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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A-2
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM_____________ TO_____________ .
COMMISSION FILE NUMBER 0-26146
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HNC SOFTWARE INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 33-0248788
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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, 1998 THERE WERE 25,436,880 SHARES OF REGISTRANT'S COMMON STOCK,
$0.001 PAR VALUE, OUTSTANDING.
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EXPLANATORY NOTE
In October 1998, the SEC issued a letter to the American Institute of
Certified Public Accountants indicating suggested practices for determining in
process research and development charges related to acquisitions to be accounted
for under the purchase method of accounting. Further, the SEC has indicated that
this methodology should be adopted for all transactions accounted for by the
purchase method. The Company originally recorded Practical Control Systems, Inc.
("PCS") during the first quarter of 1998 using then current accepted practices
and has now recorded this new methodology and its related effects, retroactively
to the quarter ended March 31, 1998.
This amendment to Form 10-Q for the quarter ended March 31, 1998 is being
filed to conform to these practices with respect to the acquisition of PCS.
INDEX LISTING
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<TABLE>
<CAPTION>
Page
Number
------
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1: FINANCIAL STATEMENTS
Consolidated Balance Sheet at March 31, 1998 (unaudited) 3
and December 31, 1997.
Consolidated Statement of Income and Comprehensive 4
Income (unaudited) for the three months ended
March 31, 1998 and 1997
Consolidated Statement of Cash Flows (unaudited) for 5
the three months ended March 31, 1998 and 1997
Notes To Consolidated Financial Statements (unaudited) 6
Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 9
PART II OTHER INFORMATION
Item 6: EXHIBITS AND REPORT ON FORM 8-K 16
Signatures 17
Exhibit Index 18
</TABLE>
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PART I - FINANCIAL INFORMATION
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Item 1: FINANCIAL STATEMENTS
HNC SOFTWARE INC.
CONSOLIDATED BALANCE SHEET
(in thousands, except per share data)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
----------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 90,889 $ 18,068
Investments available for sale 33,334 24,878
Accounts receivable, net 38,099 32,980
Current portion of deferred 11,324 11,310
income taxes
Other current assets 4,302 2,802
--------- ---------
Total current assets 177,948 90,038
Property and equipment, net 12,743 12,102
Deferred income taxes, less current 12,573 15,322
portion
Long-term investments available for 22,016 --
sale
Debt issuance costs, net 3,039 --
Other assets 5,416 2,415
---------
=========
$ 233,735 $ 119,877
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,564 $ 5,728
Accrued liabilities 6,137 5,933
Deferred revenue 8,221 3,883
Other current liabilities 179 191
--------- ---------
Total current liabilities 19,101 15,735
Convertible Subordinated Notes 100,000 --
Unissued stock payable to PCS stockholders 5,088 --
Other non-current liabilities 122 239
Minority interest in consolidated subsidiary 65 43
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:
24,730 and 24,538 shares issued and outstanding, 25 25
respectively
Paid-in capital 98,917 95,919
Retained earnings 10,416 8,029
Accumulated other comprehensive income 1 (113)
--------- ---------
Total stockholders' equity 109,359 103,860
--------- ---------
$ 233,735 $ 119,877
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
3
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HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------
March 31, 1998 March 31, 1997
-------------- --------------
<S> <C> <C>
Revenues:
License and maintenance $ 26,882 $ 18,331
Installation and implementation 3,197 1,946
Contracts and other 2,892 2,726
Service bureau 2,110 1,069
-------- --------
Total revenues 35,081 24,072
-------- --------
Operating expenses:
License and maintenance 5,972 3,994
Installation and implementation 1,863 801
Contracts and other 1,876 1,850
Service bureau 1,033 864
Research and development 6,861 4,431
In-process research and development 1,750 --
Sales and marketing 7,641 4,553
General and administrative 3,331 2,459
-------- --------
Total operating expenses 30,327 18,952
-------- --------
Operating income 4,754 5,120
Other income, net 401 429
Minority interest in income of consolidated subsidiary (22) --
-------- --------
Income before income tax provision 5,133 5,549
Income tax provision 2,746 1,337
-------- --------
Net income $ 2,387 $ 4,212
======== ========
Other comprehensive income, net of tax:
Foreign currency translation adjustments 121 (73)
Unrealized (losses) gain on securities (7) 21
available for sale -------- --------
Total other comprehensive income 114 (52)
-------- --------
Comprehensive income 2,501 4,160
-------- --------
Earnings per share:
Basic net income per common share $ 0.10 $ 0.17
======== ========
Diluted net income per common share $ 0.09 $ 0.17
======== ========
Shares used in computing basic net income per
common share 24,620 24,080
======== ========
Shares used in computing diluted net income per
common share 26,041 25,406
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
4
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HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
-------------------------------
March 31, March 31,
1998 1997
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,387 $ 4,212
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 1,598 1,190
Purchased research and development 1,750 --
Tax benefit from stock option transactions 1,168 1,282
Changes in assets and liabilities:
Accounts receivable, net (4,122) (457)
Other assets (872) (174)
Deferred income taxes 2,746 1,265
Accounts payable (1,221) (339)
Accrued liabilities (1,263) (1,757)
Deferred revenue 2,690 1,150
Other liabilities (6) (53)
--------- ---------
Net cash provided by operating activities 4,855 6,319
--------- ---------
Cash flows from investing activities:
Purchases of investments (41,145) (9,723)
Maturities of investments 10,670 1,904
Proceeds from sale of investments -- 3,001
Cash purchased in business acquisition 559
Acquisitions of property and equipment (1,778) (1,643)
--------- ---------
Net cash used in investing activities (31,694) (6,461)
--------- ---------
Cash flows from financing activities:
Net proceeds from issuance of common stock 2,681 725
Proceeds from issuance of Convertible Subordinated Notes 100,000 --
Debt issuance costs (3,087) --
Repayment of capital lease obligations (59) (124)
Distributions to CompReview Stockholders -- (1,799)
--------- ---------
Net cash provided by (used in) financing activities 99,535 (1,198)
--------- ---------
Effect of exchange rate changes on cash 125 (116)
--------- ---------
Net increase (decrease) in cash and cash equivalents 72,821 (1,456)
Cash and cash equivalents at the beginning of the period 18,068 8,121
--------- ---------
Cash and cash equivalents at the end of the period $ 90,889 $ 6,665
========= =========
Supplemental schedule of non-cash investing activities:
Stock payable for acquisition of PCS $ 5,088 $ --
========= =========
Assets assumed in acquisition of PCS $ 6,491 $ --
========= =========
Liabilities assumed in acquisition of PCS $ 1,962 $ --
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
5
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HNC SOFTWARE INC.
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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, 1998 and 1997 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, 1997 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/A-2 for the fiscal year ended December 31, 1997 (the "1997 Annual
Report"). Footnotes which would substantially duplicate the disclosures in the
Company's audited financial statements for the fiscal year ended December 31,
1997 contained in the 1997 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, 1998.
NOTE 2 BASIS OF PRESENTATION
The consolidated financial statements and related notes contained in
this Report give retroactive effect to the Company's November 29, 1997
acquisition of CompReview, Inc., accounted for as a pooling of interests, for
all periods presented. In addition, the acquisition of Practical Control Systems
Technologies, Inc. ("PCS") was completed on March 31, 1998, and accounted for as
a purchase as of that date. In connection with this acquisition, acquired
in-process research and development in the amount of $1.8 million was charged to
income at the acquisition date.
NOTE 3 ACQUISITION
In March 1998, the Company acquired PCS, a company that develops,
markets and supports fully integrated distribution center management software
products that address the distribution needs of the retail, manufacturing and
wholesale industries. HNC acquired PCS in exchange for 142,868 shares of HNC
common stock, 14,286 of which are subject to an escrow to secure certain
indemnification obligations of the former PCS stockholders plus the contingent
right, subject to PCS' achievement of certain financial objectives during
calendar 1998 and 1999, to receive certain additional shares of HNC common
stock.
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NOTE 4 SUBSEQUENT ACQUISITION
On April 7, 1998, the Company acquired Financial Technology, Inc.
("FTI"). FTI develops and markets profitability measurement, management
accounting, and executive information systems for financial institutions.
Incorporated in 1982, FTI is a provider of profitability measurement and
decision-support software to the financial services industry and serves a
substantial user base in the United States, Canada, and Europe. HNC acquired FTI
in exchange for the issuance of 396,618 shares of HNC common stock, 97,390 of
which are subject to an escrow to secure certain indemnification obligations of
the former FTI stockholders, a cash payment of $1.5 million plus the contingent
right, subject to FTI's achievement of certain financial objectives during
calendar 1998, to receive up to $5,590,000 of HNC common stock. HNC expects that
its acquisition of FTI will be treated as a "purchase" for accounting purposes.
NOTE 5 COMPREHENSIVE INCOME
During the first quarter of 1998, the Company adopted Statement of
Financial Accounting Standards No. 130 ("FAS 130"), "Reporting Comprehensive
Income." This statement requires 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. Comprehensive income is defined as
"the change in equity (net assets) of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources. It
includes all changes in equity during a period except those resulting from
investments by owners and distributions to owners."
NOTE 6 RECLASSIFICATIONS
Certain prior period balances have been reclassified to conform to the
current period presentation.
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NOTE 7 RECONCILIATION OF NET INCOME AND SHARES USED IN PER
SHARE COMPUTATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1998 1997
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<S> <C> <C>
NET INCOME USED:
Net income used in computing basic and
diluted net income per common share $ 2,387 $ 4,212
======= =======
SHARES USED:
Weighted average common shares
outstanding used in computing basic
net income per common share 24,620 24,080
Weighted average options to purchase
common stock as determined by
application of the treasury stock
method 1,406 1,318
Purchase Plan common stock
Equivalents 15 8
------- -------
Shares used in computing diluted net
income per common share 26,041 25,406
======= =======
</TABLE>
The conversion of the Company's 4.75% convertible subordinated notes for
the three month period ended March 31, 1998 of 624,000 shares was not used to
calculate diluted net income per share as their effect would be anti-dilutive.
NOTE 8 IN PROCESS RESEARCH AND DEVELOPMENT
In connection with the acquisition of PCS, acquired in-process research
and development of $1.8 million was charged to operations at the acquisition
date.
PCS is a worldwide supplier of fully integrated distribution center
management software products that address the distribution needs of the retail,
wholesale and manufacturing industries. PCS' products may be classified into
two categories: Nautilus, an off-the-shelf warehouse management software system
designed with all 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, Statement of Financial
Accounting Standards No. 2 and Financial Accounting Standards Board
Interpretation No. 4. At the time of acquisition, PCS 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 nearly complete
but had not reached technological feasibility as of the acquisition date.
8
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HNC SOFTWARE INC.
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Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS: NO ASSURANCES INTENDED
This Report (including without limitation the following section
regarding Management's Discussion and Analysis of Financial Condition and
Results of Operations) contains certain 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 Report.
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 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. 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, but are not limited to: the degree of
acceptance of the Company's products; by the markets and industries served by
the Company; the historical tendency of the Company to receive, during a given
fiscal period, a small number of relatively large customer orders, such that
failure to recognize revenue from any such order in that fiscal period may
disproportionately and adversely affect the Company's revenues and operating
results for that fiscal period; customer cancellation of long-term contracts
that yield recurring revenues or customers' ceasing their use of Company
products for which the Company receives recurring, usage-based fees and disputes
with customers regarding fees payable to the Company; the lengthy sales cycle of
most of the Company's products; the Company's ability to successfully and timely
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;
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changes in the level of operating expenses; the Company's ability to timely
achieve progress and fulfill its obligations under contracts on which revenue is
recognized in the percentage-of-completion basis; the Company's success in
completing certain pilot installations within contracted fee budgets;
competitive conditions in the enterprise software industry; domestic and
international economic conditions; and market conditions in the Company's
targeted markets. In addition, as a result of recently issued guidance on
software revenue recognition, license agreements entered into during a quarter
may not meet the Company's revenue recognition criteria, with the result that,
even if the Company meets or exceeds its forecast of aggregate licensing and
other contracting activity for a given fiscal period, it is possible that the
Company's revenues for that fiscal period would not meet expectations.
Furthermore, the Company's operating results may be affected by factors unique
to certain of its product lines. For example, although in the past a large
portion of the Company's revenues were derived from contracts providing for
periodic, recurring fees, the Company now derives a substantial and increasing
portion of its revenues from products (particularly products for the retail
industry) priced as "perpetual" license transactions in which the Company
receives a one-time license fee that is recognized 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 that fluctuations in its operating results will
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 are fixed to a
large extent in the short term, in the event of an unexpected revenue shortfall
during a fiscal period, the Company may be unable to adjust spending in time to
maintain anticipated operating results for that fiscal period. Accordingly, the
Company may not be able to maintain profitability on a quarterly or annual basis
in the future. Due to some or all of the foregoing factors, or other 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 market price of the Company's common stock and, in turn, the market price of
the Company's 4.75% convertible subordinated notes due 2003 (the "Notes"), would
likely be materially adversely affected.
RESULTS OF OPERATIONS
HNC develops, markets and supports predictive software solutions for
several leading service industries. These predictive software solutions may
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 has developed a growing family of predictive
software products that provide specific solutions for each of the
healthcare/insurance, financial services and retail markets. The Company's
healthcare/insurance products, which are developed and marketed by its Risk Data
and CompReview subsidiaries, emphasize the workmen's compensation field and
provide a variety of solutions to insurers, parties who administer insurance
claims and health care administrators. HNC's products for the financial services
market include products targeted at bank and private label payment card issuers
and payment processors and products that allow lenders to automate the loan
approval decision process. For
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the retail industry, HNC has developed a group of products that address
inventory control, merchandise management and financial control management.
The Company's revenues are comprised of license and maintenance
revenues, installation and implementation revenues, contracts and other revenues
and service bureau revenues. The Company's revenues for the three months ended
March 31, 1998 were $35.1 million, an increase of 46% over revenues of $24.1
million for the same period in the prior year.
LICENSE AND MAINTENANCE REVENUES. License and maintenance revenues were
$26.9 million for the quarter ended March 31, 1998, an increase of 47% from
$18.3 million for the comparable quarter in 1997. The Company's license and
maintenance revenues are derived from periodic recurring license and maintenance
fees and perpetual license fees. This increase in license and maintenance
revenues was due primarily to the growth of license fee revenues from the
financial services and retail industry segments. Also contributing to the
increase in license and maintenance revenues was an increase in revenues from
the healthcare/insurance market primarily from CRLink.
INSTALLATION AND IMPLEMENTATION REVENUES. Installation and
implementation revenues for the quarter ended March 31, 1998 were $3.2 million,
an increase of 64% as compared to installation and implementation revenues of
$1.9 million for the quarter ended March 31, 1997. This increase was primarily
due to new installations within the financial services industry, primarily
related to the ProfitMax and Capstone product lines. Revenues from installation
and implementation 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.
CONTRACTS AND OTHER REVENUES. Contracts and other revenues for the three
months ended March 31, 1998 were $2.9 million, an increase of 6% as compared to
$2.7 million for the same period in the prior year. Contracts and other revenues
are derived primarily from development and consulting contracts with commercial
customers and research and development contracts with the United States
Government. Revenues for new product pilots (i.e., the first production
installation of a new product) are also reported as contract and other revenues.
This increase is attributable to an increase in consulting contracts with
commercial customers in the retail industry segment. 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.
SERVICE BUREAU REVENUES. Service bureau revenues for the three months
ended March 31, 1998 were $2.1 million, an increase of 97% as compared to $1.1
million for the same period in the prior year. This increase was attributable to
an increase in the number of customers utilizing the Company's CRLink service
bureau operations.
LICENSE AND MAINTENANCE EXPENSES. License and maintenance expenses
primarily consist of the Company's expenses for personnel engaged in customer
support activities, costs of travel to customer sites and the costs of
documentation materials. License and maintenance expenses for the first quarter
of 1998 were $6.0 million and constituted 22% of license and maintenance
revenues for the quarter, whereas such expenses were $4.0 million and
represented 22% of license and maintenance revenues in the first quarter of
1997. The primary reason for the
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increase in these expenses in absolute dollars was increased staffing and
associated costs in client services to support an increased volume of business.
The Company's license and maintenance margins may vary from quarter to quarter
depending upon, among other things, the relative mix of early adopter priced
product revenues versus full priced product revenues for the quarter.
INSTALLATION AND IMPLEMENTATION EXPENSES. Installation and
implementation expenses for the first quarter of 1998 were $1.9 million and 58%
of installation and implementation revenues, whereas such expenses were $801,000
and 41% of installation and implementation revenues during the first quarter of
1997. The primary reason for the increase in these expenses in absolute dollars
was increased staffing and associated costs to support an increased volume of
business. Installation and implementation expenses as a percent of installation
and implementation revenues increased during the quarter ended March 31, 1998 as
compared to the quarter ended March 31, 1997. The associated decrease in gross
margins was a result of the mix of implementations within the financial services
segment. This decrease was due primarily to an increase in Capstone
implementations, which have substantially lower margins than implementations of
Falcon products.
CONTRACTS AND OTHER EXPENSES. Contracts and other expenses consist
primarily of personnel-related expenses associated with the Company's
performance of such development, consulting, and research and development
contracts in this expense category. Contracts and other expenses in the first
quarter of 1998 were $1.9 million or 65% of contracts and other revenues as
compared to $1.9 million or 68% of such revenues in the first quarter of 1997.
The decrease in these expenses as a percent of contracts and other revenues is
due to the completion of several higher margin pilot commercial development
contracts that were in process during the first quarter of 1997. The remaining
development contracts are primarily retail consulting contracts, government
contacts and on-going model development projects, which typically yield lower
margins than commercial new product pilot contracts.
SERVICE BUREAU EXPENSES. Service bureau expenses during the first
quarter of 1998 were $1.0 million or 49% of service bureau revenues as compared
to $864,000 or 81% of such revenues during the first quarter of 1997. The
associated increase in gross margins was the result of an increase in the number
of "complex" bills processed, which typically yield higher margins than normal
bills.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses in
the first quarter of 1998 were $6.9 million or 20% of total revenues compared to
$4.4 million or 18% of total revenues in the first quarter of the prior year.
The increase in these expenses was due primarily to increases in staffing and
related costs to support increased product development activities, primarily
related to enhancements to the retail segment products and to a lesser extent,
the healthcare/insurance segment products.
IN-PROCESS RESEARCH AND DEVELOPMENT EXPENSES. In-process research and
development expenses were $1.8 million for the three month period ended March
31, 1998. This one-time write-off was related to the acquisition of PCS.
PCS is a worldwide supplier of fully integrated distribution center
management software products that address the distribution needs of the retail,
wholesale and manufacturing industries. PCS' products may be classified into two
categories: Nautilus, an off-the-shelf warehouse
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management software system designed with all 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, Statement of Financial Accounting Standards No. 2 and Financial
Accounting Standards Board Interpretation No. 4. At the time of acquisition, PCS
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 nearly complete but had not reached technological feasibility as of
the acquisition date and approximately $280,000 of development costs were
assumed to be incurred through to their scheduled completion in mid-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 in early
1999.
All 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.
Valuation Approach. HNC used an independent appraisal firm to assist it
with its valuation of the fair market value of the purchased assets of PCS. 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 their 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.
With respect to the forecasted earnings provided to the appraiser, PCS
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 PCS' expectation of greater market acceptance with the release of its
ORACLE-based platform, as well as new improvements, that will be found in
Nautilus versions 6 and 7. PCS' gross margins are forecasted to remain
consistent relative to prior years. PCS is also expecting its current operating
expense levels to only moderately increase in absolute dollars and, as a result,
earnings before interest and taxes is expected to increase in later years.
Management believes these growth expectations are reasonable if the new product
versions are offered according to the schedules reflected in the financial
statements. The statements regarding expectations for PCS 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 in "Potential Fluctuations in
Operating Results" and elsewhere in this 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
13
<PAGE> 14
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% for PCS based upon the following methodology:
Because PCS 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.
SALES AND MARKETING EXPENSES. Sales and marketing expenses were $7.6
million or 22% of total revenues in the first quarter of 1998 compared to $4.6
million or 19% of total revenues in the first quarter of 1997. The increase in
sales and marketing expenses was due primarily to an increase in staffing
related to the Company's expansion of its direct sales and marketing staff,
including opening sales offices in Canada, Germany, South Africa, France and
Japan. The Company also established a corporate marketing infrastructure during
the third quarter of 1997 that was fully operational during the first quarter of
1998.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $3.3 million or 10% of total revenues in the first quarter of 1998,
compared to $2.5 million or 10% of total revenues in the first quarter of the
prior year. 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 of the Company resulting in part from
the Company's recent acquisitions.
OTHER INCOME, NET. Other income for the first quarter of 1998 was
$401,000 compared to $429,000 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 decrease during the first quarter of 1998 as compared to the first
quarter of the prior year is the result of increased interest expense related to
the notes, offset by increased interest income.
INCOME TAX PROVISION. The income tax provisions of $2.7 million and $1.3
million in the first quarters of 1998 and 1997, respectively, 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 effect of the non-deductible, one-time write-off of in-process
research and development related to the purchase of PCS. The income tax
provision of $1.3 million in the first quarter of 1997 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 CompReview's tax
liability being borne by its former stockholders. 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.
14
<PAGE> 15
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities during the first three months
of 1998 was $4.9 million, which represented net income before depreciation and
amortization of approximately $4.0 million. This was further increased by
purchased research and development of $1.8 million and an increase in deferred
revenue of $2.7 million, related to contract and license prepayments. Net cash
used in investing activities was $31.7 million during the first three months of
1998, primarily due to net purchases of investments of $30.5 million. Net cash
provided by financing activities of $99.5 million during the first three months
of 1998 was primarily related to proceeds from the issuance of the Company's
4.75% convertible subordinated notes due 2003 of $100.0 million issued in
conjunction with the Company's debt offering in March 1998 and net proceeds of
$2.7 million from the issuance of common stock. This was partially offset by
costs of approximately $3.1 million related to the issuance of the
above-mentioned convertible subordinated notes.
At March 31, 1998, the Company had $146.2 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. 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.
15
<PAGE> 16
Item 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.01 Financial Data Schedule
27.02 Restated Financial Data Schedule*
(b) Reports on Form 8-K
Report on Form 8-K filed on April 21, 1998 with respect to an
event dated April 7, 1998 (the acquisition of Financial
Technology, Inc.)
- ----------------
*Filed herewith.
16
<PAGE> 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this amendment to report on Form 10-Q to be
signed on its behalf by the undersigned thereunto duly authorized.
HNC SOFTWARE INC.
Date: February 5, 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)
17
<PAGE> 18
EXHIBIT INDEX
Exhibits
27.01 Financial Data Schedule
27.02 Restated Financial Data Schedule*
- ----------------
*Filed herewith.
18
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 90,889
<SECURITIES> 55,350
<RECEIVABLES> 42,157
<ALLOWANCES> (4,058)
<INVENTORY> 419
<CURRENT-ASSETS> 177,948
<PP&E> 23,210
<DEPRECIATION> (10,467)
<TOTAL-ASSETS> 233,735
<CURRENT-LIABILITIES> 19,101
<BONDS> 100,000
0
0
<COMMON> 25
<OTHER-SE> 109,333
<TOTAL-LIABILITY-AND-EQUITY> 233,735
<SALES> 35,081
<TOTAL-REVENUES> 35,081
<CGS> 10,744
<TOTAL-COSTS> 10,744
<OTHER-EXPENSES> 19,583
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 391
<INCOME-PRETAX> 5,133
<INCOME-TAX> 2,746
<INCOME-CONTINUING> 2,387
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,387
<EPS-PRIMARY> 0.10
<EPS-DILUTED> 0.09
</TABLE>
