<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 0-26146
================================================================================
HNC SOFTWARE INC.
(Exact name of registrant as specified in its charter)
================================================================================
DELAWARE 33-0248788
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5930 CORNERSTONE COURT WEST
SAN DIEGO, CA 92121
(Address of principal executive offices, including zip code)
(619) 546-8877
(Registrant's telephone number, including area code)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS: YES [X] NO [ ]
AS OF APRIL 30, 1999 THERE WERE 24,554,477 SHARES OF REGISTRANT'S COMMON STOCK,
$0.001 PAR VALUE, OUTSTANDING.
================================================================================
<PAGE> 2
INDEX LISTING
================================================================================
<TABLE>
<CAPTION>
Page
Number
<S> <C>
PART I FINANCIAL INFORMATION
Item 1: FINANCIAL STATEMENTS
Consolidated Balance Sheet at March 31, 1999 (unaudited)
and December 31, 1998 3
Consolidated Statement of Income (unaudited) for the three
months ended March 31, 1999 and 1998 4
Consolidated Statement of Cash Flows (unaudited) for
the three months ended March 31, 1999 and 1998 5
Consolidated Statement of Changes in Stockholders' Equity
and Comprehensive Income (unaudited) for the three
months ended March 31, 1999 6
Notes To Consolidated Financial Statements (unaudited) 7
Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 12
Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 26
PART II OTHER INFORMATION
Item 6: EXHIBITS AND REPORTS ON FORM 8-K 27
Signatures 28
Exhibit Index 29
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
================================================================================
Item 1: FINANCIAL STATEMENTS
HNC SOFTWARE INC.
CONSOLIDATED BALANCE SHEET
(in thousands, except per share data)
ASSETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
--------- ---------
(unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 38,900 $ 54,267
Investments available for sale 25,714 41,095
Accounts receivable, net 55,939 58,078
Current portion of deferred income taxes 10,163 10,163
Other current assets 5,777 5,459
--------- ---------
Total current assets 136,493 169,062
Property and equipment, net 18,285 14,495
Deferred income taxes, less current portion 11,381 12,829
Long-term investments available for sale 71,814 57,978
Intangible assets, net 23,340 25,103
Other assets 6,240 4,447
--------- ---------
$ 267,553 $ 283,914
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,645 $ 4,226
Accrued liabilities 11,034 16,123
Deferred revenue 10,899 9,427
Other current liabilities 21 78
--------- ---------
Total current liabilities 27,599 29,854
Convertible Subordinated Notes 100,000 100,000
Other non-current liabilities 1,077 1,039
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:
25,329 and 25,894 shares issued and outstanding, 25 26
respectively
Paid-in capital 137,424 134,674
Retained earnings 20,605 18,481
Accumulated other comprehensive loss (398) (160)
Common stock in treasury, at cost - 700 shares (18,779) --
--------- ---------
Total stockholders' equity 138,877 153,021
--------- ---------
$ 267,553 $ 283,914
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF INCOME
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------
1999 1998
-------- --------
<S> <C> <C>
Revenues:
License and maintenance $ 36,471 $ 26,882
Services and other 12,718 8,199
-------- --------
Total revenues 49,189 35,081
-------- --------
Operating expenses:
License and maintenance 10,717 5,972
Services and other 8,657 4,772
Research and development 9,520 6,861
Sales and marketing 9,778 7,641
General and administrative 4,580 3,331
In-process research and development -- 1,750
Acquisition related amortization 2,252 --
-------- --------
Total operating expenses 45,504 30,327
-------- --------
Operating income 3,685 4,754
Other income, net 303 401
Minority interest in income of consolidated subsidiary -- (22)
-------- --------
Income before income tax provision 3,988 5,133
Income tax provision 1,864 2,746
======== ========
Net income $ 2,124 $ 2,387
======== ========
Earnings per share:
Basic net income per common share $ 0.08 $ 0.10
======== ========
Diluted net income per common share $ 0.08 $ 0.09
======== ========
Shares used in computing basic net income per
common share 25,766 24,620
======== ========
Shares used in computing diluted net income per
common share 26,483 26,041
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
---------------------------------
1999 1998
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,124 $ 2,387
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 4,314 1,598
Purchased research and development -- 1,750
Cash received from fixed asset disposals 179 --
Tax benefit from stock option transactions 257 1,168
Changes in assets and liabilities:
Accounts receivable, net 2,139 (4,122)
Other assets 485 (872)
Deferred income taxes 1,448 2,746
Accounts payable 1,419 (1,221)
Accrued liabilities (5,090) (1,263)
Deferred revenue 1,472 2,690
Other liabilities 37 (6)
--------- ---------
Net cash provided by operating activities 8,784 4,855
--------- ---------
Cash flows from investing activities:
Purchases of investments (36,504) (41,145)
Maturities of investments 16,900 10,670
Proceeds from sale of investments 21,014 --
Investments in unconsolidated subsidiaries (2,750) --
Cash purchased in business acquisition -- 559
Acquisitions of property and equipment (5,781) (1,778)
--------- ---------
Net cash used in investing activities (7,121) (31,694)
--------- ---------
Cash flows from financing activities:
Net proceeds from issuance of common stock 2,047 2,681
Purchase of treasury stock (18,779) --
Proceeds from issuance of Convertible Subordinated Notes -- 100,000
Debt issuance costs -- (3,087)
Repayment of capital lease obligations (56) (59)
--------- ---------
Net cash (used in) provided by financing activities (16,788) 99,535
--------- ---------
Effect of exchange rate changes on cash (242) 125
--------- ---------
Net (decrease) increase in cash and cash equivalents (15,367) 72,821
Cash and cash equivalents at the beginning of the period 54,267 18,068
--------- ---------
Cash and cash equivalents at the end of the period $ 38,900 $ 90,889
========= =========
Supplemental schedule of non-cash investing activities:
Stock payable for acquisition of Retek Logistics $ -- $ 5,088
========= =========
Assets assumed in acquisition of Retek Logistics $ -- $ 6,491
========= =========
Liabilities assumed in acquisition of Retek Logistics $ -- $ 1,962
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMMON STOCK PAID-IN DEFERRED COMPREHENSIVE
SHARES AMOUNT CAPITAL COMPENSATION LOSS
------ ------ ------- ------------ ----
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1998 . 25,894 $ 26 $ 137,182 $ (2,508) $ (160)
Common stock options exercised 81 715
Common stock issued under
Employee Stock
Purchase Plan ............. 54 1,332
Tax benefit from stock
option transactions ....... 257
Treasury stock ............... (700) (1)
Unearned stock compensation
expense amortization ......... 446
Unrealized gain on investments 4
Foreign currency translation
adjustment .............. (242)
Net income ...................
--------- --------- --------- --------- ---------
BALANCE AT MARCH 31, 1999 .... 25,329 $ 25 $ 139,486 $ (2,062) $ (398)
========= ========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
TOTAL
RETAINED TREASURY STOCKHOLDER COMPREHENSIVE
EARNINGS STOCK EQUITY INCOME
-------- ----- ----------- ------
<S> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1998 ... $ 18,481 $ 153,021
Common stock options exercised . 715
Common stock issued under
Employee Stock
Purchase Plan ............... 1,332
Tax benefit from stock
option transactions ......... 257
Treasury stock ................. $(18,779) (18,780)
Unearned stock compensation
expense amortization ........... 446
Unrealized gain on investments 4 $ 4
Foreign currency translation
adjustment ................ (242) (242)
Net income ..................... 2,124 2,124 2,124
------------ --------- --------- ---------
BALANCE AT MARCH 31, 1999 ...... $ 20,605 $ (18,779) $ 138,877 $ 1,886
============ ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 7
================================================================================
HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 GENERAL
In management's opinion, the accompanying unaudited consolidated
financial statements for HNC Software Inc. (the "Company") for the three month
periods ended March 31, 1999 and 1998 have been prepared in accordance with
generally accepted accounting principles for interim financial statements and
include all adjustments (consisting only of normal recurring accruals) that the
Company considers necessary for a fair presentation of its financial position,
results of operations, and cash flows for such periods. However, the
accompanying financial statements do not contain all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. All such financial statements are unaudited except the
December 31, 1998 balance sheet. This Report and the accompanying unaudited and
audited financial statements should be read in conjunction with the Company's
audited financial statements and notes thereto presented in its Annual Report on
Form 10-K for the fiscal year ended December 31, 1998 (the "1998 Annual
Report"). Footnotes which would substantially duplicate the disclosures in the
Company's audited financial statements for the fiscal year ended December 31,
1998 contained in the 1998 Annual Report have been omitted. The interim
financial information contained in this Report is not necessarily indicative of
the results to be expected for any other interim period or for the full fiscal
year ending December 31, 1999.
NOTE 2 BASIS OF PRESENTATION
The acquisition of Retek Logistics Inc. ("Retek Logistics"), formerly
Practical Control Solutions, Inc., was completed on March 31, 1998 and accounted
for as a purchase as of the acquisition date. In connection with the acquisition
of Retek Logistics, acquired in-process research and development of $1.8 million
was charged to operations at the acquisition date.
NOTE 3 INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES
Investments in corporate entities with less than 20% voting interest are
generally accounted for under the cost method. On March 18, 1999, the Company
made a minority equity investment in AIM Solutions, Inc. ("AIM"), a company
which provides marketing process automation, campaign execution software, and
client-to-vendor data management to direct marketers of enhancement services.
The Company's total investment in AIM was $750,000. On March 31, 1999, the
Company made a minority equity investment in Qpass, the first web-wide
transaction and customer service network enabling commerce in digital goods and
services. The Company's total investment in Qpass was $2.0 million. These
investments are being accounted for under the cost method.
7
<PAGE> 8
NOTE 4 RECONCILIATION OF NET INCOME AND SHARES USED IN PER
SHARE COMPUTATIONS (in thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1999 1998
------- -------
<S> <C> <C>
NET INCOME USED:
Net income used in computing basic and
diluted net income per common share $ 2,124 $ 2,387
======= =======
SHARES USED:
Weighted average common shares
outstanding used in computing basic
net income per common share 25,766 24,620
Weighted average options to purchase
common stock as determined by
application of the treasury stock
method 695 1,406
Purchase Plan common stock
equivalents 22 15
------- -------
Shares used in computing diluted net
income per common share 26,483 26,041
======= =======
</TABLE>
The conversion of the Company's 4.75% convertible subordinated notes for
the three month periods ended March 31, 1999 and 1998 of 2,230 and 624 shares,
respectively, was not used to calculate diluted net income per share as their
effect would be anti-dilutive.
NOTE 5 TREASURY STOCK
During February 1999, the Company began acquiring shares of its common
stock in connection with a stock repurchase program announced in February 1999.
The program authorizes the Company to purchase approximately 700,000 common
shares from time to time for cash at market prices in open market, negotiated or
block transactions. The Company purchased 700,100 shares of common stock in the
first quarter of 1999 at an average cost of $26.82 per share. The purpose of the
stock repurchase program is to help cover the Company's annual "evergreen" stock
option grants, which provide continued incentives to the Company's employees.
NOTE 6 INCOME TAX PROVISION
The 1998 income tax provision includes the tax effects of the
non-deductible, one-time write-offs of in-process research and development
related to the purchase of Retek Logistics. The 1999 income tax provision
includes the tax effects of non-deductible acquisition related amortization
expense.
8
<PAGE> 9
NOTE 7 SEGMENT INFORMATION
The Company's reportable segments are those that are based on the
Company's method of internal reporting, which disaggregates its business by
product category. The Company's major segments are as follows: the Financial
Solutions Group ("FSG"), the Insurance Solutions Group ("ISG") and the Retail
Solutions Group ("RSG"). The FSG's predictive customer relationship management
applications analyze data to retrieve the relationship intelligence that
financial institutions use to manage customer accounts. These solutions can be
used to segment customer profiles to perform one-to-one marketing, maximize
profitability, and manage risks such as fraud, bankruptcy, and delinquency. The
ISG segment provides a medical bill repricing system for workers' compensation
and auto liability and a suite of predictive technology-based products for
maximized management of claims throughout their lifecycle. Designed to analyze
large volumes of highly complex data efficiently, these solutions automate and
improve insurance claim and healthcare management decision-making. The RSG
segment offers a suite of enterprise-wide retail management solutions, which
assimilate information from a variety of sources to provide retailers with the
ability to predict the ever-changing behaviors of customers and to manage the
warehouse, inventory and supply chain processes. This includes increasing the
efficiency and reducing the costs of how retailers handle, track and optimize
the global flow of merchandise from the vendor through the warehouse, to the
stores, and finally on to customers. The remaining segments of HNC's business
operations, reflected in the "Other" category, develop, market and support
predictive software solutions for the Internet and telecommunication service
industries.
The Company is organized on the basis of products and services. The
segments are strategic business units that offer different products and
services. The table below presents information about the reported revenues and
operating income of each segment, excluding all amortization and acquisition
related expenses, for the quarters ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------------
1999 1998
-------- --------
<S> <C> <C>
Segment revenue:
FSG $ 14,199 $ 10,744
RSG 16,646 11,141
ISG 13,649 11,130
Other 4,695 2,366
Intersegment elimination -- (300)
-------- --------
Total consolidated revenue $ 49,189 $ 35,081
======== ========
</TABLE>
9
<PAGE> 10
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-----------------------------
1999 1998
------- -------
<S> <C> <C>
Segment operating income (loss):
FSG $ 2,152 $ 2,021
RSG 3,076 2,110
ISG 705 2,282
Other 4 336
------- -------
Total segment operating income 5,937 6,749
------- -------
Acquisition expense -- (245)
In-process research and development -- (1,750)
Acquisition related amortization (2,252) --
------- -------
Consolidated operating income 3,685 4,754
------- -------
Interest and other income 1,684 792
Interest expense (1,381) (391)
Minority interest in income of
consolidated subsidiary -- (22)
------- -------
Income before income tax provision $ 3,988 $ 5,133
======= =======
</TABLE>
Specified items included in segment operating income:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------------
1999 1998
------ ------
<S> <C> <C>
Segment depreciation expense:
FSG $ 686 $ 599
RSG 440 238
ISG 504 349
Other 182 155
------ ------
Total segment depreciation expense $1,812 $1,341
====== ======
</TABLE>
The table below presents information about the reported assets of the
Company at March 31, 1999 and 1998.
<TABLE>
MARCH 31,
---------------------------------
1999 1998
--------- ---------
<S> <C> <C>
Total segment assets:
FSG $ 36,231 $ 35,154
RSG 31,513 20,157
ISG 25,435 10,809
Other 14,221 13,702
--------- ---------
Total segment assets 107,400 79,822
--------- ---------
Corporate 184,562 192,750
Eliminations (24,409) (38,837)
--------- ---------
Total consolidated assets $ 267,553 $ 233,735
========= =========
</TABLE>
Corporate assets are primarily comprised of cash, short-term and
long-term investments available for sale, deferred tax assets and intersegment
receivables. Eliminations primarily relate to intersegment payables.
10
<PAGE> 11
The following represents capital expenditures by segment for the three
months ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------------
1999 1998
------ ------
<S> <C> <C>
Segment capital expenditures:
FSG $1,248 $ 685
RSG 1,926 943
ISG 2,354 310
Other 393 51
------ ------
Total capital expenditures $5,921 $1,989
====== ======
</TABLE>
The following is revenue and long-lived asset information by geographic
areas for the three months ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------------
1999 1998
------- -------
<S> <C> <C>
Revenue by geographic area:
United States $34,887 $23,015
Foreign 14,302 12,066
------- -------
Total revenue $49,189 $35,081
======= =======
</TABLE>
<TABLE>
<CAPTION>
MARCH 31,
----------------------------
1999 1998
------- -------
<S> <C> <C>
Long-lived assets by geographic area:
United States $44,949 $20,892
Foreign 166 306
------- -------
Total long-lived assets $45,115 $21,198
======= =======
</TABLE>
The Company's foreign sales represent revenues from export sales and
international operations. Export sales include sales from the United States to
foreign countries. International operations include sales by foreign operations.
NOTE 8 SUBSEQUENT EVENTS
On April 8, 1999, the Board of Directors authorized the Company to
repurchase up to an additional 10% of its outstanding common shares under
certain conditions from time to time for cash at market prices in open market,
negotiated or block transactions.
On April 16, 1999, the Company made a minority equity investment of $6.0
million in Open Solutions Inc., a developer of client/server core data
processing solutions for community banks and credit unions.
11
<PAGE> 12
HNC SOFTWARE INC.
================================================================================
Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS: NO ASSURANCES INTENDED
This Report (including the following section regarding Management's
Discussion and Analysis of Financial Condition and Results of Operations)
contains forward-looking statements 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 Report. Additionally, statements concerning
future matters such as the development of new products, enhancements or
technologies, international sales, expense levels, possible changes in
legislation and other statements regarding matters that are not historical are
forward-looking statements.
Although forward-looking statements in this Report 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 or
anticipated by the forward-looking statements. Factors that could cause or
contribute to such differences in results and outcomes include without
limitation those discussed in "Potential Fluctuations in Operating Results" as
well as those discussed elsewhere in this Report and those discussed in the
Company's 1998 Annual Report. Readers are urged not to place undue reliance on
these forward-looking statements, which speak only as of the date of this
Report. 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 Report. Readers are urged to carefully review
and consider the various disclosures made by the Company in this Report, which
attempt to advise interested parties of the risks and factors that may affect
the Company's business, financial condition, 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. Factors affecting the Company's
revenues and 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 the Company's
products for which the Company's fees are usage based; the length of the sales
cycle of the Company's products; 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 the Company's distribution channels; changes in the level of the
Company's operating expenses; the Company's ability to achieve progress on
percentage-of-completion contracts; the Company's success in completing certain
pilot installations for
12
<PAGE> 13
contracted fees; competitive conditions in the industry; domestic and
international economic conditions; and market conditions in the Company's
targeted markets. In addition, license agreements entered into during a quarter
may not meet HNC's revenue recognition criteria. Therefore, even if the Company
meets or exceeds its forecast of aggregate licensing and other contracting
activity, it is possible that the Company's revenues would not meet
expectations. Furthermore, the Company's operating results may be affected by
factors unique to certain of its product lines. For example, the Company derives
a substantial and increasing portion of its revenues from its retail products,
which are generally priced as "perpetual" license transactions in which the
Company receives a one-time license fee. The Company recognizes these fees as
revenue upon delivery of the software and acceptance by the customer. Thus,
failure to complete a perpetual license transaction during a fiscal quarter
would preclude the Company from recognizing revenue from that transaction in
that quarter, and thus 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. Consequently, the Company believes that
period-to-period comparisons of its financial results should not be relied upon
as an indication of future performance. 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.
Accordingly, the Company may not be able to maintain profitability on a
quarterly or annual basis in the future. Due to the foregoing factors, it is
possible that in some future quarter 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 price of the Company's
4.75% Convertible Subordinated Notes due 2003, would likely be materially
adversely affected.
RESULTS OF OPERATIONS
The Company develops, markets and supports predictive software solutions
for leading service industries, including financial, insurance and retail. 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. The Company's major
segments are as follows: the Financial Solutions Group ("FSG"), the Insurance
Solutions Group ("ISG") and the Retail Solutions Group ("RSG"). The FSG's
predictive customer relationship management applications analyze data to
retrieve the relationship intelligence that financial institutions use to manage
customer accounts. These solutions can be used to segment customer profiles to
perform one-to-one marketing, maximize profitability, and manage risks such as
fraud, bankruptcy, and delinquency. The ISG segment provides a medical bill
repricing system for workers' compensation and auto liability and a suite of
predictive technology-based products for maximized management of claims
throughout their lifecycle. Designed to analyze large volumes of highly complex
data efficiently, these solutions automate and improve insurance claim and
healthcare management decision-making. The RSG segment offers a suite of
enterprise-wide retail management solutions, which assimilate information from a
variety of sources to provide retailers with the ability to predict the
ever-changing behaviors of customers and to manage the warehouse, inventory and
supply chain processes. This includes increasing the efficiency and reducing the
costs of how retailers handle, track and optimize the global flow of merchandise
13
<PAGE> 14
from the vendor through the warehouse, to the stores, and finally on to
customers. The remaining segments of HNC's business operations develop, market
and support predictive software solutions for the Internet and telecommunication
service industries.
The Company's revenues are comprised of license and maintenance
revenues, and services and other revenues. The Company's revenues for the three
months ended March 31, 1999 were $49.2 million, an increase of 40.2% over
revenues of $35.1 million for the same period in the prior year.
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 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 revenues from periodic
software license and maintenance agreements are generally recognized ratably
over the respective license or agreement periods. Revenues from certain
short-term periodic software license and maintenance agreements with a
guaranteed minimum license fee are 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. Revenues from
perpetual licenses of the Company's software for which there are no significant
continuing obligations and collection of the related receivables is probable are
recognized on delivery of the software and acceptance by the customer.
License and maintenance revenues were $36.5 million for the quarter
ended March 31, 1999, an increase of 35.7% from $26.9 million for the comparable
quarter in 1998. License and maintenance revenues from the insurance solutions
segment were $11.9 million for the quarter ended March 31, 1999, an increase of
32.4% from $9.0 million for the comparable quarter in 1998. The increase in the
insurance solutions segment was a result of an increase in revenues derived by
the COMPADVISOR (formerly CRLink) product. License and maintenance revenues from
the retail solutions segment were $11.7 million for the quarter ended March 31,
1999, an increase of 29.1% from $9.0 million for the comparable quarter in 1998.
The increase in the retail solutions segment was attributable to an increase in
sales of the Retek suite of products, primarily related to the Retek Trade
Management and Retek Distribution Management products. License and maintenance
revenues from the financial solutions segment were $9.7 million for the quarter
ended March 31, 1999, an increase of 22.5% from $7.9 million for the comparable
quarter in 1998. The increase in the financial solutions segment was
attributable to sales generated by FTI and an increase in the sales of the
Falcon suite of products.
SERVICES AND OTHER REVENUES. Services and other revenues are comprised
of installation and implementation revenues, service bureau operations revenues
and revenues which are derived from consulting contracts, new product
development contracts with commercial customers and, to a lesser extent,
research and development contracts with the United States government. Revenues
from installation and implementation services and 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. Service bureau revenues are derived from the Company's
service bureau operations, which provide COMPADVISOR's (formerly CRLink)
functionality to customers that do not wish to obtain a license, that use this
service until they can implement their own internal COMPADVISOR
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(formerly 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 and service bureau fees are recognized as revenue when
the processing services are performed.
Services and other revenues were $12.7 million for the quarter ended
March 31, 1999, an increase of 55.1% from $8.2 million for the comparable
quarter in 1998. Services and other revenues from the retail solutions segment
were $5.0 million for the quarter ended March 31, 1999, an increase of 136.6%
from the $2.1 million for the comparable quarter in 1998. This increase was due
to an increase in consulting contracts with commercial customers as a result of
an expanding customer base and an increase in the services offered. Services and
other revenues from the financial solutions segment were $4.5 million for the
quarter ended March 31, 1999, an increase of 59.6% from the $2.8 million for the
comparable quarter in 1998. This increase was attributable to an increase in
implementations of the Capstone product, and to a lesser extent the Falcon suite
of products, in the financial solutions segment. Services and other revenues
from the insurance solutions segment were $1.8 million for the quarter ended
March 31, 1999, a decrease of 18.2% from the $2.2 million for the comparable
quarter in 1998. This decrease was attributable to the loss of one of the
insurance solutions segment's service bureau customers during the first quarter
of 1999 due to industry consolidation.
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 preparation of documentation materials.
The Company's gross margin on license and maintenance revenues was 70.6% for the
first quarter of 1999 and 77.8% for the first quarter of 1998.
License and maintenance gross margin from the retail solutions segment
was 88.0% for the first quarter of 1999 and 93.0% for the first quarter of 1998.
The primary reason for the decrease in gross margin from the retail solutions
segment was an increase in staffing and associated costs in client services to
support the increased volume of business. License and maintenance gross margin
from the insurance solutions segment was 40.3% for the first quarter of 1999 and
59.6% for the first quarter of 1998. The decrease was attributable to an
increase in the Preferred Provider Organization bill repricing, which typically
have lower margins than the overall bill review business. License and
maintenance gross margin from the financial solutions segment was 80.7% for the
first quarter of 1999 and 82.9% for the first quarter of 1998.
SERVICES AND OTHER GROSS MARGIN. Services and other expenses consist of
personnel and other expenses associated with providing installation and
implementation services and performing development, consulting, and research and
development contracts and the costs associated with the service bureau
operations. The Company's gross margin on services and other revenues was 31.9%
for the first quarter of 1999 and 41.8% for the first quarter of 1998.
Services and other gross margin from the retail solutions segment was
42.2% for the first quarter of 1999 and 39.2% for the first quarter of 1998.
This increase is primarily attributable to an increase in pricing on consulting
contracts and an increase in the utilization of the services employees and less
use of subcontracted labor in the retail solutions segment during the first
quarter of 1999. Services and other gross margin from the financial solutions
segment was 33.2% and 36.4% for the first quarter of 1998, respectively. The
decrease in the margin was attributable to the increase in temporary labor,
which has a negative impact on margins due to the
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high cost. Services and other gross margin from the insurance solutions segment
was (1.9)% and 48.6% for the first quarter of 1999 and 1998, respectively. The
decrease in the gross margin was the result of the loss of one of the insurance
solutions segment's service bureau customers during the first quarter of 1999
due to industry consolidation and the continuation of employee staffing at the
prior quarter's levels.
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 in the first quarter of 1999 were
$9.5 million or 19.4% of total revenues compared to $6.9 million or 19.6% of
total revenues in the first quarter of the prior year.
The insurance solutions segment accounted for approximately $1.8 million
and $1.6 million during the quarters ended March 31, 1999 and 1998,
respectively. The retail solutions segment accounted for approximately $4.3 and
$2.9 million during the quarters ended March 31, 1999 and 1998, respectively.
The financial solutions segment accounted for approximately $2.5 and $2.3
million during the quarters ended March 31, 1999 and 1998, respectively. The
increase in these expenses in absolute dollars was due primarily to increases in
staffing and related costs to support increased product development activities,
primarily related to enhancements to the insurance solutions and retail
solutions products and, to a lesser extent, the financial solutions products.
Research and development expenses also increased in absolute dollars due to
increased efforts required to support the research and development functions of
businesses acquired by the Company in fiscal 1998.
Statement of Financial Accounting Standards No. 86, "Accounting 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 March 31, 1999. 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 were $9.8 million or 19.9% of
total revenues in the first quarter of 1999 compared to $7.6 million or 21.8% of
total revenues in the first quarter of 1998. The retail solutions segment
accounted for approximately $3.8 million and $3.3 million during the quarters
ended March 31, 1999 and 1998, respectively. The financial solutions segment
accounted for approximately $3.3 million and $2.5 million during the quarters
ended March 31, 1999 and 1998, respectively. The insurance solutions segment
accounted for approximately $956,000 and $1.3 million during the quarters ended
March 31, 1999 and 1998, respectively.
The increases in sales and marketing expenses were due primarily to
increases in staffing related to the Company's expansion of its direct sales and
marketing staff. Contributing to the increases were increased expenses for trade
shows, advertising, corporate marketing programs and other expenses to support
the recently acquired businesses. The Company expects sales and
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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 were $4.6
million or 9.3% of total revenues in the first quarter of 1999, compared to $3.3
million or 9.5% of total revenues in the first quarter of the prior year.
Included in general and administrative expenses were acquisition related costs
of $245,000 for the three month period ended March 31, 1998.
Excluding acquisition costs, the retail solutions segment accounted for
approximately $1.2 million and $934,000 during the quarters ended March 31, 1999
and 1998, respectively. Excluding acquisition costs, the financial solutions
segment accounted for approximately $1.6 million and $729,000 during the
quarters ended March 31, 1999 and 1998, respectively. Excluding acquisition
costs, the insurance solutions segment accounted for approximately $1.3 million
and $1.1 million during the quarters ended March 31, 1999 and 1998,
respectively. The increase in absolute dollars was due primarily to increased
staffing and related expenses, including recruiting costs, to support higher
levels of sales and development activity across the Company resulting in part
from the Company's recent acquisitions. The decrease of general and
administrative expenses as a percentage of total revenues was the result of
general and administrative expenses increasing at a lower rate than revenues in
the same fiscal periods.
IN-PROCESS RESEARCH AND DEVELOPMENT EXPENSES. In-process research and
development expenses were $1.8 million or 5.0% of total revenues in the first
quarter of 1998. These one-time write-offs were related to the acquisition of
Retek Logistics.
Retek Logistics Inc. (formerly Practical Control Solutions,
Inc.) Retek Logistics is a supplier of fully integrated distribution
center management software products that address the distribution needs
of the retail, wholesale and manufacturing industries. Retek Logistics'
products may be classified into two categories: Nautilus, an
off-the-shelf warehouse management software system designed to provide
the tools needed to control the course of warehouse operations and
Nautilus CBT, an operational tutorial database which guides the user
through Nautilus operations. Certain products were complete in certain
areas and under development in others. The classification of the
technology as complete or under development was made in accordance with
the guidelines of Statement of Financial Accounting Standards No. 86
("SFAS 86"), Statement of Financial Accounting Standards No. 2 ("SFAS
2") and Financial Accounting Standards Board Interpretation No. 4
("FIN4"). At the time of acquisition, Retek Logistics had a number of
new software products under development, including Nautilus Versions 6.0
and 7.0 and Nautilus CBT. Nautilus Version 6.0 and Nautilus CBT were
both completed during 1998. Nautilus 7.0 was in an early stage of
development as of the acquisition date. HNC assumed that it would incur
approximately $974,000 of additional development costs through to
technological feasibility, which was assumed to be during the second
quarter of 1999.
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The Retek Logistics in-process research and development (R&D)
projects continue to progress, in all material respects, consistently
with the assumptions that HNC provided to the independent appraiser for
use in the valuation of the in-process R&D. The inability of HNC to
complete this technology within the expected timeframes could materially
impact future revenues and earnings, which could have a material adverse
effect on HNC's business, financial condition and results of operations.
Financial Technology, Inc. FTI has been a provider of management
accounting software for financial institutions since 1982. Since 1994,
FTI has focused on profitability measurement and other decision support
systems. FTI's products are generally classified into six categories:
ProfitVision, MarketVision, RiskVision, DataVision, Decision Support
Products and Financial Platform Products. FTI had various new products
under development in each of these categories, none of which had reached
technological feasibility as of the acquisition date. The classification
of each new technology as complete or under development was made in
accordance with the guidelines of SFAS 86, SFAS 2 and FIN4. Each new
product under development has varying release dates for completion
ranging from July 1998 through December 1999. The valuation of
in-process research and development was based on the assumption that the
estimated cost to complete all products under development, measured as
of the acquisition date, is approximately $2.1 million, of which $1.2
million would be incurred through December 1998 and an additional
$900,000 would be incurred during 1999. The valuation approach also
assumed that these products would generate revenues through the year
2002. These statements regarding revenues and expenses are
forward-looking statements, which are subject to risks and
uncertainties. Actual results may differ materially from those
anticipated. The important factors that could cause actual results to
differ include those discussed elsewhere in this Report and in the
Company's 1998 Annual Report. The inability of HNC to complete this
technology within the expected timeframes could materially impact future
revenues and earnings, which could have a material adverse effect on
HNC's business, financial condition and results of operations.
The FTI in-process research and development projects continue to
progress, in all material respects, consistently with management's
original assumptions that were provided to the independent appraiser and
used to value the in-process R&D.
ATACS. ATACS is a fraud management software solution for the
wireline, wireless and Internet telecommunication service provider
industries. The system detects fraudulent traffic thereby avoiding
significant financial losses to traditional telecommunication carriers
and Internet Service Providers. ATACS' Version 4.2 includes significant
enhanced features from its prior version, including new enhancements to
Velocity, Message Handlers and a subsystem to support fraud detection of
on-line transactions. ATACS Version 4.1 was completed and producing
revenues prior to the acquisition date while Version 4.2, which includes
new technology that allows the system to function on three interface
platforms, was under development and had not yet reached technological
feasibility as of the acquisition date. Although Version 4.2 has as its
foundation technology from the completed as well as in-process
technology, HNC believes that it will have changed significantly so as
to be considered new research and development efforts. The
classification of each research and development project as complete or
under development was made in accordance with the guidelines of SFAS 86,
SFAS 2 and FIN4. The valuation approach assumed that the cost to
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reach technological feasibility would be approximately $250,000 and the
release would be completed by July 1998.
The ATACS in-process research and development projects continue
to progress, in all material respects, consistently with HNC's original
assumptions that were provided to the independent appraiser and used to
value the in-process R&D.
Valuation Approach. HNC used an independent appraisal firm to
assist it with its valuation of the fair market value of the purchased
assets of Retek Logistics, FTI and ATACS. Fair market value is defined
as the estimated amount at which an asset might be expected to be
exchanged between a willing buyer and willing seller assuming the buyer
continues to use the assets in its current operations. HNC provided
assumptions by product line of revenue, cost of goods sold and operating
expense to the appraiser to assist in the valuation. The appraisal
considered three traditional approaches to valuation: the cost approach,
the market approach and the income approach.
Retek Logistics Inc. (formerly Practical Control Solutions,
Inc.) With respect to the forecasted earnings provided to the appraiser,
Retek Logistics is forecasting slightly higher revenue growth rates as
long as it can continue to meet market demands with new releases each
year. These higher growth rates reflect Retek Logistics' expectation of
greater market acceptance with the release of its ORACLE-based platform,
as well as improvements planned to be incorporated into Nautilus
versions 6 and 7. Retek Logistics' gross margins are forecasted to
remain consistent relative to prior years. Retek Logistics is also
expecting its current operating expense levels to increase only
moderately in absolute dollars and, as a result, earnings before
interest and taxes are expected to increase in later years. Management
believes these growth expectations are reasonable if new product
versions are offered according to schedule. The statements regarding
expectations for Retek Logistics are forward-looking statements, which
are subject to risks and uncertainties. Actual results may differ
materially from those anticipated. The important factors that could
cause actual results to differ include those discussed elsewhere in this
Report and in the Company's 1998 Annual Report.
Financial Technology Inc. Prior to 1997, FTI primarily sold
financial reporting general ledger software to mid-sized banks. During
1997, FTI began to derive a significant amount of its revenue from
ProfitVision, a customer profitability system for these same financial
institutions. With respect to the forecasted earnings provided to the
appraiser, FTI is forecasting significant revenue growth from a full
line of new software measurement tools. The financial forecasts
reflected in the appraiser's report reflect management's expectation of
significant revenue growth from a number of new product offerings.
Operating margins (before interest and taxes) are currently expected to
increase from historical trends. Management currently believes that
these projected increases are reasonable in light of the number of new
product offerings and increased gross profit obtained from these new
software measurement tools which is in contrast to those obtained from
the financial reporting packages historically sold by FTI. The
statements regarding expectations for FTI are forward-looking
statements, which are subject to risks and uncertainties. Actual results
may differ materially from those anticipated. The important factors that
could cause actual results to differ include those discussed elsewhere
in this Report and in the Company's 1998 Annual Report.
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ATACS. ATACS represented a product line within Bedford
Associates, Inc. since 1995. Management was provided with limited
historical information but in conjunction with the acquisition, reviewed
contracts that supported revenue. The Company identified and ultimately
hired the development and support team that represents the underlying
costs of revenue as well as development costs. Under Bedford, ATACS was
not an aggressively marketed product and, as a result, sales growth
slowed and margins dropped slightly. The product becomes more widely
marketable with the offering of Version 4.2, which expands the
functionality to three new operating environments. With respect to the
forecasted earnings provided to the appraiser, the forecasts reflected
higher growth rates than prior years' ranges, reflecting the new product
offering and several years of prior marketing of the product now
generating sales opportunities. Gross margins are also forecasted to
increase rather significantly reflecting higher revenue levels and
economies of scale in the production and support cost areas. The
statements regarding expectations for ATACS are forward-looking
statements, which are subject to risks and uncertainties. Actual results
may differ materially from those anticipated. The important factors that
could cause actual results to differ include those discussed elsewhere
in this Report and in the Company's 1998 Annual Report.
With respect to the discount rates used in the valuation
approach, the incomplete technology represents a mix of near and
mid-term prospects for the business and imparts a level of uncertainty
to its prospects. It is the nature of the business to be constantly
developing new software for future product releases. A reasonable
expectation of return on the incomplete technology would be higher than
that of completed technology due to these inherent risks. As a result,
the earnings associated with incomplete technology were discounted at a
rate of 40.0%, 27.0% and 22.5% for Retek Logistics, FTI and ATACS,
respectively, based upon the following methodologies:
Retek Logistics Inc. (formerly Practical Control Solutions,
Inc.) Because Retek Logistics did not have short-term or long-term debt
as of the date of acquisition, the Moody's seasoned Baa rate for March
31, 1998 was utilized as the cost of debt. The Capital Asset Pricing
Model was used to determine the cost of equity. It combines a risk free
rate of return with an equity risk premium multiplied by a factor,
referred to as Beta, which is based on the performance of common stock
prices of similar publicly traded companies. Employing these data, the
discount rate attributable to the business was 30%, which was used for
valuing completed technology. Since incomplete technology represents a
mix of near and mid-term prospects for the business and imparts a
certain level of uncertainty and would require a higher return than
completed technology, the valuation report prepared by the Company's
appraiser suggests that a rate of 40% be ascribed to the excess earnings
of incomplete technology.
Financial Technology Inc. The cash flows attributable to FTI's
technology were discounted based on a weighted average cost of capital
("WACC") analysis attributable to the business. In determining an
appropriate discount rate utilizing the WACC analysis, an analysis was
made of short-term interest rates, the yields of long-term corporate and
government bonds, and other alternative investment instruments, as well
as the typical capital structure of companies in the industry. Employing
this formula, the discount rate attributed to the business was 17%,
which was used to discount the completed technology. Incomplete
technology represents a mix of near- and mid-term prospects for the
business and imparts a certain level of uncertainty. The valuation
report prepared by the Company's appraiser suggests that a rate of 27%
be ascribed to the excess earnings of incomplete technology.
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ATACS. Because ATACS did not have short-term or long-term debt
as of the date of acquisition, the Moody's seasoned Baa rate for May 19,
1998 was utilized as the cost of debt. The Capital Asset Pricing Model
was used to determine the cost of equity. It combines a risk free rate
of return with an equity risk premium multiplied by a factor, referred
to as Beta, which is based on the performance of common stock prices of
similar publicly traded companies. Employing these data, the discount
rate attributable to the business was 17.5%, which was used for valuing
completed technology. Since incomplete technology represents a mix of
near- and mid-term prospects for the business and imparts a certain
level of uncertainty and would require a higher return than completed
technology, the valuation report prepared by the Company's appraiser
suggests that a rate of 22.5% be ascribed to the excess earnings of
incomplete technology.
ACQUISITION RELATED AMORTIZATION EXPENSES. Acquisition related
amortization expenses were $2.3 million or 4.6% of total revenues in the first
quarter of 1999. These expenses primarily represent the amortization of
intangible assets purchased in conjunction with the Company's 1998 acquisitions
of Retek Logistics and FTI, the asset purchase of ATACS and the acquisition of
the minority interest of Aptex, which was previously a majority-owned
subsidiary. The average amortization life is approximately 4 years.
OPERATING INCOME. The above factors resulted in operating income of $3.7
million in the first quarter of 1999, constituting 7.5% of total revenues in the
same period, and operating income of $4.8 million in the first quarter of 1998,
constituting 13.6% of total revenues in the same period.
OTHER INCOME, NET. Other income for the first quarter of 1999 was
$303,000 compared to $401,000 in the first quarter of the prior year. Other
income is comprised of interest income earned on cash and investment balances,
net of interest expense related to the 4.75% Convertible Subordinated Notes due
2003 (the "Notes"). HNC issued the Notes in February 1998. Other income for the
first quarter of 1999 included a full quarter of interest expense related to the
Notes as compared to the same period in the prior year. This was partially
offset by an increase in interest income related to the investment of the
proceeds from the public offering in March 1998 of $100 million related to the
Notes.
INCOME TAX PROVISION. The income tax provisions of $1.9 million in the
first quarter of 1999 and $2.7 million in the first quarter of 1998 are based on
management's estimates of the effective tax rates to be incurred by the Company
during those respective full fiscal years. The 1998 income tax provision
includes the tax effects of the non-deductible, one-time write-offs of
in-process research and development related to the purchase of Retek Logistics.
The 1999 income tax provision includes the tax effects of non-deductible
acquisition related amortization expense.
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LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities during the first three months
of 1999 was $8.8 million, which included net income before depreciation and
amortization of approximately $6.4 million. Cash was further increased by
decreases in accounts receivable of $2.1 million and deferred income taxes of
$1.4 million and increases in accounts payable of $1.4 million and deferred
revenue of $1.5 million, offset by a decrease in accrued liabilities of $5.1
million which was primarily attributable to payment of acquisition costs and
bonuses accrued for at December 31, 1998 and payment of interest on the 4.75%
Convertible Subordinated Notes due 2003. Net cash used in investing activities
was $7.1 million during the first three months of 1999, primarily due to
purchases of investments available for sale of $36.5 million, offset by $16.9
million of maturities and $21.0 million of proceeds from the sales of
investments available for sale. Contributing to the increase were acquisitions
of property and equipment of $5.8 million and acquisitions of minority equity
investments of $2.8 million during the first quarter of 1999. Net cash used by
financing activities of $16.8 million during the first three months of 1999 was
primarily related to the purchase of treasury stock of $18.8 million offset by
net proceeds of $2.0 million from the issuance of common stock.
At March 31, 1999, the Company had $136.4 million in cash, cash
equivalents and investments. The Company believes that its current cash, cash
equivalents and investments available for sale balances, 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 Company expects to invest approximately $14.1
million in capital assets, including computer equipment and building
improvements during 1999. Management intends to invest the Company's cash in
excess of current operating requirements in short-term, interest-bearing,
investment-grade securities. A portion of the Company's cash could also be used
to acquire or invest in complementary businesses or products or otherwise to
obtain the right to use complementary technologies or data. From time to time,
in the ordinary course of business, the Company evaluates potential acquisitions
of such businesses, products, technologies or data. The Company has no present
understandings, commitments or agreements with respect to any material
acquisition of businesses, products, technologies or data.
YEAR 2000 COMPLIANCE
GENERAL
It is generally anticipated that many organizations will experience
operational difficulties at the beginning of the Year 2000 as a result of the
fact that many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. Significant
uncertainty exists in the software and other industries concerning the scope and
magnitude of problems associated with the century change. As early as 1997, the
Company had begun the process of planning and updating, in some cases, its
earlier versions of existing software products. More recent versions of these
same products as well as new products were developed with Year 2000 date
processing in mind. To track performance of completing any remaining compliance
work as well as to assess the Year 2000 issue more broadly, the Company
developed a Year 2000 project plan.
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PROJECT
The Company initiated a company-wide Year 2000 Project (Y2k Project)
during 1998 to more formally monitor compliance of its year 2000 exposure for
each major business unit and has divided the project into three major sections
that address its critical date sensitive components: software products,
information technology ("IT") infrastructure, and non-IT systems. The Y2k
Project consists of (1) assessing the current state of readiness for all
critical components, (2) developing project plans that track the status of work
performed toward completing planned solutions and (3) developing contingency
plans.
In August 1998, IT directors of all significant business units were
asked to inventory all major components and provide the current state of
readiness as well as an indication as to when readiness would otherwise be
expected. In addition, each major business unit was asked to provide project
plan status reports that indicate how compliance would be achieved, as well as
to quantify the extent and timing of the effort and to identify when testing of
the solution would be completed. Finally, each major business unit was asked to
consider various scenarios that might impact successful implementation of their
Year 2000 solutions and to develop alternative or back-up plans to mitigate the
risk of not being ready on time.
CURRENT STATUS
The Company completed the initial stage of its Y2k Project during 1998
by taking inventory of its more major software products, identifying the state
of readiness for each and developing project plans for completing and
implementing designed solutions. Based on the Company's assessment of its major
software products, the Company believes that the current version of each is Year
2000 compliant. However, there can be no assurance that all of the Company's
customers will install the Year 2000 compliant version of the Company's products
in a timely manner, which could lead to failure of customer systems and product
liability claims against the Company.
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The Company has also substantially completed its review of major non-IT
system components for Year 2000 compliance and is undertaking appropriate repair
or replace actions based on the results of the review. Non-IT systems include
hardware and other electronic systems, excluding application systems, used in
operations of the Company's business. In general, the Company relies on
manufacturer's recommendations, certifications and warranties as validation of
Year 2000 compliance.
The Company's plan for the Year 2000 calls for compliance verification
of third parties supplying software and information systems to the Company for
both IT and non-IT systems and communication with significant suppliers to
determine the readiness of third parties' remediation of their own Year 2000
issues. As part of its assessment, the Company is evaluating the level of
validation it will require of third parties to ensure their Year 2000 readiness
and the necessary contingency plans should such a situation arise. To date, the
Company has not encountered any material Year 2000 issues concerning its
computer systems.
Potential worst case Year 2000 scenarios currently being considered by
the Company address issues arising from non-compliance by its customers,
suppliers or internal operating systems. Although the Company's Y2k Project will
strive to uncover significant non-compliance issues, in the worst case not all
Y2k problems may be uncovered by the year 2000, which could have a material
adverse effect on the Company's business. However, the Company believes that its
most probable worst case scenario is more likely to arise from its customers'
and vendors' inability to become Year 2000 compliant than from the Company's
failure to bring its own products into compliance. As a result, the Company's
supply chain and revenues could be adversely impacted. As discussed below, the
Company generates a significant portion of its revenues from usage-based license
fees which would be at risk if its customers are unable to operate their
computer systems due to Year 2000 problems caused by software developed
internally by the customer or purchased from a third party vendor. Some
considerations include quantifying the impact that usage-based fees may have on
the Company's business and understanding the compliance programs and contingency
plans, if any, the Company's vendors and customers have developed.
COSTS
All costs associated with carrying out the Company's plan for the Year
2000 compliance are being expensed as incurred. The total cost associated with
preparation for the Year 2000 has not been, and is not expected to be, material
to the Company's business, financial condition or results of operations.
Nevertheless, the Company may not timely identify and remediate all significant
Year 2000 problems and remedial efforts may involve significant time and
expense. Failure to identify such problems could, for example, impair the
Company's internal product development efforts and internal management systems.
There can be no assurance that any Year 2000 compliance problems of the Company
or its customers or suppliers will not have a material adverse effect on the
Company's business, financial condition and results of operations.
RISKS
The inability of the Company to complete its assessment and any
necessary modifications to recently acquired products could have a material
adverse effect on the Company's business, financial condition and results of
operations. Even if the Company's products are Year 2000 compliant, the Company
may in the future be subject to claims based on Year 2000 issues in the
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products of other companies, or issues arising from the integration of multiple
products within a system. The costs of defending and resolving Year 2000-related
disputes, and any liability of the Company for Year 2000 related damages,
including consequential damages, could have a material adverse effect on the
Company's business, financial condition and results of operations. Further, the
Company's products are generally used with enterprise systems involving complex
software products developed by other vendors, which may not be Year 2000
compliant. In particular, many of the Company's customers are financial
institutions, insurance companies and other companies with insurance and
financial services businesses, all of which use legacy computer systems that are
expected to be particularly susceptible to Year 2000 compliance issues. If the
Company's customers are unable to use their information systems because of the
failure of such non-compliant systems or software or for any other reason, there
would be a decrease in the volume of transactions that the Company's customers
process using the Company's products. As a result, the Company's recurring
revenue in the form of usage-based transactional fees from customers in the
insurance and financial solutions markets would decline, which would have a
material adverse effect on the Company's business, financial condition and
results of operations. Such failure could also affect the perceived performance
of the Company's products, which could have a negative effect on the Company's
competitive position. 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.
25
<PAGE> 26
Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to a variety of risks, including foreign currency
fluctuations and changes in the market value of its investments. In the normal
course of business, the Company employs established policies and procedures to
manage its exposure to fluctuations in foreign currency values and changes in
the market value of its investments.
The Company's foreign currency risks are mitigated principally by
contracting primarily in US dollars and maintaining only nominal foreign
currency cash balances. Working funds necessary to facilitate the short term
operations of the Company's subsidiaries are kept in the local currencies in
which they do business, with excess funds transferred to the Company's offices
in the United States for investment. For the quarter ended March 31, 1999,
approximately 14.0% of the Company's sales were denominated in currencies other
than the Company's functional currency, which is the US dollar. These foreign
currencies are primarily those of Western Europe, Canada and Australia.
The fair value of the Company's investments available for sale at March
31, 1999 was $97.5 million. The objectives of the Company's investment policy
are the safety and preservation of invested funds and liquidity of investments
that is sufficient to meet cash flow requirements. The Company's policy is to
place its cash, cash equivalents and investments available for sale with large
financial institutions and commercial companies and government agencies in order
to limit the amount of credit exposure. It is also the Company's policy to
maintain certain concentration limits and to invest only in certain "allowable
securities" as determined by the Company's management. The Company's investment
policy also provides that its investment portfolio must not have an average
portfolio maturity of beyond one year and that the Company must maintain certain
liquidity positions. Investments are prohibited in certain industries and
speculative activities. Investments must be denominated in U.S. dollars.
26
<PAGE> 27
Item 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.01 Financial Data Schedule
(b) Reports on Form 8-K
Report on Form 8-K filed dated January 22, 1999 reporting the
acquisition of Aptex Software Inc. under Item 5.
27
<PAGE> 28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report on Form 10-Q to be signed on its behalf
by the undersigned thereunto duly authorized.
HNC SOFTWARE INC.
Date: May 14, 1999 By: /s/ Raymond V. Thomas
--------------------------------
Raymond V. Thomas
Vice President, Finance &
Administration and Chief Financial
Officer
(for Registrant as duly authorized
officer and as Principal Financial
Officer)
28
<PAGE> 29
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibits
--------
<S> <C>
27.01 Financial Data Schedule
</TABLE>
29
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 38,900
<SECURITIES> 25,714
<RECEIVABLES> 58,989
<ALLOWANCES> (3,050)
<INVENTORY> 450
<CURRENT-ASSETS> 136,493
<PP&E> 33,908
<DEPRECIATION> (15,623)
<TOTAL-ASSETS> 267,553
<CURRENT-LIABILITIES> 27,599
<BONDS> 100,000
0
0
<COMMON> 25
<OTHER-SE> 139,250
<TOTAL-LIABILITY-AND-EQUITY> 267,553
<SALES> 49,189
<TOTAL-REVENUES> 49,189
<CGS> 19,374
<TOTAL-COSTS> 19,374
<OTHER-EXPENSES> 26,130
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,381
<INCOME-PRETAX> 3,988
<INCOME-TAX> 1,864
<INCOME-CONTINUING> 2,124
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,124
<EPS-PRIMARY> 0.08
<EPS-DILUTED> 0.08
</TABLE>
