6,702
-------- -------- --------- -------- -------- --------
$ 6,077 $11,893 $ 17,565 $ 1,762 $ 4,747 $14,299
======== ======== ========= ======== ======== ========
</TABLE>
Transaction costs of $563, $515 and $1,440 were incurred to complete the
acquisitions of Risk Data, Retek and CompReview, respectively. Transaction costs
were deferred and charged to income when the related transactions were
consummated. Transaction costs consisted primarily of investment banker, legal
and accounting fees, and printing, mailing and registration expenses.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany transactions and
balances have been eliminated.
During 1996, the Company established Aptex Software Inc. ("Aptex"), a
majority owned subsidiary, in order to develop, market and support certain text
analysis technology that is being used to develop products for the Internet
market. The minority stockholders' interest in Aptex's financial position and
results of operations is presented as a minority interest in the Company's
consolidated financial statements.
Financial Statement Preparation
The preparation of financial statements, in conformity with generally
accepted accounting principles, requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
F-8
<PAGE> 155
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Cash Equivalents
Cash equivalents are highly liquid investments and consist of investments
in money market accounts and commercial paper purchased with maturities of three
months or less.
Investments
Management determines the appropriate classification of its investments in
marketable debt and equity securities at the time of purchase and re-evaluates
such designation as of each balance sheet date. The Company classifies all
securities as "available for sale" and carries them at fair value with
unrealized gains or losses related to these securities included in stockholders'
equity in the Company's consolidated balance sheet.
Property and Equipment
Property and equipment are recorded at cost. The Company computes
depreciation and amortization using either the straight-line method over the
estimated useful lives of the assets of three to seven years or an accelerated
method over the estimated useful lives of the assets of five to seven years. The
Company amortizes leasehold improvements over the shorter of their estimated
useful lives or the remaining term of the related lease. Repair and maintenance
costs are charged to expense as incurred.
Software Costs
Software costs are recorded at cost and amortized over their estimated
useful lives of 36 to 42 months. Software costs are comprised of purchased
software and other rights that are stated at the lower of cost or net realizable
value. At December 31, 1996 and 1997, software costs of $2,561 and $2,581,
respectively, were included in other assets in the consolidated balance sheet
net of accumulated amortization of $642 and $1,451, respectively.
Development costs for software to be licensed or sold that are incurred
from the time technological feasibility is established until the product is
available for general release to customers are capitalized and reported at the
lower of cost or net realizable value. Through December 31, 1997, no significant
amounts were expended subsequent to reaching technological feasibility.
Long-Lived Assets
The Company investigates potential impairments of long-lived assets,
certain identifiable intangibles and associated goodwill when events or changes
in circumstances have made recovery of an asset's carrying value unlikely. An
impairment loss would be recognized if the sum of the expected future net cash
flows were less than the carrying amount of the asset. No such impairments of
long-lived assets existed through December 31, 1997.
Stock-Based Compensation
The Company measures compensation expense for its stock-based employee
compensation plans using the intrinsic value method and provides pro forma
disclosures of net income and earnings per share as if the fair value-based
method had been applied in measuring compensation expense.
F-9
<PAGE> 156
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Revenue Recognition
The Company's revenue from periodic software license and maintenance
agreements is generally recognized ratably over the respective license periods.
Revenue from certain short-term periodic software license and maintenance
agreements with guaranteed minimum license fees is recognized as related
services are performed. Transactional fees are recognized as revenue based on
system usage or when fees based on system usage exceed the monthly minimum
license fees. Revenue from perpetual licenses of the Company's software for
which there are no significant continuing obligations and collection of the
related receivables is probable is recognized on delivery of the software and
acceptance by the customer. Revenue from hardware product sales, which is
included in contracts and other revenue, is recognized upon shipment to the
customer.
The Company's revenue from software installation and implementation and
from contract services is generally recognized as the services are performed
using the percentage of completion method based on costs incurred to date
compared to total estimated costs at completion. Amounts received under
contracts in advance of performance are recorded as deferred revenue and are
generally recognized within one year from receipt. Contract losses are recorded
as a charge to income in the period such losses are first identified. Unbilled
accounts receivable are stated at estimated realizable value.
Service bureau fees are from review and repricing of customers' medical
bills and are assessed to customers on the basis of volume of bills processed
and are recognized as revenue when the processing services are performed.
Income Taxes
The Company's current income tax expense is the amount of income taxes
expected to be payable for the current year. A deferred income tax asset or
liability is computed for the expected future impact of differences between the
financial reporting and tax bases of assets and liabilities as well as the
expected future tax benefit to be derived from tax loss and tax credit
carryforwards. Valuation allowances are established, when necessary, to reduce
deferred tax assets to the amount "more likely than not" to be realized in
future tax returns. Tax rate changes are reflected in income during the period
such changes are enacted.
Net Income Per Common Share
The Company adopted Statement of Financial Accounting Standard No. 128
("FAS 128"), "Earnings per Share," for fiscal 1997 and retroactively restated
all prior periods to conform with FAS 128 as required. Basic net income per
common share is computed as net income less accretion of dividends on
mandatorily redeemable convertible preferred stock divided by the weighted
average number of common shares outstanding during the period. Diluted net
income per common share is computed as net income divided by the weighted
average number of common shares and potential common shares, using the treasury
stock method, outstanding during the period and assumes conversion into common
stock at the beginning of each period of all outstanding shares of convertible
preferred stock (Note 8).
Unaudited Pro Forma Data
Prior to the acquisition of CompReview by HNC on November 28, 1997,
CompReview had elected subchapter S corporation status for income tax purposes;
therefore, its income was included in the tax returns of its stockholders, and
no income tax provision was recorded for
F-10
<PAGE> 157
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CompReview other than certain minimum state taxes on subchapter S corporations.
As a result of the acquisition, beginning November 29, 1997, CompReview became
subject to corporate income taxes on its taxable income. For comparative
purposes, the consolidated statement of income includes unaudited pro forma
adjusted data with respect to the merged companies' income tax provision as if
CompReview had been subject to corporate income taxes on its taxable income for
all periods presented.
Foreign Currency Translation
The financial statements of the Company's international operations are
translated into U.S. dollars using period-end exchange rates for assets and
liabilities and average exchange rates during the period for revenues and
expenses. Cumulative translation gains and losses are excluded from results of
operations and recorded as a separate component of stockholders' equity. Gains
and losses resulting from foreign currency transactions (transactions
denominated in a currency other than the entity's local currency) are included
in the consolidated statement of income and are not material.
Diversification of Credit Risk
The Company's financial instruments that are subject to concentrations of
credit risk consist primarily of cash equivalents, investments available for
sale and accounts receivable, which are generally not collateralized. The
Company's policy is to place its cash, cash equivalents and investments
available for sale with high credit quality financial institutions and
commercial companies and government agencies in order to limit the amount of its
credit exposure. The Company's software license and installation agreements and
commercial development contracts are primarily with large customers in the
healthcare/insurance, financial services and retail industries. The Company
maintains reserves for potential credit losses.
The Company has one major product or product line in each of its three
target markets. In the healthcare/insurance market, revenues from one product
accounted for 29.8%, 24.6% and 23.0% of the Company's total revenues for 1995,
1996 and 1997, respectively. During those same periods, one product in the
retail market accounted for 2.2%, 13.6% and 18.9%, respectively, of the
Company's total revenues, and one product line in the financial services market
accounted for 28.0%, 20.9% and 16.0%, respectively, of the Company's total
revenues. Revenues from international operations and export sales, primarily to
Western Europe and Canada, represented approximately 12.6%, 17.7% and 16.8% of
total revenues in 1995, 1996 and 1997, respectively. Export sales were $4,595,
$7,310 and $7,896 in 1995, 1996 and 1997, respectively.
Disclosures About Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents and accrued liabilities
approximate fair value because of the short-term maturities of these financial
instruments. The carrying amounts of capital lease obligations approximate their
fair values based on interest rates currently available to the Company for
borrowings with similar terms and maturities.
Reincorporation and Stock Split
In May 1995, the Company's stockholders approved an Agreement and Plan of
Merger whereby the Company merged with and into a newly incorporated Delaware
corporation ("HNC Delaware"), which is the surviving corporation. In conjunction
with the merger, each share of the
F-11
<PAGE> 158
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Company's common stock, preferred stock and options and warrants to purchase the
Company's common stock was exchanged for one-half share of HNC Delaware's common
stock, preferred stock and options and warrants to purchase HNC Delaware's
common stock, at twice the exercise price for options and warrants. In April
1996, the Company consummated a two-for-one stock split effected in the form of
a common stock dividend. All references to share and per share amounts of common
and preferred stock and other data in these financial statements have been
retroactively restated to reflect the reincorporation and stock split.
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130 ("FAS 130"), "Reporting
Comprehensive Income," which the Company is required to adopt for 1998. This
statement will require the Company to report in the financial statements, in
addition to net income, comprehensive income and its components including
foreign currency items and unrealized gains and losses on certain investments in
debt and equity securities. Upon adoption of FAS 130, the Company is also
required to reclassify financial statements for earlier periods provided for
comparative purposes. The adoption of FAS 130 will not have a significant impact
on the Company's consolidated financial statement disclosures.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and Related
Information," which the Company is required to adopt for its 1998 annual
financial statements. This statement establishes standards for reporting
information about operating segments in annual financial statements and requires
selected information about operating segments in interim financial reports
issued to stockholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. Under FAS
131, operating segments are to be determined consistent with the way that
management organizes and evaluates financial information internally for making
operating decisions and assessing performance. The Company has not determined
the impact of the adoption of this new accounting standard on its consolidated
financial statement disclosures.
In November 1997, the American Institute of Certified Public Accountants
issued Statement of Position No. 97-2 ("SOP 97-2"), "Software Revenue
Recognition," which the Company is required to adopt for agreements entered into
with customers beginning in 1998. This statement provides guidance for
recognizing revenue related to sales by software vendors. The adoption of SOP
97-2 will not have a significant impact on the timing of the Company's revenue
recognition.
F-12
<PAGE> 159
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Reclassifications
Certain prior year balances have been reclassified to conform to the
current year presentation.
NOTE 2 -- COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
------- -------
<S> <C> <C>
Accounts receivable, net:
Billed............................................. $13,266 $27,812
Unbilled........................................... 9,299 8,368
------- -------
22,565 36,180
Less allowance for doubtful accounts................. (709) (3,200)
------- -------
$21,856 $32,980
======= =======
</TABLE>
Unbilled accounts receivable represent revenue recorded in excess of
amounts billable pursuant to contract provisions and generally become billable
at contractually specified dates or upon the attainment of milestones. Unbilled
amounts are expected to be realized within one year.
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
------- -------
<S> <C> <C>
Property and equipment, net:
Computer equipment................................. $ 9,302 $15,611
Furniture and fixtures............................. 2,210 4,632
Leasehold improvements............................. 273 1,012
------- -------
11,785 21,255
Less accumulated depreciation and amortization....... (5,446) (9,153)
------- -------
$ 6,339 $12,102
======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
------- -------
<S> <C> <C>
Accrued liabilities:
Payroll and related benefits....................... $ 1,645 $ 3,456
Vacation........................................... 860 927
Other.............................................. 1,928 1,550
------- -------
$ 4,433 $ 5,933
======= =======
</TABLE>
F-13
<PAGE> 160
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 3 -- INVESTMENTS
At December 31, 1996 and 1997, the amortized cost and estimated fair value
of investments available for sale were as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
---------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
U.S. government and federal
agencies........................ $ 18,212 $ -- $ (38) $18,174
Foreign government debt........... 1,006 -- (2) 1,004
U.S. corporate debt............... 4,851 -- (14) 4,837
Foreign corporate debt............ 2,718 -- (5) 2,713
------- ------- ------- -------
$ 26,787 $ -- $ (59) $26,728
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
---------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
U.S. government and federal
agencies........................ $ 20,682 $ -- $ (1) $20,681
U.S. corporate debt............... 1,894 -- (1) 1,893
Foreign corporate debt............ 2,304 -- -- 2,304
------- ------- ------- -------
$ 24,880 $ -- $ (2) $24,878
======= ======= ======= =======
</TABLE>
No significant gains or losses were realized during the years ended
December 31, 1996 and 1997. The cost of securities sold is determined by the
specific identification method.
NOTE 4 -- NOTES PAYABLE
The Company has a Credit Agreement with a bank which provides for a $15,000
revolving line of credit through July 11, 1999. The agreement requires that the
Company maintain certain financial ratios and levels of working capital,
tangible net worth and profitability, and also restricts the Company's ability
to pay cash dividends and make loans, advances or investments without the bank's
consent. At December 31, 1997, the Company had no amounts outstanding under the
revolving line of credit. Interest is payable monthly at the bank's prime rate
or LIBOR rate plus 1.5%. The applicable interest rate was 7.22% at December 31,
1997.
The Risk Data credit facilities were comprised of a revolving line of
credit secured by eligible accounts receivable, as well as a bridge loan that
was secured by the guarantees of certain stockholders. The revolving line of
credit matured on January 5, 1997. The bridge loan matured on September 5, 1996.
All outstanding amounts were repaid during 1996, and neither credit facility was
renewed.
During 1995, the preferred stockholders of Risk Data loaned the Company
$1,000 under subordinated note agreements (secured by the assets of Risk Data
but subordinated to borrowings under the Risk Data line of credit) bearing
interest at 9%. All outstanding amounts were repaid during 1996.
F-14
<PAGE> 161
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 5 -- LEASES
At December 31, 1997, the Company was obligated through 2004 under
noncancelable operating leases for its facilities and certain equipment as
follows:
<TABLE>
<CAPTION>
NET FUTURE
FUTURE MINIMUM LESS SUBLEASE MINIMUM LEASE
LEASE PAYMENTS INCOME PAYMENTS
-------------- ------------- -------------
<S> <C> <C> <C>
1998............................. $2,984 $ 127 $ 2,857
1999............................. 3,047 -- 3,047
2000............................. 3,043 -- 3,043
2001............................. 2,994 -- 2,994
2002............................. 2,884 -- 2,884
thereafter....................... 1,535 -- 1,535
</TABLE>
The lease for the Company's corporate headquarters provides for scheduled
rent increases and an option to extend the lease for five years with certain
changes to the terms of the lease agreement and a refurbishment allowance. Rent
expense under operating leases for the years ended December 31, 1995, 1996 and
1997 was approximately $1,503, $1,623 and $2,687, respectively, net of sublease
income of $83, $125 and $477, respectively.
Risk Data maintains a lease line of credit with a leasing company for the
acquisition of equipment under capital lease arrangements. Future minimum
payments are $222 for 1998 and $66 for 1999 with a total of $34 of such amounts
representing interest.
The gross value of assets under capital leases at December 31, 1996 and
1997 was $1,481 and $714, and accumulated amortization was $599 and $556,
respectively. Amortization expense for assets acquired under capital leases is
included in depreciation expense.
NOTE 6 -- CAPITAL STOCK
During June 1995, the Company completed its initial public offering of
5,176 shares of common stock (of which 2,376 shares were sold by the Company and
2,800 shares were sold by certain selling stockholders) at a price to the public
of $7.00 per share, which resulted in net proceeds to the Company of $15,461
after the payment of underwriters' commissions but before the deduction of
offering expenses. Upon the closing of the Company's initial public offering,
all outstanding shares of Series A, B, C, D and E convertible preferred stock
were automatically converted into shares of common stock at their then effective
conversion prices. Upon conversion, the preferred stockholders were no longer
entitled to any undeclared cumulative dividends and all class voting rights
terminated.
During December 1995, the Company completed a follow-on public offering of
3,000 shares of common stock (of which 1,116 shares were sold by the Company and
1,884 shares were sold by certain selling stockholders) at a price to the public
of $18.50 per share, which resulted in net proceeds to the Company of $19,606
after the payment of underwriters' commissions but before the deduction of
offering expenses.
The Company's Board of Directors is authorized to issue up to 4,000 shares
of preferred stock and to determine the price, rights, preferences, privileges
and restrictions, including voting rights, of those shares without any further
vote or action by the stockholders. The rights of the holders of common stock
will be subject to the rights of the holders of any preferred stock that may be
issued in the future.
F-15
<PAGE> 162
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 7 -- INCOME TAXES
Income (loss) before income tax (benefit) provision was taxed under the
following jurisdictions:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1995 1996 1997
------ ------- -------
<S> <C> <C> <C>
Domestic.................................. $5,764 $ 8,599 $23,907
Foreign................................... (198) 2,760 1,012
------ ------- -------
$5,566 $11,359 $24,919
====== ======= =======
</TABLE>
The income tax (benefit) provision is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1995 1996 1997
------ ------- -------
<S> <C> <C> <C>
CURRENT:
Federal................................. $ 97 $ 1,132 $ 2,257
State................................... 143 204 537
Foreign................................. -- 51 233
DEFERRED:
Federal................................. (521) (1,569) 3,197
State................................... (186) (56) 985
Foreign................................. (44) (296) 145
------ ------- -----
$ (511) $ (534) $ 7,354
====== ======= =====
</TABLE>
Deferred tax assets are summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-------------------
1996 1997
------- -------
<S> <C> <C>
Taxable pooling basis difference..................... $18,397 $16,955
Net operating loss carryforwards..................... 8,587 7,404
Tax credit carryforwards............................. 1,878 2,059
Other................................................ 487 214
------- -------
Gross deferred tax assets............................ 29,349 26,632
Deferred tax asset valuation allowance............... -- --
------- -------
Net deferred tax asset..................... $29,349 $26,632
======= =======
</TABLE>
During 1995, the Company released the valuation allowance related to its
deferred tax assets based on management's assessment that it was more likely
than not that the Company would realize a portion of those assets in future
periods due to improvements in the Company's operating results. During 1996, the
Company released the valuation allowances related to Risk Data's and Retek's
deferred tax assets based on management's assessment that it was more likely
than not that the Company would realize those assets in future periods due to
improvements in the operating results of those subsidiaries.
During 1995, 1996 and 1997, the Company realized certain tax benefits
related to stock option transactions in the amount of $800, $7,889 and $4,192,
respectively. The benefit from the stock option tax deduction is credited
directly to paid-in capital.
F-16
<PAGE> 163
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
During 1996, in connection with the acquisition of Retek, the Company made
an Internal Revenue Code Section 338 election for federal and state tax
purposes, resulting in the treatment of the acquisition as a taxable
transaction, whereby the tax bases of the acquired assets and liabilities were
adjusted to their fair values as of the date of the acquisition. As the purchase
price exceeded the carrying value of the net assets acquired by approximately
$46,000, the Company recorded a deferred tax asset in the amount of $18,397.
A reconciliation of the income tax (benefit) provision to the amount
computed by applying the statutory federal income tax rate to income before
income tax provision is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Amounts computed at statutory federal
rate................................... $ 1,892 $ 3,862 $ 8,472
State income taxes.................. 465 554 1,407
Subchapter S corporation earnings... (1,366) (1,901) (2,888)
Change in tax status of S
corporation....................... -- -- 869
Tax credit carryforwards
generated......................... (68) (334) (284)
Release of valuation allowance...... (2,223) (2,717) --
Foreign income taxes................ (44) (296) 27
Losses without tax benefit.......... 794 -- --
Other............................... 39 298 (249)
------- ------- -------
Income tax (benefit) provision........... $ (511) $ (534) $ 7,354
======= ======= =======
</TABLE>
Prior to the acquisition of CompReview by the Company on November 28, 1997,
CompReview had elected subchapter S corporation status and the cash basis of
accounting for income tax purposes; therefore, its cash basis income was
included in the tax returns of its stockholders, and no income tax provision was
recorded for CompReview other than certain minimum state taxes on subchapter S
corporations. As of the date of CompReview's acquisition, its tax status was
changed to C corporation status with the accrual basis of accounting. As a
result of this change in tax status, the Company recorded a deferred tax
liability in the amount of $869 based on the cumulative income recognition
differences as of the date of acquisition between CompReview's former and
prospective tax accounting methods.
At December 31, 1997, the Company had federal, state and foreign net
operating loss carryforwards of approximately $19,992, $7,785 and $352,
respectively. The net operating loss carryforwards expire as follows:
<TABLE>
<S> <C>
2001...................................... $ 6,982
2003...................................... 84
2005...................................... 123
2006...................................... 1,670
2007...................................... 17
2008...................................... 1,692
2009...................................... 1,370
2010...................................... 1,840
2011...................................... 14,086
</TABLE>
The Company also has approximately $1,295 of federal research and
development credit carryforwards, which expire from 2000 to 2012, $711 of state
research and development credit
F-17
<PAGE> 164
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
carryforwards, which have no expiration date, and $53 of foreign tax credit
carryforwards, which expire from 1999 to 2002. Certain of these net operating
loss and research and development credit carryforwards generated by Risk Data,
Retek and CompReview prior to their acquisitions by HNC are subject to annual
limitations on their utilization and also are limited to utilization solely by
the company that generated them. Should a substantial change in HNC's ownership
occur, as defined by the Tax Reform Act of 1986, there will be an annual
limitation on its utilization of net operating loss and research and development
credit carryforwards.
NOTE 8 -- RECONCILIATION OF NET INCOME AND SHARES USED IN PER SHARE COMPUTATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
NET INCOME USED:
Net income used in computing basic net income per common share..... $ 5,729 $11,893 $17,565
Add back accretion of dividends on mandatorily redeemable
convertible preferred stock...................................... 348 -- --
------- ------- -------
Net income used in computing diluted net income per common share... $ 6,077 $11,893 $17,565
======= ======= =======
SHARES USED:
Weighted average common shares outstanding used in computing basic
net income per common share...................................... 15,195 23,552 24,275
Weighted average options and warrants to purchase common stock as
determined by application of the treasury stock method......... 1,995 1,796 1,383
Incremental shares for assumed conversion of convertible
preferred stock................................................ 4,265 -- --
Purchase Plan common stock equivalents........................... 55 15 23
------- ------- -------
Shares used in computing diluted net income per common share....... 21,510 25,363 25,681
======= ======= =======
</TABLE>
All outstanding shares of the Company's preferred stock automatically
converted into shares of common stock upon the closing of the Company's initial
public offering on June 26, 1995. Shares used in computing diluted net income
per common share for 1995 assume conversion of all outstanding shares of
convertible preferred stock were converted at the beginning of that year.
NOTE 9 -- EMPLOYEE BENEFIT PLANS
During 1987, the Company adopted the 1987 Stock Option Plan and reserved
2,500 shares of the Company's common stock for issuance pursuant to nonqualified
and incentive stock options to its officers, directors, key employees and
consultants. The plan, as amended, is administered by the Board of Directors or
its designees and provides generally that, for incentive stock options and
nonqualified stock options, the exercise price must not be less than the fair
market value of the shares as determined by the Board of Directors at the date
of grant. The options expire no later than ten years from the date of grant and
may be exercised in installments based upon stipulated timetables (not in excess
of seven years). At December 31, 1997, options to purchase 490 shares were
exercisable.
During 1995, the Company adopted the 1995 Directors Stock Option Plan (the
"Directors Plan"), the 1995 Equity Incentive Plan (the "Incentive Plan") and the
1995 Employee Stock Purchase Plan (the "Purchase Plan"). For purposes of the
discussion contained in the three paragraphs below, "fair market value" means
the closing price of the Company's common stock on the Nasdaq National Market on
the grant date.
F-18
<PAGE> 165
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The Directors Plan provides for the issuance of up to 300 nonqualified
stock options to the Company's outside directors. Under the provisions of the
Directors Plan, options to purchase 25 shares of the Company's common stock are
granted to outside directors upon their respective dates of becoming members of
the Board of Directors and options to purchase ten shares of such stock will be
granted on each anniversary of such dates. Options under the Directors Plan are
granted at the fair market value of the stock at the grant date and vest at
specific times over a four-year period. At December 31, 1997, options to
purchase 72 shares were exercisable.
The Incentive Plan provides for the issuance of up to 3,550 shares of the
Company's common stock in the form of nonqualified or incentive stock options,
restricted stock or stock bonuses. In addition, all shares that remained
unissued under the 1987 Stock Option Plan on the effective date of the Incentive
Plan, and all shares issuable upon exercise of options granted pursuant to the
1987 Stock Option Plan that expire or become unexercisable for any reason
without having been exercised in full are available for issuance under the
Incentive Plan. Nonqualified stock options and restricted stock may be awarded
at a price not less than 85% of the fair market value of the stock at the date
of the award. Incentive stock options must be awarded at a price not less than
100% of the fair market value of the stock at the date of the award. Options
granted under the Incentive Plan may have a term of up to ten years. The Company
has the discretion to provide for restrictions and the lapse thereof in respect
of restricted stock awards. Options typically vest at the rate of 25% of the
total grant per year over a four-year period; however, the Company may, at its
discretion, implement a different vesting schedule with respect to any new stock
option grant. At December 31, 1997, 316 shares were exercisable.
The Purchase Plan provides for the issuance of a maximum of 400 shares of
common stock. Each purchase period, eligible employees may designate between 2%
and 10% of their cash compensation, subject to certain limitations, to be
deducted from their compensation for the purchase of common stock under the
Purchase Plan. The purchase price of the shares under the Purchase Plan is equal
to 85% of the lesser of the fair market value per share on the first day of the
twelve-month offering period or the last day of each six-month purchase period.
Approximately 60% of eligible employees have participated in the Purchase Plan
in the last two years.
Risk Data's stock option plan is administered by HNC's Board of Directors.
All outstanding Risk Data options were converted into options to purchase HNC
common stock and adjusted to give effect to the acquisition exchange ratio in
the Risk Data acquisition. No changes were made to the terms of the Risk Data
options in connection with the exchange. Options granted under the Risk Data
stock option plan generally vest at the rate of 25% of the total grant per year
and expire ten years after the date of grant. At December 31, 1997, 30 shares
were exercisable under the Risk Data plan.
Retek's stock options are administered by HNC's Board of Directors. All
outstanding Retek options were converted into options to purchase the Company's
common stock and adjusted to give effect to the acquisition exchange ratio in
the Retek acquisition. No changes were made to the terms of the Retek options in
connection with the exchange. Options granted vest ratably over periods from one
to four years and have a term of up to ten years. At December 31, 1997, options
to purchase 32 shares were exercisable.
The CompReview 1995 Stock Option Plan is administered by HNC's Board of
Directors. All outstanding CompReview stock options were converted into options
to purchase HNC common stock in the CompReview acquisition and adjusted to give
effect to the acquisition exchange ratio. No changes were made to the terms of
the CompReview options in connection with the exchange. Options granted under
the CompReview Stock Option Plan generally vest ratably over periods from
F-19
<PAGE> 166
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
two to four years and expire ten years after the date of grant. At December 31,
1997, options to purchase 156 shares were exercisable.
Transactions under the Company's stock option and purchase plans during the
years ended December 31, 1995, 1996 and 1997, including options under the Risk
Data stock option plan, options under the Retek stock option plan and options
under the CompReview Stock Option Plan, but excluding options to purchase stock
of Aptex, a subsidiary of the Company, are summarized as follows.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------
1995 1996 1997
------------------------ ------------------------ ------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------ ---------------- ------ ---------------- ------ ----------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year.... 2,080 $ 0.49 2,868 $ 2.84 3,215 $15.65
Options granted...... 1,272 6.08 1,645 27.98 2,177 32.61
Options exercised.... (207) 0.52 (1,140) 0.96 (475) 6.16
Options canceled..... (277) 1.80 (158) 17.62 (326) 26.33
------ ------
Outstanding at end of
year................. 2,868 2.84 3,215 15.65 4,591 23.92
====== ======
Options exercisable at
end of year.......... 1,437 841 1,096
Weighted average fair
value of options
granted during the
year................. $ 3.10 $14.50 $19.79
</TABLE>
The following table summarizes information about employee stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED -------------------------
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING AT REMAINING AVERAGE OUTSTANDING AT AVERAGE
RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICES 1997 LIFE (IN YEARS) PRICE 1997 PRICE
---------------------- -------------- --------------- -------- -------------- --------
<S> <C> <C> <C> <C> <C>
$ 0.02 to $ 3.00...... 1,002 5.90 $ 1.90 702 $ 1.60
4.50 25.38..... 793 8.21 19.22 188 15.69
25.60 30.75...... 791 8.86 29.39 147 30.33
30.81 31.50...... 944 9.57 31.40 1 30.94
31.88 39.00...... 774 9.42 36.03 32 34.24
39.09 49.50...... 287 9.27 41.42 26 42.64
----- -----
0.02 49.50..... 4,591 8.37 23.92 1,096 9.82
===== =====
</TABLE>
During 1996, Aptex adopted the 1996 Equity Incentive Plan (the "Aptex
Plan") whereby 2,000 shares of Aptex common stock were reserved for issuance
pursuant to nonqualified and incentive stock options and restricted stock
awards. The plan is administered by the Board of Directors of Aptex or its
designees and provides generally that nonqualified stock options and restricted
stock may be awarded at a price not less than 85% of the fair market value, as
determined by the Board of Directors, of the stock at the date of the award.
Incentive stock options must be awarded at a price not less than 100% of the
fair market value of the stock at the date of the award, or 110% of fair market
value for awards to more than 10% stockholders. Options granted under the
Incentive Plan may have a term of up to ten years. The Company has the
F-20
<PAGE> 167
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
discretion to provide for restrictions and the lapse thereof in respect of
restricted stock awards, and options typically vest at the rate of 25% of the
total grant per year. However, the Company may, at its discretion, implement a
different vesting schedule with respect to any new stock option grant. During
1996, Aptex issued 1,000 shares of common stock at fair market value under the
Aptex Plan for cash consideration of $0.03 per share. At December 31, 1997,
options to purchase 79 shares were exercisable under the Aptex Plan.
The Company applies Accounting Principles Board Opinion No. 25 and related
Interpretations in accounting for its stock-based compensation. No compensation
expense has been recognized for its employee stock option grants, which are
fixed in nature, as the options have been granted at fair market value. No
compensation expense has been recognized for the Purchase Plan. Had compensation
cost for the Company's stock-based compensation awards issued during 1997 and
1996 been determined based on the fair value at the grant dates of awards
consistent with the method of Financial Accounting Standards Board Statement No.
123 ("FAS 123"), the Company's net income and basic and diluted pro forma net
income per common share would have been reduced to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1995 1996 1997
------ ------- -------
<S> <C> <C> <C>
Net income:
As reported................................. $6,077 $11,893 $17,565
Pro forma................................... 5,126 6,122 2,232
Basic net income per common share:
As reported................................. 0.38 0.50 0.72
Pro forma................................... 0.31 0.26 0.09
Diluted net income per common share:
As reported................................. 0.28 0.47 0.68
Pro forma................................... 0.24 0.24 0.09
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions used for grants during the years ended December 31, 1995, 1996 and
1997, respectively: dividend yield of 0.0% for all three years, risk-free
interest rates of 6.29%, 6.03% and 6.10%, expected volatilities of 75%, 70% and
65% (0% for 1995 and 1996 options granted by Risk Data, Retek and CompReview
prior to their acquisition by HNC), and expected lives of 3.5, 3.5 and 3.0
years. The fair value of the employees' purchase rights pursuant to the Purchase
Plan is estimated using the Black-Scholes model with the following assumptions:
dividend yield of 0.0% for all three years, risk-free interest rates of 5.66%,
5.36% and 5.32%, expected volatilities of 75%, 70% and 65%, and an expected life
of 6 months for all three years. The weighted average fair value of those
purchase rights granted in 1995, 1996 and 1997 was $2.75, $9.61 and $14.10,
respectively.
The fair value of each option granted under the Aptex Plan is estimated on
the date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions used for grants during the years ended
December 31, 1996 and 1997: dividend yield of 0.0% for both years, risk-free
interest rates of 6.42% and 6.33%, expected volatility of 90% for both years,
and expected lives of 9.25 and 8.0 years. Options to purchase 704 shares and 214
shares were granted during 1996 and 1997, with weighted average exercise prices
per share of $0.03 and $0.08, respectively. During 1997, options to purchase 173
shares with a weighted average exercise price of $0.03 per share were exercised.
During 1997, options to purchase 58 shares
F-21
<PAGE> 168
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
with a weighted average exercise price of $0.03 per share were cancelled. The
weighted average fair value per share of options granted during 1996 and 1997
was $0.03 and $0.07, respectively.
The following table summarizes information about Aptex employee stock
options outstanding at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED -------------------------
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING AT REMAINING AVERAGE OUTSTANDING AT AVERAGE
RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICES 1997 LIFE (IN YEARS) PRICE 1997 PRICE
------------------- -------------- --------------- -------- -------------- --------
<S> <C> <C> <C> <C> <C>
$0.03 to $0.03 497 8.75 $ 0.03 79 $ 0.03
0.05 0.05 39 9.40 0.05 -- --
0.10 0.10 151 9.82 0.10 -- --
----- ---
0.03 0.10 687 9.03 0.05 79 0.03
========== ==========
</TABLE>
NOTE 10 -- CONTINGENCIES
Various claims arising in the course of business, seeking monetary damages
and other relief, are pending. The amount of the liability, if any, from such
claims cannot be determined with certainty; however, in the opinion of
management, the ultimate liability for such claims will not have a material
adverse effect on the Company's consolidated financial position, results of
operations or cash flows.
NOTE 11 -- SUBSEQUENT EVENTS
On January 30, 1998, the Company signed a definitive agreement to acquire
Practical Control Systems Technologies, Inc. ("PCS"), a distribution center
management software vendor based in Cincinnati, Ohio, subject to the
satisfaction of certain closing conditions and the approval of PCS'
shareholders. If consummated, the acquisition of PCS will be accounted for under
the purchase method and will not be considered a "significant" acquisition
pursuant to regulations set forth by the Securities and Exchange Commission.
On February 13, 1998, the Company adopted the 1998 Stock Option Plan (the
"1998 Plan"), under which 1,000,000 shares of HNC Common Stock were reserved for
issuance pursuant to nonqualified stock options. The 1998 Plan is administered
by the Board of Directors of HNC or a committee appointed by the Board and
provides that nonqualified stock options granted under the plan must be awarded
at an exercise price of not less than 100% of the fair market value of the stock
at the date of grant. Options granted under the 1998 Plan may have a term of up
to ten years. No options have been granted under the 1998 Plan to date.
F-22
<PAGE> 169
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN OR
INCORPORATED BY REFERENCE IN THIS PROSPECTUS. IF GIVEN OR MADE, SUCH INFORMATION
OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
COMPANY, THE SELLING STOCKHOLDERS OR ANY OF THE UNDERWRITERS. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, SUCH
SECURITIES BY ANYONE IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS
UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY
SINCE THE DATES AS OF WHICH INFORMATION IS GIVEN IN THIS PROSPECTUS.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information.................. 2
Incorporation of Certain Documents by
Reference............................ 2
Prospectus Summary..................... 3
Risk Factors........................... 4
Use of Proceeds........................ 14
Price Range of Common Stock............ 14
Dividend Policy........................ 14
Capitalization......................... 15
Selected Consolidated Financial Data... 16
Management's Discussion and Analysis of
Financial Condition and Results of
Operations........................... 18
Business............................... 28
Management............................. 44
Selling Stockholders................... 46
Description of Capital Stock........... 47
Underwriting........................... 50
Legal Matters.......................... 51
Experts................................ 51
Index to Consolidated Financial
Statements........................... F-1
</TABLE>
- ------------------------------------------------------------
LOGO
1,500,000 SHARES
COMMON STOCK
DEUTSCHE MORGAN GRENFELL
BANCAMERICA
ROBERTSON STEPHENS
SALOMON SMITH BARNEY
PROSPECTUS
, 1998
<PAGE> 170
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses to be paid by the
Registrant in connection with the issuance and distribution of the Securities
being registered. All amounts are estimates except for the Securities and
Exchange Commission registration fee, the NASD filing fee and the Nasdaq
National Market filing fee.
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee..... $ 42,917
NASD filing fee......................................... 15,048
Nasdaq National Market filing fee....................... 3,000
Accounting fees and expenses............................ 175,000
Legal fees and expenses................................. 195,000
Trustee fee............................................. 15,000
Rating Agency fee....................................... 50,000
Transfer Agent fee...................................... 5,000
Printing and engraving expenses......................... 200,000
Blue sky fees and expenses.............................. 10,000
Miscellaneous........................................... 39,035
--------
Total......................................... $750,000
========
</TABLE>
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
As permitted by Section 145 of the Delaware General Corporation Law, the
Registrant's Certificate of Incorporation includes a provision that eliminates
the personal liability of its directors to the Registrant or its stockholders
for monetary damages for breach of fiduciary duty as a director, except for
liability (i) for any breach of the director's duty of loyalty to the
corporation or its stockholders, (ii) for acts or omissions not in good faith or
that involve intentional misconduct or a knowing violation of law, (iii) under
Section 174 of the Delaware General Corporation Law or (iv) for any transaction
from which the director derived an improper personal benefit. In addition, as
permitted by Section 145 of the Delaware General Corporation Law, the Bylaws of
the Registrant provide that: (i) the Registrant is required to indemnify its
directors and executive officers to the fullest extent permitted by the Delaware
General Corporation Law; (ii) the Registrant may, in its discretion, indemnify
other officers, employees and agents as set forth in the Delaware General
Corporation Law; (iii) upon receipt of an undertaking to repay such advances if
indemnification is determined to be unavailable, the Registrant is required to
advance expenses, as incurred, to its directors and executive officers to the
fullest extent permitted by the Delaware General Corporation Law in connection
with a proceeding provided that the Registrant will not be required to advance
any expenses to a person against whom the Registrant directly brings a claim, in
proceeding, alleging that such person has breached his or her duty of loyalty to
the Registrant, committed an act or omission not in good faith or that involves
intentional misconduct or a knowing violation of law, or derived an improper
personal benefit from transactions; (iv) the rights conferred in the Bylaws are
not exclusive and the Registrant is authorized to enter into indemnification
agreements with its directors, officers, employees and agents; (v) the
Registrant may not retroactively amend the Bylaw provisions relating to
indemnity; and (vi) to the fullest extent permitted by the Delaware General
Corporation Law, a director or executive officer will be deemed to have acted in
good faith and in a manner he or she reasonably believed to be in or not opposed
to the best interests of the Registrant, and, with respect to any criminal
action or proceeding, to have had no reasonable cause to believe that his or her
conduct was unlawful, if his or her action is based on the records or books of
account of the Registrant or on information supplied to him or her
II-1
<PAGE> 171
by officers of the Registrant in the course of their duties or on the advice of
legal counsel for the Registrant or on information or records given or reports
made to the Registrant by independent certified public accountants or appraisers
or other experts.
The Registrant's policy is to enter into indemnity agreements with each of
its directors and executive officers. The indemnity agreements provide that
directors and executive officers will be indemnified and held harmless to the
fullest possible extent permitted by law including against all expenses
(including attorneys' fees), judgments, fines and settlement amounts paid or
reasonably incurred by them in any action, suit or proceeding, including any
derivative action by or in the right of Registrant, on account of their services
as directors, officers, employees or agents of the Registrant or as directors,
officers, employees or agents of any other company or enterprise when they are
serving in such capacities at the request of the Registrant. The Registrant will
not be obligated pursuant to the agreements to indemnify or advance expenses to
an indemnified party with respect to proceedings or claims (i) initiated by the
indemnified party and not by way of defense, except with respect to a proceeding
authorized by the Board of Directors and successful proceedings brought to
enforce a right to indemnification under the indemnity agreements; (ii) for any
amounts paid in settlement of a proceeding unless the Registrant consents to
such settlement; (iii) on account of any suit in which judgment is rendered
against the indemnified party for an accounting of profits made from the
purchase or sale by the indemnified party of securities of the Registrant
pursuant to the provisions of Section 16 (b) of the Securities Exchange Act of
1934 and related laws; (iv) on account of conduct by an indemnified party that
is finally adjudged to have been in bad faith or conduct that the indemnified
party did not reasonably believe to be in, or not opposed to, the best interests
of the Registrant; (v) on account of any criminal action or proceeding arising
out of conduct that the indemnified party had reasonable cause to believe was
unlawful; or (vi) if a final decision by a court having jurisdiction in the
matter shall determine that such indemnification is not lawful.
The indemnity agreement requires a director or executive officer to
reimburse the Registrant for expenses advanced only to the extent it is
ultimately determined that the director or executive officer is not entitled,
under Delaware law, the Bylaws, his or her indemnity agreement or otherwise to
be indemnified for such expenses. The indemnity agreement provides that it is
not exclusive of any rights a director or executive officer may have under the
Certificate of Incorporation, Bylaws, other agreements, any majority-in-interest
vote of the stockholders or vote of disinterested directors, the Delaware law,
or otherwise.
The indemnity provision in the Bylaws, and the indemnity agreements entered
into between the Registrant and its directors and executive officers, may be
sufficiently broad to permit indemnification of the Registrant's directors and
executive officers for liabilities arising under the Securities Act.
As authorized by the Registrant's Bylaws, the Registrant, with approval by
the Registrant's Board of Directors, has obtained directors and officers
liability insurance.
II-2
<PAGE> 172
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following exhibits are filed herewith or incorporated by reference
herein:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
---------- ----------------------------------------------------------------------------
<C> <S>
1.01 Form of Underwriting Agreement for the Note offering (draft dated February
, 1998).*
1.02 Form of Underwriting Agreement for the Common Stock offering (draft dated
February , 1998).*
2.01 Agreement and Plan of Reorganization dated as of July 19, 1996 by and among
the Registrant, HNC Merger Corp. and Risk Data Corporation, as amended.
(Incorporated by reference to Exhibit Number 2.01 to Registrant's Current
Report on Form 8-K filed on September 12, 1996, as amended (the "Risk Data
8-K").)
2.02 Agreement of Merger dated August 30, 1996 by and between HNC Merger Corp.
and Risk Data Corporation. (Incorporated by reference to Exhibit Number 2.02
to the Risk Data 8-K.)
2.03 Exchange Agreement dated as of October 25, 1996 by and among the Registrant,
Retek Distribution Corporation and the shareholders of Retek Distribution
Corporation. (Incorporated by reference to Exhibit Number 2.01 to
Registrant's Current Report on Form 8-K filed on December 12, 1996 (the
"Retek 8-K").)
2.04 Form of Option Exchange Agreement between the Registrant and each person who
held outstanding options to purchase shares of Retek Distribution
Corporation on November 29, 1996. (Incorporated by reference to Exhibit
Number 2.02 to the Retek 8-K.)
2.05 Agreement and Plan of Reorganization dated as of July 14, 1997 by and among
the Registrant, FW1 Acquisition Corp., CompReview, Inc., Robert L. Kaaren
and Mishel E. Munnayer, a.k.a. Michael Munayyer, Trustee of the Michael
Munayyer Trust dated August 11, 1995. (Pursuant to Item 601(b)(2) of
Regulation S-K, certain schedules have been omitted but will be furnished
supplementally to the Commission upon request.) (Incorporated by reference
to Exhibit Number 2.01 to Registrant's Current Report on Form 8-K filed on
December 15, 1997 (the "CompReview 8-K").)
2.06 Agreement of Merger dated as of November 28, 1997 by and between FW1
Acquisition Corp. and CompReview, Inc. (Incorporated by reference to Exhibit
Number 2.02 to the CompReview 8-K.)
3(i).01 Registrant's Restated Certificate of Incorporation filed with the Secretary
of State of Delaware on June 13, 1996. (Incorporated by reference to Exhibit
Number 3(i).04 to Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1996 (the "Second Quarter 1996 10-Q").)
3(ii).02 Registrant's Bylaws, as amended. (Incorporated by reference to Exhibit
Number 3(ii).05 to the Second Quarter 1996 10-Q.)
4.01 Form of Specimen Certificate for Registrant's Common Stock. (Incorporated by
reference to Exhibit Number 4.01 to Registrant's Form S-1 Registration
Statement, as amended (File No. 33-91932) (the "IPO S-1").)
4.02 Third Amended Registration Rights Agreement dated March 10, 1993, as
amended. (Incorporated by reference to Exhibit Number 4.02 to the IPO S-1.)
4.03 Second Waiver and Amendment to Third Amended Registration Rights Agreement.
(Incorporated by reference to Exhibit Number 4.03 to Registrant's Form S-1
Registration Statement, as amended (File No. 33-99980).
4.04 Registration Rights Agreement dated as of August 30, 1996 by and among the
Company and the former shareholders of Risk Data Corporation. (Incorporated
by reference to Exhibit Number 4.01 to the Risk Data 8-K.)
</TABLE>
II-3
<PAGE> 173
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
---------- ----------------------------------------------------------------------------
<C> <S>
4.05 Registration Rights Agreement dated as of October 25, 1996 by and among
registrant and the former shareholders of Retek Distribution Corporation.
(Incorporated by reference to Exhibit Number 4.01 to the Retek 8-K.)
4.06 Amendment No. 1 to the Registration Rights Agreement dated as of February
24, 1997 by and between the Registrant and the former shareholders of Retek
Distribution Corporation. (Incorporated by reference to Exhibit Number 4.06
to Registrant's Annual Report on Form 10-K, as amended, for the year ended
December 31, 1996.)
4.07 Registration Rights Agreement dated as of November 28, 1997 by and among the
Registrant and the former shareholders of CompReview, Inc. (Incorporated by
reference to Exhibit Number 4.01 to the CompReview 8-K.)
4.08 Form of Indenture between the Registrant and State Street Bank and Trust
Company of California, N.A., as Trustee, including the form of Notes.*
5.01 Opinion of Fenwick & West LLP for the Note offering.*
5.02 Opinion of Fenwick & West LLP for the Common Stock offering.*
12.01 Computation of Ratio of Earnings to Fixed Charges.
23.01 Consent of Price Waterhouse LLP.
23.02 Consent of Fenwick & West LLP (included in Exhibit 5.01).*
24.01 Power of Attorney (See page II-5).
25.01 Statement of Eligibility of Trustee (separately bound).*
</TABLE>
- ---------------
* To be filed by amendment.
ITEM 17. UNDERTAKINGS
The undersigned Registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 that is incorporated by reference in the registration
statement shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions described under Item 15 above, or
otherwise, the Registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable. In the event that a claim
for indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
II-4
<PAGE> 174
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-5
<PAGE> 175
SIGNATURES
Pursuant to the requirements of the Securities Act, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized in the City of San Diego, State of California, on February 16, 1998.
HNC SOFTWARE INC.
By: /s/ RAYMOND V. THOMAS
------------------------------------
Raymond V. Thomas
Vice President, Finance and
Administration,
Chief Financial Officer and
Secretary
POWER OF ATTORNEY
KNOWN ALL PERSON BY THESE PRESENTS that each individual whose signature
appears below constitutes and appoints Robert L. North, Raymond V. Thomas and
Kenneth A. Linhares, and each of them, his true and lawful attorneys-in-fact and
agents with full power of substitution, for him and in his name, place and
stead, in any and all capacities, to sign any and all amendments (including
post-effective amendments) to this Registration Statement, and to sign any
registration statement for the same offering covered by this Registration
Statement that is to be effective upon filing pursuant to Rule 462(b)
promulgated under the Securities Act, and all post-effective amendments thereto,
and to file the same, with all exhibits thereto and all documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorney-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorney-in-fact and agents or any of them, or his or their substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------------------------------------------- --------------------------- ------------------
<C> <S> <C>
PRINCIPAL EXECUTIVE OFFICER:
/s/ ROBERT L. NORTH President, Chief Executive February 16, 1998
- --------------------------------------------- Officer and a Director
Robert L. North
PRINCIPAL FINANCIAL AND
PRINCIPAL ACCOUNTING OFFICER:
/s/ RAYMOND V. THOMAS Vice President, Finance and February 16, 1998
- --------------------------------------------- Administration, Chief
Raymond V. Thomas Financial Officer and
Secretary
ADDITIONAL DIRECTORS:
/s/ EDWARD K. CHANDLER Director February 16, 1998
- ---------------------------------------------
Edward K. Chandler
/s/ OLIVER D. CURME Director February 16, 1998
- ---------------------------------------------
Oliver D. Curme
Director February , 1998
- ---------------------------------------------
Thomas F. Farb
/s/ CHARLES H. GAYLORD, JR. Director February 16, 1998
- ---------------------------------------------
Charles H. Gaylord, Jr.
</TABLE>
II-6
<PAGE> 176
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER EXHIBIT TITLE PAGE
-------- --------------------------------------------------------------- ------------
<C> <S> <C>
1.01 Form of Underwriting Agreement for the Note offering (draft
dated February , 1998).*.....................................
1.02 Form of Underwriting Agreement for the Common Stock offering
(draft dated February , 1998).*..............................
2.01 Agreement and Plan of Reorganization dated as of July 19, 1996
by and among the Registrant, HNC Merger Corp. and Risk Data
Corporation, as amended. (Incorporated by reference to Exhibit
Number 2.01 to Registrant's Current Report on Form 8-K filed on
September 12, 1996, as amended (the "Risk Data 8-K").).........
2.02 Agreement of Merger dated August 30, 1996 by and between HNC
Merger Corp. and Risk Data Corporation. (Incorporated by
reference to Exhibit Number 2.02 to the Risk Data 8-K.)........
2.03 Exchange Agreement dated as of October 25, 1996 by and among
the Registrant, Retek Distribution Corporation and the
shareholders of Retek Distribution Corporation. (Incorporated
by reference to Exhibit Number 2.01 to Registrant's Current
Report on Form 8-K filed on December 12, 1996 (the "Retek
8-K").)........................................................
2.04 Form of Option Exchange Agreement between the Registrant and
each person who held outstanding options to purchase shares of
Retek Distribution Corporation on November 29, 1996.
(Incorporated by reference to Exhibit Number 2.02 to the Retek
8-K.)..........................................................
2.05 Agreement and Plan of Reorganization dated as of July 14, 1997
by and among the Registrant, FW1 Acquisition Corp., CompReview,
Inc., Robert L. Kaaren and Mishel E. Munnayer, a.k.a. Michael
Munayyer, Trustee of the Michael Munayyer Trust dated August
11, 1995. (Pursuant to Item 601(b)(2) of Regulation S-K,
certain schedules have been omitted but will be furnished
supplementally to the Commission upon request.) (Incorporated
by reference to Exhibit Number 2.01 to Registrant's Current
Report on Form 8-K filed on December 15, 1997 (the "CompReview
8-K").)........................................................
2.06 Agreement of Merger dated as of November 28, 1997 by and
between FW1 Acquisition Corp. and CompReview, Inc.
(Incorporated by reference to Exhibit Number 2.02 to the
CompReview 8-K.)...............................................
3(i).01 Registrant's Restated Certificate of Incorporation filed with
the Secretary of State of Delaware on June 13, 1996.
(Incorporated by reference to Exhibit Number 3(i).04 to
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1996 (the "Second Quarter 1996 10-Q").).........
</TABLE>
<PAGE> 177
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER EXHIBIT TITLE PAGE
-------- --------------------------------------------------------------- ------------
<C> <S> <C>
3(ii).02 Registrant's Bylaws, as amended. (Incorporated by reference to
Exhibit Number 3(ii).05 to the Second Quarter 1996 10-Q.)......
4.01 Form of Specimen Certificate for Registrant's Common Stock.
(Incorporated by reference to Exhibit Number 4.01 to
Registrant's Form S-1 Registration Statement, as amended (File
No. 33-91932) (the "IPO S-1").)................................
4.02 Third Amended Registration Rights Agreement dated March 10,
1993, as amended. (Incorporated by reference to Exhibit Number
4.02 to the IPO S-1.)..........................................
4.03 Second Waiver and Amendment to Third Amended Registration
Rights Agreement. (Incorporated by reference to Exhibit Number
4.03 to Registrant's Form S-1 Registration Statement, as
amended (File No. 33-99980)....................................
4.04 Registration Rights Agreement dated as of August 30, 1996 by
and among the Company and the former shareholders of Risk Data
Corporation. (Incorporated by reference to Exhibit Number 4.01
to the Risk Data 8-K.).........................................
4.05 Registration Rights Agreement dated as of October 25, 1996 by
and among registrant and the former shareholders of Retek
Distribution Corporation. (Incorporated by reference to Exhibit
Number 4.01 to the Retek 8-K.).................................
4.06 Amendment No. 1 to the Registration Rights Agreement dated as
of February 24, 1997 by and between the Registrant and the
former shareholders of Retek Distribution Corporation.
(Incorporated by reference to Exhibit Number 4.06 to
Registrant's Annual Report on Form 10-K, as amended, for the
year ended December 31, 1996.).................................
4.07 Registration Rights Agreement dated as of November 28, 1997 by
and among the Registrant and the former shareholders of
CompReview, Inc. (Incorporated by reference to Exhibit Number
4.01 to the CompReview 8-K.)...................................
4.08 Form of Indenture between the Registrant and State Street Bank
and Trust Company of California, N.A., as Trustee, including
the form of Notes.*............................................
5.01 Opinion of Fenwick & West LLP for the Note offering.*..........
5.02 Opinion of Fenwick & West LLP for the Common Stock offering.*..
12.01 Computation of Ratio of Earnings to Fixed Charges..............
23.01 Consent of Price Waterhouse LLP................................
23.02 Consent of Fenwick & West LLP (included in Exhibit 5.01).*.....
24.01 Power of Attorney (See page II-5)..............................
25.01 Statement of Eligibility of Trustee (separately bound).*.......
</TABLE>
- ---------------
* To be filed by amendment.
<PAGE> 1
EXHIBIT 12.01
HNC SOFTWARE INC.
STATEMENT RE COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1993 1994 1995 1996 1997
------ ------ ------ ------- -------
<S> <C> <C> <C> <C> <C>
Earnings:
Income before income tax (benefit)
provision...................... $ 906 $2,741 $5,566 $11,359 $24,919
Fixed charges..................... 453 709 929 1,019 977
------ ------ ------ ------- -------
Total.......................... $1,359 $3,450 $8,495 $12,378 $25,896
====== ====== ====== ======= =======
Fixed charges:
Interest expense.................. $ 149 $ 312 $ 428 $ 478 $ 81
Portion of rent expense deemed to
be interest.................... 304 397 501 541 896
------ ------ ------ ------- -------
Total.......................... $ 453 $ 709 $ 929 $ 1,019 $ 977
====== ====== ====== ======= =======
Ratio of earnings to fixed
charges........................... 3.00 4.87 6.99 12.15 26.51
====== ====== ====== ======= =======
</TABLE>
<PAGE> 1
EXHIBIT 23.01
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-3 of our report dated January 29, 1998, except
as to Note 11 which is as of February 13, 1998, relating to the financial
statements of HNC Software Inc., which appears in such Prospectus. We also
consent to the incorporation by reference in the Prospectus constituting part of
this Registration Statement on Form S-3 of our report dated January 29, 1998,
except as to Note 11 which is as of February 13, 1998, appearing on page 36 of
HNC Software Inc.'s Annual Report on Form 10-K for the year ended December 31,
1997. We also consent to the incorporation by reference of our report on the
Financial Statement Schedule, which appears on page 62 of such Annual Report on
Form 10-K. We also consent to the references to us under the headings "Experts"
and "Selected Consolidated Financial Data" in such Prospectus. However, it
should be noted that Price Waterhouse LLP has not prepared or certified such
"Selected Consolidated Financial Data."
PRICE WATERHOUSE LLP
San Diego, California
February 17, 1998
