<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 0-26146
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HNC SOFTWARE INC.
(Exact name of registrant as specified in its charter)
--------------------------------------------------------------------------------
<TABLE>
<S> <C>
DELAWARE 33-0248788
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</TABLE>
5935 CORNERSTONE COURT WEST
SAN DIEGO, CA 92121
(Address of principal executive offices, including zip code)
(858) 546-8877
(Registrant's telephone number, including area code)
------------------------------------
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS: YES [X] NO [ ]
AS OF OCTOBER 31, 2000 THERE WERE 32,192,484 SHARES OF REGISTRANT'S COMMON
STOCK, $0.001 PAR VALUE, OUTSTANDING.
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<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
HNC Retek
--- -----
Page
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS,
Consolidated Balance Sheet as of September 30, 2000 (unaudited)
and December 31, 1999................................................... 3 29
Consolidated Statement of Operations (unaudited) for the three and nine
months ended September 30, 2000 and 1999................................ 4 30
Consolidated Statement of Cash Flows (unaudited) for the nine months ended
September 30, 2000 and 1999 5 31
Consolidated Statement of Changes in Stockholders' Equity
and Comprehensive Income (unaudited) for the nine
months ended September 30, 2000......................................... 6 32
Notes to Consolidated Financial Statements (unaudited)..................... 7 33
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS........................................ 16 37
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................. 49 49
PART II. OTHER INFORMATION
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS................................. 50 --
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K........................................... 51 --
Signatures................................................................................ 52 --
Exhibit Index............................................................................. 53 --
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HNC SOFTWARE INC.
CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(Unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 84,205 $ 136,340
Short-term investments available for sale - debt 56,729 22,368
Short-term investments available for sale - equity 1,865 6,810
Trade accounts receivable, net 45,291 64,189
Current portion of deferred income taxes 15,382 20,384
Other current assets 21,244 11,144
--------- ---------
Total current assets 224,716 261,235
--------- ---------
Long-term investments available for sale-debt 47,388 68,563
Equity investments 14,719 14,219
Property and equipment, net 21,691 22,219
Intangible assets, net 158,495 29,068
Deferred income taxes, less current portion 19,447 18,085
Other assets 2,913 3,032
--------- ---------
$ 489,369 $ 416,421
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 83,584 $ 30,049
Deferred revenue 10,470 15,274
--------- ---------
Total current liabilities 94,054 45,323
--------- ---------
Non-current liabilities 219 4,111
Convertible Subordinated Notes 16,452 100,000
--------- ---------
Total liabilities 110,725 149,434
--------- ---------
Contingencies (Note 9)
Minority interest in consolidated subsidiaries -- 17,414
--------- ---------
Stockholders' equity:
Preferred stock, $0.001 par value -- 4,000 shares authorized;
no shares issued or outstanding -- --
Common stock, $0.001 par value -- 120,000 shares authorized;
32,179 and 25,704 shares issued and outstanding,
respectively 32 26
Common stock in treasury, at cost --49 and 882 shares,
respectively (1,813) (19,613)
Paid-in capital 492,822 275,955
Retained earnings (accumulated deficit) (98,671) 12,209
Notes receivable from employee stockholders (11,796) --
Unearned stock-based compensation (1,071) (20,511)
Accumulated other comprehensive income (loss) (859) 1,507
--------- ---------
Total stockholders' equity 378,644 249,573
--------- ---------
$ 489,369 $ 416,421
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues:
License and maintenance $ 52,008 $ 42,345 $ 126,192 $ 120,152
Services and other 25,804 16,428 73,615 43,743
--------- --------- --------- ---------
Total revenues 77,812 58,773 199,807 163,895
--------- --------- --------- ---------
Operating expenses:
License and maintenance (excluding non-cash stock-based
compensation expense of $2,364 and $2,658 for the three
and nine months ended September 30, 2000) 15,516 9,528 41,804 30,367
Services and other (excluding non-cash stock based
compensation expense of $1,753 and $2,548 for the three
and nine months ended September 30, 2000) 18,753 10,548 52,216 29,532
Research and development (excluding non-cash stock based
compensation expense of $8,076 and $10,629 for the three
and nine months ended September 30, 2000) 19,848 11,833 55,034 32,961
Sales and marketing (excluding non-cash stock based
compensation expense of $2,565 and $4,167 for the three
and nine months ended September 30, 2000) 20,060 10,741 55,220 31,282
General and administrative (excluding non-cash stock based
compensation expense of $2,175 and $1,640 for the
three and nine months ended September 30, 2000) 10,326 5,868 27,156 15,511
Stock-based compensation 16,933 -- 21,642 --
Transaction-related amortization and costs 14,115 2,656 29,478 6,964
In-process research and development 1,151 -- 7,601 --
Expense related to spin-off of Retek
subsidiary 46,473 -- 46,473
--------- --------- --------- ---------
Total operating expenses 163,175 51,174 336,624 146,617
Operating income (loss) (85,363) 7,599 (136,817) 17,278
Other income, net 3,090 855 9,564 3,825
Interest expense related to convertible debt (1,272) (1,342) (4,095) (4,026)
Expense related to debt conversion (12,676) -- (12,676) --
Minority interest in losses of consolidated subsidiaries 2,163 -- 7,582 --
--------- --------- --------- ---------
Income (loss) before income tax provision (benefit) (94,058) 7,112 (136,442) 17,077
Income tax provision (benefit) (15,539) 3,781 (25,562) 8,277
--------- --------- --------- ---------
Net income (loss) $ (78,519) $ 3,331 $(110,880) $ 8,800
========= ========= ========= =========
Net income (loss) per share:
Basic net income (loss) per share $ (2.71) $ 0.14 $ (4.04) $ 0.35
========= ========= ========= =========
Diluted net income (loss) per share $ (2.71) $ 0.13 $ (4.04) $ 0.34
========= ========= ========= =========
Shares used in computing basic net income (loss) per share 28,970 24,235 27,414 24,842
========= ========= ========= =========
Shares used in computing diluted net income (loss) per share 28,970 25,491 27,414 25,575
========= ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited and in thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2000 1999
------------ -------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $(110,880) $ 8,800
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Provision for doubtful accounts 4,107 3,174
Depreciation and amortization 38,402 13,387
Acquired in-process research and development 7,601
Stock-based compensation expense 21,642
Deferred income tax benefit (25,562)
Tax benefit from stock option transactions 39,309 2,151
Minority interest in losses of consolidated subsidiary (7,582)
Changes in assets and liabilities:
Trade accounts receivable, net (38,895) (12,863)
Deferred income taxes (41,126) 4,533
Other assets (10,652) (3,748)
Accounts payable and accrued liabilities 55,419 731
Deferred revenue 40,537 724
--------- ---------
Net cash provided by (used in) operating activities (27,680) 16,889
--------- ---------
Cash flows from investing activities:
Net sales (purchases) of investments available for sale (29,638) 18,737
Cash paid for equity investments (5,750) (13,720)
Issuance of employee loans (1,300)
Acquisitions of property and equipment (21,895) (13,252)
Cash paid in business acquisitions, net of cash acquired (22,975)
Proceeds from sale of property and equipment -- 191
--------- ---------
Net cash used in investing activities (81,558) (8,044)
--------- ---------
Cash flows from financing activities:
Net proceeds from issuance of HNC common stock 77,406 10,534
Net proceeds from issuance of Retek common stock 5,635
Repurchase of HNC common stock for treasury (18,616) (50,381)
Net proceeds from sales of receivables 31,971
Spin-off of Retek, Inc. (30,463)
Repayment of debt and capital lease obligations (7,737) (77)
--------- ---------
Net cash provided by (used in) financing activities 58,196 (39,924)
--------- ---------
Effect of exchange rate changes on cash (1,093) (20)
--------- ---------
Net decrease in cash and cash equivalents (52,135) (31,099)
Cash and cash equivalents at beginning of the period 136,340 54,267
--------- ---------
Cash and cash equivalents at end of the period $ 84,205 $ 23,168
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
(Unaudited and in thousands)
<TABLE>
<CAPTION>
COMMON STOCK TREASURY STOCK
------------------- ------------------- PAID-IN RETAINED
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS
(ACCUMULATED
DEFICIT)
------ ------ ------ ------ ------- --------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,1999.................. 25,704 $ 26 882 $ (19,613) $ 275,955 $ 12,209
Common stock options exercised............... 3,227 3 (1,026) 32,637 63,470
Purchase of HNC common stock for treasury.... (250) 250 (18,616)
Release of FTI escrow shares
into treasury.............................. (49) 49 (1,808)
Common stock issued under Employee
Stock Purchase Plan........................ 106 (106) 4,149 515
Effect of common stock issued under Retek
Employee Stock Purchase Plan............... 3,635
Tax benefit from stock option
transactions................................ 39,309
Stock-based compensation, net................ 9,557
Retek initial public offering costs.......... (243)
Spin-off of Retek subsidiary................. (130,798)
Common stock issued in business
acquisitions................................ 1,529 1 133,200
Effect of Retek common stock issued in
business acquisition....................... 5,432
Effect of Retek common stock issued in
business alliance.......................... 8,010
Common stock issued upon conversion of
Subordinated Notes......................... 1,862 2 82,225
Common stock issued for PCS earn-out......... 50 3,993
Unrealized loss on investments, net of tax...
Foreign currency translation adjustment, net
of tax.....................................
Net loss..................................... (110,880)
------ --------- ------ --------- --------- ---------
BALANCE AT SEPTEMBER 30, 2000................ 32,179 $ 32 49 $ (3,251) $ 494,260 $ (98,671)
====== ========= ====== ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
EMPLOYEE ACCUMULATED
STOCKHOLDER UNEARNED OTHER TOTAL
NOTES STOCK-BASED COMPREHENSIVE STOCKHOLDERS' COMPREHENSIVE
RECEIVABLE COMPENSATION INCOME (LOSS) EQUITY INCOME (LOSS)
---------- ------------ ------------- ------ -------------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,1999.................. $ (20,511) $ 1,507 $ 249,573 $ (4,605)
=========
Common stock options exercised............... $ (11,796) 84,314
Purchase of HNC common stock for treasury.... (18,616)
Release of FTI escrow shares
into treasury.............................. (1,808)
Common stock issued under Employee
Stock Purchase Plan........................ 4,664
Effect of common stock issued under Retek
Employee Stock Purchase Plan............... 3,635
Tax benefit from stock option
transactions................................ 39,309
Stock-based compensation expense............. 6,185 15,742
Retek initial public offering costs.......... (243)
Spin-off of Retek subsidiary................. 13,255 1,594 (115,949)
Common stock issued in business
acquisitions................................ 133,201
Effect of Retek common stock issued in
business acquisition....................... 5,432
Effect of Retek common stock issued in
business alliance.......................... 8,010
Common stock issued upon conversion of
Subordinated Notes ........................ 82,227
Common stock issued for PCS earn-out......... 3,993
Unrealized loss on investments, net of tax... (2,856) (2,856) (2,856)
Foreign currency translation adjustment, net
of tax..................................... (1,104) (1,104) (1,104)
Net loss..................................... (110,880) (110,880)
--------- --------- --------- --------- ---------
BALANCE AT SEPTEMBER 30, 2000................ $ (11,796) $ (1,071) $ (859) $ 378,644 $(119,445)
========= ========= ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 7
HNC SOFTWARE INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 1--GENERAL
HNC Software Inc.
We develop, market, and support innovative predictive software solutions for
leading service industries. These intelligent decision management solutions
employ proprietary neural-network predictive decision engines, profiles,
traditional statistical modeling, business models, expert rules and/or context
vector technology to convert existing data and business experiences into
meaningful recommendations and actions. We currently serve the insurance,
financial services, telecommunications, e-business, and retail markets. In this
Report, HNC Software Inc. is referred to as "we," "our," and "HNC". Our former
subsidiary Retek Inc., which we spun-off to our stockholders in September
2000 (See Note 2 below), is referred to as "Retek".
Basis of Presentation
We have prepared the accompanying interim consolidated financial statements,
without audit, in accordance with the instructions to Form 10-Q. Consequently,
we have not necessarily included in this Form 10-Q all information and footnotes
required for audited financial statements.
In our opinion, the accompanying unaudited interim consolidated financial
statements in this Form 10-Q reflect all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of our financial
position and results of operations. These consolidated financial statements and
notes thereto should be read in conjunction with our audited financial
statements and notes thereto presented in our Annual Report on Form 10-K/A for
the fiscal year ended December 31, 1999. The interim financial information
contained in this Report is not necessarily indicative of the results to be
expected for any other interim period or for any entire fiscal year.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
effect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Certain prior year balances
have been reclassified to conform to the current presentation.
Sales of Receivables
From time to time, we enter into agreements to sell an undivided interest in
specifically identified trade accounts receivable. We generally sell these trade
accounts receivables at a discount to a bank, based upon defined short-term
market rates. Uncollected receivables that have been sold are not included in
our trade accounts receivables balance on our consolidated balance sheet. During
the three and nine months September 30, 2000, we sold $11,238 and $31,971 (of
which $10,000 and $24,645 pertained to Retek) of receivables, respectively,
representing approximately 13% and 14%, respectively, of our total cash
collected from customers' receivables during these respective periods. We did
not sell any receivables during the first nine months of 1999. Expenses related
to receivables sold totaled $31 and $104 during the three and nine months
ended September 30, 2000, respectively, and are included in interest expense in
our consolidated statement of operations.
7
<PAGE> 8
HNC SOFTWARE INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities", or FAS 133. This statement establishes a new model for
accounting for derivatives and hedging activities. Under FAS 133, all
derivatives must be recognized as assets and liabilities and measured at fair
value. In July 1999, the FASB issued Statement of Accounting Standards No. 137
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133" which defers the requirement to adopt
FAS 133 to the first quarter of 2001. We have not yet determined the impact of
the adoption of this new accounting standard on our consolidated financial
position, results of operations or disclosures.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements", or SAB 101,
which provides additional guidance in applying generally accepted accounting
principles for the recognition and reporting of revenue for certain transactions
that existing accounting rules do not specifically address. An amendment in June
2000 delayed SAB 101's effective date until the fourth quarter of 2000. We have
not yet determined the impact of the adoption of this new accounting standard on
our consolidated financial position, results of operations or disclosures.
In January 2000, the Financial Accounting Standards Board's Emerging Issues Task
Force published Issue No. 00-2 "Accounting for Web Site Development Costs", or
the guidance given in the American Institute of Certified Public Accountants'
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use", or SOP 98-1, to Web site development
costs. Under SOP 98-1, software development costs, consisting of internally
developed software and Web site development costs, including internal and
external costs incurred to develop internal-use computer software during the
application development stage are capitalized. Application development stage
costs generally include software configuration, coding, installation to hardware
and testing. Costs of significant upgrades and enhancements that result in
additional functionality are also capitalized. Costs incurred for maintenance
and minor upgrades and enhancements are expensed as incurred. The estimated
useful lives are based on planned or expected significant modification or
replacement of software applications, in response to the rapid rate of change in
the internet industry and technology in general. Adoption of EITF 00-2 was
required for the third quarter of 2000. The adoption of EITF 00-2 did not have a
significant impact on our consolidated financial position, results of operations
or disclosures.
NOTE 2--INITIAL PUBLIC OFFERING AND SPIN-OFF OF RETEK INC.
On September 10, 1999, Retek filed a registration statement with the Securities
and Exchange Commission relating to an initial public offering of Retek's common
stock. The offering was consummated in November 1999. In the offering, Retek
sold 6,325 shares of its common stock. Prior to the offering, we transferred to
Retek all of the shares of our wholly owned subsidiary, Retek Information
Systems, Inc.
On August 7, 2000, HNC's board of directors declared a dividend of all of the
shares of Retek common stock held by HNC, or 40.0 million shares, to complete
the spin-off of our Retek subsidiary. We received a private letter ruling from
the Internal Revenue Service that HNC's dividend of its shares of Retek common
stock would be tax-free to HNC and our stockholders for U.S. federal income tax
purposes. This dividend was paid on September 29, 2000 to all HNC stockholders
of record as of September 15, 2000 using a distribution ratio of approximately
1.24 shares of Retek Inc. common stock for each share of HNC common stock held.
Cash was paid in lieu of fractional shares. The shares of Retek common stock
that were distributed by HNC in the Retek spin-off constituted all the Retek
shares owned by HNC and represented approximately 83.9% of Retek's outstanding
shares as of the September 29, 2000 distribution date. As a result of our
distribution of our Retek common shares, Retek is no longer affiliated with HNC.
In connection with the spin-off of our Retek subsidiary, we accelerated the
vesting of 25 percent of the outstanding HNC stock options that would have been
unvested as of the September 15, 2000 record date for the Retek dividend in
order
8
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HNC SOFTWARE INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
to afford our option holders the opportunity to participate in receipt of the
dividend. Additionally, we provided option holders with the opportunity to
exercise a portion of their vested options prior to the record date through the
issuance of secured, full recourse promissory notes payable to HNC. The notes
are to be repaid on or prior to December 31, 2000, bear interest at the rate of
9.0% per annum, and are collateralized by the underlying shares of stock. At
September 30, 2000, stockholder notes receivable totaled $11,796, which we have
recorded as a reduction to stockholders' equity. To reflect the Retek dividend
we also adjusted the exercise price of all HNC stock options that were
outstanding immediately following payment of the dividend. The adjusted stock
option exercise prices were calculated by multiplying the pre-dividend option
exercise price by the price of HNC common stock immediately after payment of the
dividend, and dividing that product by the price of HNC common stock immediately
before payment of the dividend. The vesting acceleration of HNC stock options
and the adjustment to HNC stock option exercise prices that were greater than
the closing price of HNC common stock on September 29, 2000 resulted in
stock-based compensation charges. See Note 8 for further discussion.
Because the adjustment of HNC options described above was estimated to be less
than the change in value of unvested HNC stock options resulting from the Retek
distribution, in October 2000 we paid cash bonuses aggregating $39 million to
employees who held unvested stock options as of the record date. HNC estimated
that the adjustment to the exercise price of its unvested options and the cash
bonus, taken together, were less than the change in value of unvested HNC
options arising from the Retek distribution.
NOTE 3--ACQUISITIONS
In March 2000, we acquired all of the outstanding stock and other securities of
Onyx Technologies, Inc., or Onyx, in exchange for approximately 383 shares of
our common stock, including 30 shares representing options we exchanged, and
$1,500 in cash. We placed 35 of the shares issued into escrow to secure
indemnification obligations of the former Onyx shareholders. We applied the
purchase method of accounting for the acquisition of Onyx, which resulted in a
purchase price of $49,555, of which $3,500 represents our initial 1999
investment in Onyx.
In March 2000, we acquired all of the outstanding stock and other securities of
the Center for Adaptive Systems Applications, Inc., or CASA, in exchange for 142
shares of our common stock, including 80 shares representing options we
exchanged. We placed 38 of the shares issued into escrow to secure
indemnification obligations of the former CASA stockholders. We applied the
purchase method of accounting for the acquisition of CASA, which resulted in a
purchase price of $23,756.
In March 2000, we acquired all of the outstanding stock and other securities of
Adaptive Systems Applications, Inc., or AIM, in exchange for 9 shares of our
common stock, including 0.4 shares representing options we exchanged. We applied
the purchase method of accounting for the acquisition of AIM, which resulted in
a purchase price of $1,656, of which $750 represents our initial 1999 investment
in AIM.
In April 2000, we acquired all of the outstanding stock and other securities of
Celerity Technologies, Inc., or Celerity, in exchange for approximately 220
shares of our common stock and $2,400 in cash. We placed 33 of the shares issued
into escrow to secure indemnification obligations of the former Celerity
shareholders. We applied the purchase method of accounting for the acquisition
of Celerity, which resulted in a purchase price of $18,591.
In May 2000, Retek acquired all of the outstanding stock and other securities of
HighTouch Technologies, Inc., or HighTouch, in exchange for 389 shares of
Retek's common stock and $18,000 in cash. Retek applied the purchase method of
accounting for the acquisition of HighTouch, which resulted in a purchase price
of $26,308.
In September 2000, we acquired all of the outstanding stock and other securities
of Systems/Link Corporation, or Systems/Link, in exchange for approximately 634
shares of our common stock, including 40 shares representing options we
exchanged, and $5,512 in cash. We placed 127 of the shares issued into escrow to
secure indemnification obligations of the former Systems/Link stockholders. We
applied the purchase method of accounting for the acquisition of Systems/Link,
which resulted in a purchase price of $42,549.
In September 2000, we acquired all of the outstanding stock and other securities
of CardAlert Services, Inc., or CardAlert, in exchange for approximately 208
shares of our common stock. We placed 42 of the shares
9
<PAGE> 10
HNC SOFTWARE INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
issued into escrow to secure indemnification obligations of the former CardAlert
stockholders. We applied the purchase method of accounting for the acquisition
of CardAlert, which resulted in a purchase price of $12,608.
In connection with the CASA, Celerity, HighTouch, Systems/Link and CardAlert
acquisitions, we recorded in-process research and development expenditures
totaling $1,400, $1,050, $4,000, $730 and $421, respectively, relating to the
write-off of acquired in-process research and development in connection with
these acquisitions. We made our assessment of whether acquired technologies in
these acquisitions were complete or under development in accordance with the
guidelines prescribed by Statement of Financial Accounting Standards No. 86,
Statement of Financial Accounting Standards No. 2, and Financial Accounting
Standards Board Interpretation No. 4.
The unaudited pro forma results of operations below present the impact on our
results of operations as if the Onyx, CASA, AIM, Celerity, HighTouch,
Systems/Link and CardAlert acquisitions had occurred on January 1, 1999, instead
of on their respective later acquisition dates (unaudited):
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------------------------------------
2000 1999
----------------------------- ----------------------------
PRO FORMA PRO FORMA
HISTORICAL COMBINED HISTORICAL COMBINED
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Total revenues $ 199,807 $ 215,115 $ 163,895 $ 186,695
Net income (loss) (110,880) (115,806) 8,800 8,204
Basic net income
(loss) per share $ (4.04) $ (4.22) $ 0.35 $ 0.31
Diluted net income
(loss) per share $ (4.04) $ (4.22) $ 0.34 $ 0.30
</TABLE>
In May 2000, we entered into a settlement agreement with the former shareholders
of Financial Technology Inc., or FTI, pertaining to the release and distribution
of the 97 shares of our common stock that were placed into escrow to secure
potential indemnification obligations resulting from our April 1998 acquisition
of FTI. In accordance with this settlement agreement, one-half of the escrow
shares were released to us and placed into treasury while the remaining escrow
shares were released to the former FTI shareholders, representing a full and
complete release of the former FTI shareholders' contractual indemnification
obligations to us.
NOTE 4--EQUITY INVESTMENTS
In March 2000, Open Solutions Inc., or OSI, completed a private placement of its
preferred stock. We participated in this financing by purchasing 161 shares of
OSI Series F preferred stock for $9.32 per share in order to maintain our
approximate 6% ownership of OSI. This investment is accounted for using the cost
method.
In July 2000, Burning Glass Technologies LLC, or Burning Glass, completed a
private placement of its preferred and common stock. We participated in this
financing by purchasing 239 shares of Burning Glass Preferred Issue stock for
$4.18 per share, representing an approximate 3.9% ownership in Burning Glass.
This investment is being accounted for using the cost method.
In July 2000, we became a limited partner in Azure Capital Partners Venture
Fund, a venture capital investment management fund, through an initial
investment of $2.3 million. We have committed to invest an additional $2.7
million into this fund and anticipate that this additional funding will occur in
the fourth quarter of 2000. Our commitment to this fund does not exceed
2.0% of total fund ownership. This investment is being accounted for using the
cost method.
10
<PAGE> 11
HNC SOFTWARE INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE 5--CONVERTIBLE SUBORDINATED NOTES
During the quarter ending September 30, 2000, $83.5 million of our 4.75% $100.0
million Convertible Subordinated Notes, or the Notes, were converted into HNC
common stock at a conversion rate of 22.30 shares per $1,000 principal amount of
the Notes (equivalent to a conversion price of $44.85 per share). In connection
with these note conversions, we issued approximately 1,862 shares of our common
stock. Additionally, we paid approximately $12.7 million in conversion premiums
to the converting note holders, which we recorded as a debt conversion charge
during the quarter ended September 30, 2000.
As of September 30, 2000, $16.5 million of the Notes remained outstanding. In
connection with the spin-off of our Retek subsidiary that was completed on
September 29, 2000, the indenture governing the Notes required an adjustment to
the conversion price of the remaining outstanding Notes that were not converted
prior to the Retek spin-off. This conversion price was based upon a formula that
calculated an adjusted conversion rate using the relative per common share
values of HNC and Retek as of the date of the spin-off. As a result of this
adjustment, the remaining Notes are now convertible into our common stock at a
conversion rate of 100.20 shares per $1,000 principal amount of the Notes
(equivalent to a conversion price of $9.98 per share).
NOTE 6--PER SHARE DATA
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
-----------------------
2000 1999
-------- --------
(In thousands, unaudited)
<S> <C> <C>
Net income (loss) $(78,519) $ 3,331
======== ========
Shares used in computing basic net income
(loss) per common share 28,970 24,235
Weighted average options to purchase common
stock as determined by application of the
treasury stock method -- 1,230
Employee Stock Purchase Plan common stock
equivalents -- 26
-------- --------
Shares used in computing diluted net income
(loss) per common share 28,970 25,491
======== ========
</TABLE>
11
<PAGE> 12
HNC SOFTWARE INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
2000 1999
--------- ---------
(In thousands, unaudited)
<S> <C> <C>
Net income (loss) $(110,880) $ 8,800
========= =========
Shares used in computing basic net income
(loss) per common share 27,414 24,842
Weighted average options to purchase common
stock as determined by application of the
treasury stock method -- 707
Employee Stock Purchase Plan common stock
equivalents -- 26
--------- ---------
Shares used in computing diluted net income
(loss) per common share 27,414 25,575
========= =========
</TABLE>
The conversion of 1,648 shares of our common stock issuable upon the conversion
of our $16.5 million remaining Notes outstanding as of the three and nine months
ended September 30, 2000 were not used to calculate diluted net income (loss)
per common share, as the effect would be anti-dilutive. The conversion of 2,230
shares of our common stock issuable upon the conversion of our $100.0 million
Notes outstanding as of the three and nine months ended September 30, 1999 were
not used to calculate diluted net income (loss) per common share, as the effect
would be anti-dilutive.
For the three and nine month periods ended September 30, 2000, weighted average
options to purchase 1,337 and 2,067 shares, respectively, of common stock and
Employee Stock Purchase Plan common stock equivalents of 20 shares, and warrant
common stock equivalents of 6 shares, were not included in the computation of
diluted net loss per common share, as their effect in these periods would be
anti-dilutive.
NOTE 7--SEGMENT DATA
Our reportable segments are based upon our method of internal reporting to
management, who views our business by functional market. Our operating segments
reflect the way our management team organizes and evaluates internal financial
information, in order to make operating decisions and assess performance.
Excluding Retek, our primary operating segments include HNC Insurance Solutions,
or IS, HNC Financial Solutions, or FS, and HNC Telecom Solutions, or TS.
HNC IS provides users with the ability to reduce fraud losses and streamline
operations in the containment of the medical costs of workers' compensation and
automobile accident insurance claims, workers' compensation loss reserving,
workers' compensation fraud, managed care effectiveness and provider
effectiveness. HNC FS provides transaction-based, real-time fraud detection,
authorization and action decisions for applications such as credit card charge
authorization and the loan approval decision process. Our HNC FS segment also
includes the activities associated with our former eHNC division, the activities
of which we reintegrated into FS. HNC TS provides our telecommunications carrier
customers with the ability to reduce fraud losses and determine customer
profitability. HNC TS is presented below within our "Other" segment category,
which also includes activities associated with our Advanced Technology Solutions
group, which primarily conducts research and development for the United States
government, as well as corporate activity. Retek, which we spun-off to
stockholders effective September 29, 2000, offers predictive software solutions
that allow retailed marketing models, and is also presented separately below.
Segment revenue and operating income (loss), which excludes certain non-cash and
non-recurring expenditures that we do not allocate between segments, are as
follows (unaudited):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
--------------------
2000 1999
------- -------
<S> <C> <C>
Segment revenue:
IS $21,179 $17,278
FS 25,668 20,121
Other 4,602 1,305
------- -------
HNC 51,449 38,704
Retek 26,363 20,069
------- -------
Total consolidated revenue $77,812 $58,773
======= =======
</TABLE>
12
<PAGE> 13
HNC SOFTWARE INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
2000 1999
-------- --------
<S> <C> <C>
Segment revenue:
IS $ 60,656 $ 45,765
FS 69,569 54,144
Other 9,668 6,228
-------- --------
HNC 139,893 106,137
Retek 59,914 57,758
-------- --------
Total consolidated revenue $199,807 $163,895
======== ========
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
-----------------------
2000 1999
-------- --------
<S> <C> <C>
Segment operating income (loss):
IS $ 3,254 $ 4,210
FS 73 3,414
Other (605) (1,326)
-------- --------
HNC 2,722 6,298
Retek (9,413) 3,957
-------- --------
Total segment operating income (loss) (6,691) 10,255
Stock-based compensation (16,933) --
Acquisition-related costs and amortization (14,115) (2,656)
In-process research and development (1,151) --
Expense related to spin-off of Retek subsidiary (46,473) --
-------- --------
Consolidated operating income (loss) (85,363) 7,599
Other income, net 3,090 855
Interest expense (1,272) (1,342)
Expense related to debt conversion (12,676) --
Minority interest in losses of consolidated
subsidiary 2,163 --
-------- --------
Income (loss) before income tax provision
(benefit) $(94,058) $ 7,112
======== ========
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
2000 1999
--------- ---------
<S> <C> <C>
Segment operating income (loss):
IS $ 8,171 $ 7,637
FS 374 8,104
Other (3,223) (1,765)
--------- ---------
HNC 5,222 13,976
Retek (36,845) 10,266
--------- ---------
Total segment operating income (loss) (31,623) 24,242
Stock-based compensation (21,642) --
Acquisition-related costs and amortization (29,456) (6,964)
In-process research and development (7,623) --
Expense related to spin-off of Retek subsidiary (46,473) --
--------- ---------
Consolidated operating income (loss) (136,817) 17,278
Interest and other income, net 9,564 3,825
Interest expense (4,095) (4,026)
Expense related to debt conversion (12,676) --
Minority interest in losses of consolidated
subsidiary 7,582 --
--------- ---------
Income (loss) before income tax provision
(benefit) $(136,442) $ 17,077
========= =========
</TABLE>
13
<PAGE> 14
HNC SOFTWARE INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Corporate assets are primarily comprised of cash, short-term and long-term
investments available for sale, deferred tax assets and inter-segment
receivables. All tax related assets and liabilities are included within the
Corporate line item. Eliminations primarily relate to intercompany payables and
investments in subsidiaries.
Total assets:
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
-------------------------
2000 1999
--------- ---------
<S> <C> <C>
Total segment assets:
IS $ 58,966 $ 32,151
FS 124,604 48,143
Other 77,543 4,371
--------- ---------
HNC 261,113 84,665
Retek -- 52,363
--------- ---------
Total segment assets 261,113 137,028
Corporate 299,921 166,555
Eliminations (71,665) (45,128)
--------- ---------
Total consolidated
assets $ 489,369 $ 258,455
========= =========
</TABLE>
NOTE 8--STOCK-BASED COMPENSATION
Excluding stock-based compensation charges attributable to our Retek spin-off,
which are discussed separately below, we recorded net stock-based compensation
expense totaling $3.0 million and $7.7 million during the three and nine months
ended September 30, 2000, respectively. This net compensation expense relates
primarily to the amortization of unearned stock-based compensation of $2.9
million and $8.6 million during these periods, respectively (of which $2.8
million and $8.3 million related to Retek), and also includes additional net
compensation expense of $0.1 million and net compensation income of $0.9
million, respectively, primarily related to variable awards. The net
compensation income recorded during the nine months ended September 30, 2000
relates primarily to the reversal of compensation expense recorded in the fourth
quarter of 1999 in connection with consultant option grants, due to a decline in
the fair values of these awards during 2000. The fair values of these awards
were estimated using the Black-Scholes option pricing model with the following
weighted average assumptions: dividend yield of 0.0%, risk-free interest rate
of 6.42%, volatility of 100% and an expected life of 5 months.
In August 2000, we accelerated the vesting of 25 percent of the outstanding
stock options that would have been unvested as of the September 15, 2000 record
date to afford our option holders the opportunity to participate in receipt of
the Retek share dividend. As a result of this award modification, we recorded a
non-cash stock-based compensation charge of $6.7 million during the third
quarter of 2000 in accordance with Financial Accounting Standards Board
Interpretation No. 44, or FIN 44.
As a result of the proportionate option repricing in connection with the Retek
spin-off, certain options failed to qualify for fixed accounting under FIN 44.
During the third quarter of 2000, we recorded a one-time charge to operations of
$7.2 million related to the modification and estimated cash repurchase of
options in connection with the Retek spin-off.
NOTE 9--CONTINGENCIES
Various claims arising in the course of business, seeking monetary damages and
other relief, are pending. The amount of the liability, if any, cannot be
determined with certainty; however, in the opinion of management, the ultimate
liability will not have a material adverse effect on our consolidated financial
position, results of operations or cash flows.
In November 1998, Nestor filed a complaint against us in the United States
District Court for the District of Rhode Island (C.A. No. 98 569). In the
complaint, Nestor alleged that we violated the federal Sherman Antitrust Act and
the Rhode Island Antitrust Act and tortiously interfered with prospective
contractual business relationships of Nestor in connection with our marketing of
our Falcon credit card fraud detection product. The complaint also alleged that
we infringed United States patents Nos. 4,326,259 and 4,760,604 held by Nestor.
Nestor seeks to recover unspecified compensatory damages, treble damages and
punitive damages and to obtain injunctive relief arising from these claims. The
complaint also sought a declaratory judgment that a United States patent we hold
relating to technology used in our Falcon products is invalid and unenforceable
due to our alleged inequitable conduct in obtaining this patent, and that
Nestor's products do not infringe this patent.
In January 2000, Nestor dropped its claim of patent infringement against us. In
July 2000 we filed a motion with the Court to dismiss our counter-claim that
Nestor infringes our patent, and Nestor's claims that the patent is invalid or
unenforceable. That motion is still before the court in Rhode Island. The other
Nestor claims for antitrust and unfair competition were severed by the court in
an earlier ruling and will not be considered until after resolution of the
patent issues.
Our claims for patent infringement and unfair competition which were pending in
the United States District Court venued in San Diego against Nestor's
distributors Transaction Systems Architects, Inc., or TSAI, and ACI Worldwide,
Inc., or ACI, were dismissed in April, 2000. We agreed with TSAI and ACI to
dismiss our lawsuit against them in order to enable us to commence discussions
with them regarding a
14
<PAGE> 15
HNC SOFTWARE INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
possible future business relationship. However, no agreements have been reached
to date with TSAI or ACI.
We believe that these legal proceedings will not result in a material negative
impact on our results of operations, liquidity or financial condition.
15
<PAGE> 16
HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Report (including without limitation the following section regarding
Management's Discussion and Analysis of Financial Condition and Results of
Operations) contains forward-looking statements regarding HNC and its business,
financial condition, results of operations and prospects. Words like "expects,"
"anticipates," "intends," "plans," "believes," "seeks," "estimates" and similar
expressions or variations of these words are intended to identify
forward-looking statements, but are not the exclusive means of identifying
forward-looking statements in this Report. Additionally, statements concerning
future matters, for example the development of new products, enhancements or
technologies, possible changes in legislation, and other statements regarding
matters that are not historical are forward-looking statements. In this Report,
HNC Software Inc. is referred to as "we," "our," and "HNC".
Although forward-looking statements in this Report reflect the good faith
judgment of our management, these statements can only be based on facts and
factors currently known to us and might change if future factual circumstances
change. Consequently, all forward-looking statements have inherent risks and
uncertainties and actual results and outcomes may differ materially from the
results and outcomes discussed in or anticipated by the forward-looking
statements. Factors that could cause or contribute to differences in results and
outcomes include without limitation whether we are successful in integrating new
businesses we have recently acquired, the impact of decisions we make regarding
future strategic directions of our business units, whether we are successful in
transitioning many of our products to solutions based on the application service
provider, or ASP, business model, as well as those factors discussed in our
Annual Report on Form 10-K/A for the fiscal year ended December 31, 1999, or
1999 Annual Report, and this Report should be read in conjunction with our 1999
Annual Report. Readers are urged not to place undue reliance on these
forward-looking statements, which speak only as of the date of this Report. We
undertake no obligation to revise or update any forward-looking statements in
order to reflect any event or circumstance that may arise after the date of this
Report. Readers are urged to carefully review and consider the various
disclosures made in this Report, which attempt to advise interested parties of
the risks and factors that may affect our business, financial condition, results
of operations and prospects.
OVERVIEW
We are a business-to-business software company that develops, markets, licenses
and supports intelligent decision management software solutions for various
service industries, including companies in the insurance, financial services,
telecommunications, and e-commerce markets. Our predictive software solutions
help global companies better manage the challenges associated with customer
acquisition, management and retention. By analyzing high volumes of customer
transactions in real-time, our solutions help companies gain insight into and
predict customer needs and actions. This benefits companies by decreasing the
cost of acquiring and retaining customers, improving profitability by lowering
the cost of service, and increasing the value of customers. The increasing
conduct of e-business over the Internet increases the demand for intelligent
analysis of large volumes of real-time information, which these solutions
provide.
On September 10, 1999, our subsidiary Retek, Inc., or Retek, filed a
registration statement with the Securities and Exchange Commission relating to
an initial public offering of Retek's common stock. The offering was consummated
in November 1999. In the offering Retek sold 6,325 shares of its common stock.
Prior to the offering, we transferred to Retek all of the shares of our wholly
owned subsidiary, Retek Information Systems, Inc. On August 7, 2000, HNC's board
of directors declared a dividend of all of the shares of Retek common stock held
by HNC, or approximately 40.0 million shares, to complete the spin-off of our
Retek subsidiary. We received a private letter ruling from the Internal Revenue
Service that HNC's dividend of its shares of Retek common stock would be
tax-free to HNC and our stockholders for U.S. federal income tax purposes. This
dividend was paid on September 29, 2000 to all HNC stockholders of record as of
September 15, 2000 using a distribution ratio of 1.243038 shares of Retek Inc.
common stock for each share of HNC common stock held. Cash was paid in lieu of
fractional shares. The shares of Retek common stock that were distributed by HNC
in the Retek spin-off constituted all the Retek shares owned by HNC and
represented approximately 83.9% of Retek's outstanding shares as of the
September 29, 2000 distribution date. As a result of our distribution of our
Retek common shares, Retek is no longer affiliated with HNC.
16
<PAGE> 17
HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
Excluding Retek, our core business segments are organized as follows: HNC
Insurance Solutions segment, or IS, HNC Financial Solutions segment, or FS, and
HNC Telecom Solutions, or TS.
INSURANCE SOLUTIONS
IS develops software solutions for the insurance industry that are
designed to add value to its customers' businesses through cost
reduction and improved management of risks. Customers in this segment
include insurance carriers, third-party administrators, managed care
organizations, preferred provider organizations, insurance industry
trade groups, brokers, and other service organizations. Our current
product offerings are targeted to the workers' compensation and
automobile segments of the property and casualty insurance market, as
well as the group health segment of the insurance market.
FINANCIAL SOLUTIONS
FS provides a suite of products that addresses the
customer-lifecycle management needs of banks and other financial
institutions. FS provides transaction-based, real-time fraud detection,
authorization and action decisions for applications such as credit card
charge authorization and the loan approval decision process.
TELECOM SOLUTIONS
TS provides solutions designed to help telecommunications carriers
acquire more customers and enhance relationships with existing customers
in order to retain customers for longer periods, including solutions to
reduce fraud losses and determine customer profitability.
Our revenues and operating results have varied significantly in the past and may
do so in the future. Factors affecting our revenues and operating results
include: the degree of market acceptance of our products; the relatively large
size and small number of customer orders that may be received during a given
period; customer cancellation of long-term contracts yielding recurring revenues
or customers' ceasing their use of our products for which our fees are based on
customer usage; the length of our products' sales cycles; our ability to
successfully develop, introduce and market new products and product
enhancements; the timing of new product announcements and introductions by us
and our competitors; changes in the mix of our distribution channels; changes in
the level of our operating expenses; our ability to achieve progress on
percentage-of-completion contracts; our success in completing pilot product
installations for contracted fees; competitive and other market conditions in
the industries and markets we serve; and domestic and international economic
conditions. In addition, license agreements we enter into during a given quarter
may not meet our revenue recognition criteria, and thus may not produce revenue
in that quarter. Therefore, even if we meet or exceed our forecast of aggregate
licensing and other contracting activity, it is possible that our revenues would
not meet our expectations or those of securities analysts. Furthermore, our
operating results may be affected by other factors unique to our product lines.
For example, in the past we have derived a portion of our revenues from product
lines that have generally been priced as "perpetual" license transactions in
which we receive a one-time license fee, most of which is typically recognized
as revenue upon signing and delivery. Thus, failure to sign a significant
perpetual license in the quarter it was anticipated to be signed could result in
a material shortfall of revenue for that quarter versus expectations.
We expect fluctuations in our operating results to continue for the foreseeable
future. Consequently, we believe that period-to-period comparisons of our
financial results should not be relied upon as an indication of our future
performance. Because our expense levels are based in part on our expectations
regarding future revenues and in the short term are fixed to a large extent, we
may be unable to adjust our spending in time to compensate for any unexpected
revenue shortfall. We may not be able to maintain profitability on a quarterly
or annual basis in the future. In addition, in the past we have acquired several
companies and may continue to do so in the future and such transactions
typically generate significant continuing charges that decrease our net income,
often for many fiscal periods. Due to the foregoing factors, it is possible that
in some future quarter our operating results will be below the expectations of
public market analysts and investors. In that event, the price of our Common
Stock and, in turn, the price of our outstanding 4.75% Convertible Subordinated
Notes due 2003, would likely be harmed.
17
<PAGE> 18
HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
RESULTS OF OPERATIONS
REVENUES
Our revenues are comprised of license and maintenance revenues and services and
other revenues. Our revenues for the three months ended September 30, 2000 were
$77.8 million, an increase of 32.3% over revenues of $58.8 million for the same
period in the prior year. Our revenues for the nine months ended September 30,
2000 were $199.8 million, an increase of 21.9% over revenues of $163.9 million
for the same period in the prior year.
For a discussion of Retek's license and maintenance revenues and services and
other revenues, see page 39.
LICENSE AND MAINTENANCE REVENUES. We recognize license and maintenance revenues
in several different ways, depending on the terms on which the software and
maintenance are provided. Revenue from periodic software license and maintenance
agreements, under which fees are paid to us on a recurring, periodic basis is
generally recognized ratably over the respective license periods. Revenue from
short-term periodic software license and maintenance agreements, with guaranteed
minimum license fees, is recognized as related services are performed.
Transaction-based fees are recognized as revenue based on system usage or when
fees based on system usage exceed the monthly minimum license fees. Revenue from
perpetual licenses of our software for which there are no significant continuing
obligations and collection of the related receivables is probable is recognized
on delivery of the software and when acceptance by the customer is probable.
Amounts received under contracts in advance of performance are recorded as
deferred revenue and are generally recognized within one year from receipt.
SERVICES AND OTHER REVENUES. Services and other revenues are comprised of
installation and implementation revenues, remote hosted service operation
revenues and revenues which are derived from consulting contracts, new product
development contracts with commercial customers and, to a lesser extent,
research and development contracts with the United States Government. Revenue
from software installation and implementation and from contract services is
generally recognized as the services are performed using the percentage of
completion method based on costs incurred to date compared to total estimated
costs at completion. Amounts received under contracts in advance of performance
are recorded as deferred revenue and are generally recognized within one year
from receipt. Contract losses are recorded as a charge to income in the period
any losses are first identified. Unbilled accounts receivable are stated at
estimated realizable value.
Remote hosted service fees are derived from review of and re-pricing of
customers' medical bills and are assessed to customers on the basis of volume of
bills processed. Remote hosted service customers typically subscribe for
services under month-to-month agreements and service fees are recognized as
revenue when the processing services are performed.
THREE MONTHS ENDED SEPTEMBER 30, 2000
LICENSE AND MAINTENANCE REVENUES. License and maintenance revenues were $52.0
million for the third quarter in 2000, an increase of 22.9% from $42.3 million
for the third quarter in 1999. This $9.7 million increase over the prior year
quarter was driven by a $6.5 million increase at HNC and a $3.2 million increase
at Retek. Our recurring license and maintenance revenues, as a percentage of
total license and maintenance revenues, increased to 66.3% in the third quarter
of 2000, up from 61.3% for the same period in 1999.
Within HNC, the $6.5 million increase in revenues was driven by a $3.1 million,
or 21.7% increase at our FS segment, a $2.8 million, or 296.6% increase at our
combined TS and other segments, and a $0.6 million, or 4.1% increase at our IS
segment. The increase at our FS segment is primarily due to increases in sales
of our Falcon and Capstone products, while the increase at our combined TS and
other segments is attributable primarily to growth in the TS license and
maintenance business, including growth from
18
<PAGE> 19
HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
acquisitions. The increase at our IS segment is attributable to increased sales
volume of our CompAdvisor and MIRA products, and was partially offset by IS's
transfer of customer contracts for the CompCompare and ProviderCompare products
to a third party under a master license agreement signed in the third quarter of
1999. Under that contract, we no longer receive license and maintenance fees
from the transferred contracts and instead receive royalty fees which are
classified as services and other revenues.
SERVICES AND OTHER REVENUES. Services and other revenues were $25.8 million for
the third quarter in 2000, an increase of 57.3% from $16.4 million for the third
quarter in 1999. This $9.4 million increase over the prior year quarter was
driven by a $6.3 million increase at HNC and a $3.1 million increase at Retek.
Within HNC, the $6.3 million increase in revenues was driven by a $2.4 million,
or 42.8% increase at our FS segment, a $3.4 million, or 75.8% increase at our IS
segment, and a $0.5 million, or 140.4% increase at our combined TS and other
segments. The increase at FS was primarily related to a higher volume of
Capstone implementations while the IS increase is attributable primarily to
overall growth in our remote hosted services customer base, including the
commencement of full-scale hosted service operations for a primary customer.
NINE MONTHS ENDED SEPTEMBER 30, 2000
LICENSE AND MAINTENANCE REVENUES. License and maintenance revenues were $126.2
million for the nine months ended September 30, 2000, an increase of 5.0% from
$120.2 million for the same period in 1999. This $6.0 million increase over the
prior year quarter was driven by a $12.2 million increase at HNC, and offset by
a $6.2 million decrease at Retek. Our recurring license and maintenance
revenues, as a percentage of total license and maintenance revenues, increased
to 72.9% in the nine months ended September 30, 2000, up from 61.7% for the same
period in 1999.
Within HNC, the $12.2 million increase in revenues was driven by a $9.5 million,
or 25.3% increase at our FS segment and a $3.1 million, or 69.1% increase at our
combined TS and other segments, offset in part by a $0.4 million, or 1.0%
decrease at our IS segment. The increase at our FS segment is primarily
attributable to increases in sales of our Falcon and Capstone products, while
the increase in our combined TS and other segments is attributable primarily to
growth in the TS license and maintenance business, including growth from
acquisitions. The net decline at our IS segment resulted primarily from IS's
transfer of customer contracts for the CompCompare and ProviderCompare products
to a third party under a master license agreement signed in the third quarter of
1999, under which we no longer receive license and maintenance fees from the
transferred contracts and instead receive royalty fees which are classified as
services and other revenues. Also contributing to the IS decrease was a decline
in PPO revenues as a result of industry consolidations and increasing price
competition, which was partly offset by the addition of new customers.
SERVICES AND OTHER REVENUES. Services and other revenues were $73.6 million for
the nine months ended September 30, 2000, an increase of 68.4% from $43.7
million for the nine months ended September 30, 1999. This $29.9 million
increase over the prior year was driven by a $21.6 million increase at HNC and a
$8.3 million increase at Retek.
Within HNC, the $21.6 million increase in revenues was driven by a $5.9 million,
or 35.7% increase at our FS segment, a $15.3 million, or 170.3% increase at our
IS segment, and a $0.4 million, or 20.3% increase at our combined TS and other
segments. The increase at FS was primarily related to a higher volume of
Capstone implementations while the IS increase is attributable primarily to
overall growth in our hosted services customer base, including the commencement
of full-scale hosted service operations for a primary customer.
GROSS MARGIN
LICENSE AND MAINTENANCE GROSS MARGIN. License and maintenance costs primarily
represent our expenses for personnel engaged in customer support, travel to
customer sites and documentation
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
materials and excludes non-cash stock-based compensation expense of $2,364 and
$2,658 for the three and nine months ended September 30, 2000, respectively.
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 hosted service operations
and excludes non-cash stock-based compensation expense of $1,753 and $2,548 for
the three and nine months ended September 30, 2000, respectively.
For discussion of Retek's license and maintenance cost of revenues and services
and other cost of revenues, see page 40.
THREE MONTHS ENDED SEPTEMBER 30, 2000
LICENSE AND MAINTENANCE GROSS MARGIN. Our gross margins on license and
maintenance revenues decreased 7.3% from the third quarter in 1999 to the third
quarter in 2000, from 77.5% to 70.2%. This decrease was driven by a 30.5%
decline at Retek, offset by a 4.2% increase at HNC.
Within HNC, license and maintenance gross margin at our IS segment remained
relatively constant, decreasing by 1.6%, while gross margin at our FS segment
increased by 6.3%, due primarily to Falcon and Capstone margin improvements.
Gross margin associated with our combined TS and other segments also increased
3.8% due primarily to growth in the TS license and maintenance business.
SERVICES AND OTHER GROSS MARGIN. Our gross margin on services and other revenues
decreased 8.5%, to 27.3% for the third quarter of 2000 from 35.8% for the third
quarter of 1999. The decrease in our services and other gross margin was driven
by a 10.4% decline at Retek and a 7.6% decline at HNC.
Within HNC, services and other gross margin at our IS segment decreased by
14.3%, while gross margin at our FS segment decreased by 5.1%. Our IS segment's
gross margins decreased quarter over quarter primarily due to several
non-recurring, higher margin contracts that were recorded in the third quarter
of 1999, while the margin decline at FS is due primarily to the increased use of
third party consultants, who have a higher average cost and lower gross margin
than internal resources, for Capstone implementations.
NINE MONTHS ENDED SEPTEMBER 30, 2000
LICENSE AND MAINTENANCE GROSS MARGIN. Our gross margins on license and
maintenance revenues decreased 7.8% from the nine months ended September 30,
1999 to the nine months ended September 30, 2000, from 74.7% to 66.9%. This
decrease was driven by a 32.9% decline at Retek, offset by a 4.0% increase at
HNC.
Within HNC, license and maintenance gross margin at our IS and FS segments each
increased by 2.2%, while gross margin associated with our combined TS and other
segments remained relatively flat, decreasing by 0.5%. The FS increase is due
primarily to Falcon and Capstone margin improvements while the IS margin
increase is due primarily to reductions in PPO access fees and the re-alignment
of resources.
SERVICES AND OTHER GROSS MARGIN. Our gross margin on services and other revenues
decreased 3.4%, to 29.1% for the nine months ended September 30, 2000 from 32.5%
for the nine months ended September 30, 1999. The decrease in our services and
other gross margin was driven primarily by a 7.2% decline at Retek, while HNC
margins remained relatively constant, decreasing by 1.8%.
Within HNC, services and other gross margin at our IS segment increased by 3.7%,
while gross margin at our FS segment decreased by 9.0%. Our IS segment's gross
margins increased primarily because of improved efficiencies in their remote
hosted service operations. Our FS segment's gross
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
margins decreased primarily due to the increased use of third party consultants,
who have a higher average cost and lower gross margin than internal resources,
for Capstone implementations.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development expenses consist primarily of salaries and other
personnel-related expenses, subcontracted development services, depreciation for
development equipment, and supplies and excludes non-cash stock-based
compensation expense of $8,076 and $10,629 for the three and nine months ended
September 30, 2000, respectively.
For a discussion of Retek's research and development expense see page 40.
THREE MONTHS ENDED SEPTEMBER 30, 2000
Research and development expenses increased $8.0 million, or 67.8%, to $19.8
million in the third quarter of 2000 from $11.8 million in the third quarter of
1999. This increase was driven by a $3.6 million increase at HNC and a $4.4
million increase at Retek.
Within HNC, this increase in research and development expenses is attributable
primarily to a $3.2 million increase at our FS segment and a $0.4 million
increase at our combined TS and other segments, while research and development
expenditures within our IS segment remained flat quarter over quarter. The
increase in absolute dollars quarter over quarter is attributable primarily to
increases in staffing and related costs to support new product development
activities, primarily associated with our Capstone and Falcon products lines. We
anticipate that research and development expenses will increase in dollar amount
and could increase as a percentage of total revenues for the foreseeable future.
NINE MONTHS ENDED SEPTEMBER 30, 2000
Research and development expenses increased $22.0 million, or 66.7%, to $55.0
million in the nine months ended September 30, 2000 from $33.0 million in the
nine months ended September 30, 1999. This increase was driven by a $10.6
million increase at HNC and a $11.4 million increase at Retek.
Within HNC, the increase in research and development expenses period over period
is attributable to a $6.8 million increase at our FS segment, a $2.2 million at
our IS segment and a $1.6 million increase at our combined TS and other
segments. The increases in absolute dollars period over period were attributable
to increases in staffing and related costs to support new product development
activities, primarily associated with our CompAdvisor, Capstone, Falcon, Spyder
and ASP product-delivery products. We anticipate that research and development
expenses will increase in dollar amount and could increase as a percentage of
total revenues for the foreseeable future.
SALES AND MARKETING EXPENSE
Sales and marketing expenses consist primarily of salaries and benefits,
commissions, travel, entertainment and promotional expenses and excludes
non-cash stock-based compensation expense of $2,565 and $4,167 for the three and
nine months ended September 30, 2000, respectively.
For a discussion of Retek's sales and marketing expenses see page 40.
THREE MONTHS ENDED SEPTEMBER 30, 2000
Sales and marketing expenses increased $9.4 million, to $20.1 million in the
third quarter of 2000 from $10.7 million in the third quarter of 1999. This
increase was driven by a $4.0 million increase at HNC and a $5.4 million
increase at Retek.
Within HNC, the increase in sales and marketing expense quarter over quarter is
attributable to a $2.8 million increase at our FS segment, a $0.6 million
increase at our IS segment and a $0.6 million increase at our combined TS and
other segments. These increase are attributable primarily to increases in
staffing
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
related to the expansion of direct sales and marketing staff. Contributing to
the increases were increased expenses for trade shows, advertising, corporate
marketing programs and other expenses to support recently acquired businesses.
We expect sales and marketing expenses to continue to increase in absolute
dollars for the foreseeable future. These expenses could also increase as a
percentage of total revenues as we continue to develop a direct sales force in
Europe and other international markets, expand our domestic sales and marketing
organization and increase the breadth of our product lines.
NINE MONTHS ENDED SEPTEMBER 30, 2000
Sales and marketing expenses increased $23.9 million, to $55.2 million for the
nine months ended September 30, 2000 from $31.3 million for the nine months
ended September 30, 1999. This increase was driven by a $8.6 million increase at
HNC and a $15.3 million increase at Retek.
Within HNC, the increase in sales and marketing expense quarter over quarter is
attributable to a $5.4 million increase at our FS segment, a $2.5 million
increase at our IS segment and a $0.7 million increase at our combined TS and
other segments. The increases are attributable primarily to increases in
staffing related to the expansion of direct sales and marketing staff.
Contributing to the increases were increased expenses for trade shows,
advertising, corporate marketing programs and other expenses to support recently
acquired businesses. We expect sales and marketing expenses to continue to
increase in absolute dollars for the foreseeable future. These expenses could
also increase as a percentage of total revenues as we continue to develop a
direct sales force in Europe and other international markets, expand our
domestic sales and marketing organization and increase the breadth of our
product lines.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expenses consist primarily of personnel costs for
finance, contract administration, human resources and general management, as
well as acquisition, insurance and professional services expenses and excludes
non-cash stock-based compensation expense of $2,175 and $1,640 for the three and
nine months ended September 30, 2000, respectively.
For a discussion of Retek's general and administrative expenses see page 41.
THREE MONTHS ENDED SEPTEMBER 30, 2000
General and administrative expenses increased $4.4 million, to $10.3 million in
the third quarter of 2000 from $5.9 million in the third quarter of 1999. This
growth was driven by a $3.1 million increase at HNC and a $1.3 million increase
at Retek.
Within HNC, the increase in general and administrative expenses quarter over
quarter are attributable to a $1.3 million increase at our FS segment, a $1.1
million increase at our IS segment, and a $0.7 million increase at our combined
TS and other segments. These increases are related primarily to additional
staffing and related expenses, including recruiting costs, to support a higher
volume of business, resulting in part from our recent acquisitions.
NINE MONTHS ENDED SEPTEMBER 30, 2000
General and administrative expenses increased $11.7 million, to $27.2 million in
the nine months ended September 30, 2000 from $15.5 million in the nine months
ended September 30, 1999. This growth was driven by a $7.8 million increase at
HNC and a $3.9 million increase at Retek.
Within HNC, the increase in general and administrative expenses period over
period is attributable to a $4.4 million increase at our FS segment, a $1.9
million increase at our IS segment, and a $1.5 million increase at our combined
TS and other segments. These increases are related primarily to additional
staffing and related expenses, including recruiting costs, to support a higher
volume of business, resulting in part from our recent acquisitions.
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
STOCK-BASED COMPENSATION EXPENSE
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000
Excluding stock-based compensation charges attributable to our Retek spin-off,
which are discussed separately below, we recorded net stock-based compensation
expense totaling $3.0 million and $7.7 million during the three and nine months
ended September 30, 2000, respectively. This net compensation expense relates
primarily to the amortization of unearned stock-based compensation of $2.9
million and $8.6 million during these periods, respectively (of which $2.8
million and $8.3 million related to Retek), and also includes additional net
compensation expense of $0.1 million and net compensation income of $0.9
million, respectively, primarily related to variable awards. The net
compensation income recorded during the nine months ended September 30, 2000
relates primarily to the reversal of compensation expense recorded in the fourth
quarter of 1999 in connection with consultant option grants, due to a decline in
the fair values of these awards during 2000. The fair values of these awards
were estimated using the Black-Scholes option pricing model with the following
weighted average assumptions: dividend yield of 0.0%, risk-free interest rate
of 6.42%, volatility of 100% and an expected life of 5 months.
In August 2000, we accelerated the vesting of 25 percent of the outstanding
stock options that would have been unvested as of the September 15, 2000 record
date to afford our option holders the opportunity to participate in receipt of
the Retek share dividend. As a result of this award modification, we recorded a
non-cash stock-based compensation charge of $6.7 million during the third
quarter of 2000 in accordance with Financial Accounting Standards Board
Interpretation No. 44, or FIN 44.
As a result of the proportionate option repricing in connection with the Retek
spin-off, certain options failed to qualify for fixed accounting under FIN 44.
During the third quarter of 2000, we recorded a one-time charge to operations of
$7.2 million related to the modification and estimated cash repurchase of
options in connection with the Retek spin-off.
TRANSACTION-RELATED AMORTIZATION AND COSTS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000
Transaction-related amortization and costs primarily include acquisition-related
amortization during the three and nine months ended September 30, 2000 and 1999.
Additional transaction related costs during the three and nine months ended
September 30, 2000 and 1999 include $0.8 million related to the write-off of
deferred offering costs during the third quarter of 2000 and $0.6 million
related to the write-off of deferred offering costs during the third quarter of
2000 and $0.6 million related to the write-off of deferred merger costs during
the third quarter of 1999, respectively.
Transaction-related amortization and costs increased from $2.7 million in the
third quarter of 1999 to $14.1 million in the third quarter of 2000, and from
$7.0 million in the nine months ended September 30, 1999 to $29.5 million in the
nine months ended September 30, 2000. These period over period increases are
primarily attributable to incremental intangible asset amortization charges as a
result of our business acquisitions during 1999 and 2000. Transaction-related
amortization and costs represent the amortization of intangible assets
purchased in conjunction with our acquisitions of Systems/Link and CardAlert in
the third quarter of 2000; Celerity and HighTouch in the second quarter of 2000;
AIM, CASA and Onyx in the first quarter of 2000; WebTrak in 1999; and our
acquisitions of Practical Control Systems Technologies, Inc., or PCS, FTI (now
HNC Financials Solutions, Inc.), and the Advanced Telecommunications Abuse
Control System, or ATACS product line assets during 1998. The average
amortization period and useful life for these intangible assets is approximately
3.5 years.
IN-PROCESS RESEARCH AND DEVELOPMENT EXPENSE
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000
In-process research and development expense was $1.2 million for the three
months ended September 30, 2000. These write-offs were related to the
acquisitions of Systems/Link and CardAlert. In-process research and development
expense was $7.6 million for the nine months ended September 30, 2000. These
write-offs were related to the acquisitions of CASA, Celerity, HighTouch,
Systems/Link and CardAlert.
CASA, acquired in the first quarter of 2000, is an advanced analytics solutions
company that provides account optimization and precision marketing solutions
through an ASP delivery platform. The classification of the technology as
complete or under development was made in accordance with the guidelines of
Statement of Financial Accounting Standards No. 86, Statement of Financial
Accounting Standards No. 2 and Financial Accounting Standards Board
Interpretation No. 4. Prior to 2000, CASA primarily sold its Adaptive Dynamic
Marketing ("ADM") ASP solution to businesses to improve revenue and customer
retention. At the time of acquisition, CASA had a number of new technologies
under development related to account management algorithms and pricing
algorithms, which in-process R&D projects which were estimated to achieve
technological feasibility in the second quarter of 2000.
Celerity, acquired in the second quarter of 2000, is involved in developing and
marketing electronic data interchange ("EDI") solutions for the workers'
compensation industry. The company is a developer and provider of translation
software, desktop software, and value-added network services in support of the
claims handling process. The classification of the technology as complete or
under development was made in accordance with the guidelines of Statement of
Financial Accounting Standards No. 86, Statement of Financial Accounting
Standards No. 2 and Financial Accounting Standards Board Interpretation No. 4.
Prior to its acquisition, Celerity primarily sold its software and network
services to insurance carriers, third party administrators managed care
organizations, employers, and medical providers to facilitate the workers
compensation claims handling process. At the time of acquisition, Celerity had a
number of new technologies under development related to world-wide web-enabling
and EDI network technology, which in-process R&D
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
projects were estimated to achieve technological feasibility in the second and
third quarters of 2000.
HighTouch, acquired in the second quarter of 2000 by Retek, is a provider of
customized software and services relating to customer relationship management
("CRM"). The classification of the technology as complete or under development
was made in accordance with the guidelines of Statement of Financial Accounting
Standards No. 86, Statement of Financial Accounting Standards No. 2 and
Financial Accounting Standards Board Interpretation No. 4. Prior to its
acquisition, HighTouch primarily sold customized software and services to a
variety of customers in the retail industry. At the time of acquisition,
HighTouch had technology under development relating to the creation of the
company's first fully integrated standardized off-the-shelf CRM product, which
in-process R&D project was estimated to achieve technological feasibility in the
third quarter of 2000.
Systems/Link is a software developer that creates data management solutions for
large telecommunications companies. The company provides applications for
real-time data collection, call detail record exchange, fraud control and
prepaid services for carriers. 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, Systems/Link had one new technology under
development related to real-time roamer record exchange system for enhanced
fraud control capabilities, which in-process R&D project was estimated to
achieve technological feasibility in the middle of 2001.
CardAlert provides ATM and debit card risk management services to domestic
financial institutions and debit card networks. The company's Accelerated
Detection technology analyzes daily ATM transactions for fraudulent activity.
The classification of the technology as complete or under development was made
in accordance with the guidelines of Statement of Financial Accounting Standards
No. 86, Statement of Financial Accounting Standards No. 2 and Financial
Accounting Standards Board Interpretation No. 4. Prior to its acquisition,
CardAlert primarily provided fraud detection services to large domestic debit
card networks. At the time of acquisition, CardAlert had one new technology
under development related to fraud detection for signature-based credit card
activity, which in-process R&D project was estimated to achieve technological
feasibility in the fourth quarter of 2000.
We used an independent appraisal firm to assist us with our valuations of the
fair market values of the purchased assets of CASA, Celerity, HighTouch,
Systems/Link and CardAlert. Fair market value is defined as the estimated amount
at which an asset might be expected to be exchanged between a willing buyer and
willing seller assuming the buyer continues to use the assets in its current
operations. The in-process R&D projects were valued through the use of a
discounted cash flow analysis, taking into account projected future cash flows
associated with these projects once they achieve technological feasibility,
their stage of completion as of the acquisition date, and the expected return
requirements (i.e. discount rates) for determining present values of the
projected cash flows. Stages of completion were estimated by considering time,
cost, and complexity of tasks completed prior to the acquisition as a percentage
of total time, cost and effort required for the total project up to achieving
technological feasibility.
With respect to the projected financial information provided to our appraiser
pertaining to these acquisitions, CASA prepared a detailed set of projections
forecasting revenue from the new algorithms as well as gross profit and
operating profit margins, Celerity and HNC prepared a detailed set of
projections forecasting revenue from the web-enabling and EDI technology as well
as gross profit and operating profit margins, Retek prepared a detailed set of
projections forecasting revenue from the HighTouch CRM technology as well as
gross profit and operating profit margins, Systems/Link and HNC prepared a
detailed set of projections forecasting revenue from the real-time roamer record
exchange technology as well as gross profit and operating profit margins, and
CardAlert and HNC prepared a detailed set of projections forecasting revenue
from the credit card fraud detection technology as well as gross profit and
operating profit margins. These projections were made based on an assessment of
customer needs and the expected pricing and cost structure.
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
With respect to the discount rates used in the valuation approach, the
incomplete technology represents a mix of near and mid-term prospects for the
business and imparts a level of uncertainty to its prospects. A reasonable
expectation of return on the incomplete technology would be higher than that of
completed technology due to these inherent risks. As a result, for CASA,
Celerity, HighTouch, Systems/Link and CardAlert, the earnings associated with
incomplete technology were discounted at rates of 27.0%, 24.3%, 26.2%, 31.0% and
31.0% based upon the following methodologies:
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 for CASA,
Celerity, HighTouch, Systems/Link and CardAlert, the discount rates attributable
to the businesses were 22.0%, 19.3%, 21.2%, 21.0% and 21.0%, respectively, which
were used for valuing completed technology. Since incomplete technology would
require a higher return than completed technology, the valuation report prepared
by our appraiser utilized rates of 27.0%, 24.3%, 26.2%, 31.0% and 31.0% for
CASA, Celerity, HighTouch, Systems/Link and CardAlert, respectively, to present
value cash flows (in excess of a return on other assets of the business)
attributable to in-process research and development projects.
The in-process research and development for the CASA, Celerity, HighTouch,
Systems/Link and CardAlert projects continue to progress, in all material
respects, consistently with our original assumptions that were provided to the
independent appraiser and used to value the in-process research and development.
These statements regarding projected revenues and expenses are forward-looking
statements, which are subject to risks and uncertainties. Actual results may
differ materially from those anticipated. Our inability to complete the
in-process technologies within the expected timeframes could materially impact
future revenues and earnings, which could have a negative impact on our
business, financial condition and results of operations.
EXPENSE RELATED TO SPIN-OFF OF RETEK
We incurred $46.5 million in costs during the third quarter of 2000 associated
with the spin-off of Retek. These costs primarily consisted of investment
banking, legal, accounting and other administrative costs, including the accrual
of approximately $39.0 million in cash bonuses to be paid to unvested stock
option holders.
OTHER INCOME, NET
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000
Other income, net is comprised primarily of interest income earned on cash and
investment balances. Other income, net for the third quarter of 2000 was $3.1
million, compared to $0.9 million in the third quarter of 1999. Other income,
net for the nine months ended September 30, 2000 was $9.6 million, compared to
$3.8 million in the nine months ended September 30, 1999. The increase in other
income, net during the three and nine months ended June 30, 2000 was
attributable primarily to an increase in interest income as a result of higher
average cash and investment balance during the first three quarters
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
in 2000 as compared to the same periods in 1999. The higher cash and investment
balances can be attributed in part to the net proceeds received from Retek's
initial public offering in November 1999, proceeds from stock option exercises
and employee stock purchase plan contributions, as well as the net effect of
other operating, investing and financing activities between the respective
periods.
EXPENSE RELATED TO DEBT CONVERSION
In connection with our conversion of $83.5 million in Convertible Subordinated
Notes during the quarter ended September 30, 2000, we incurred and paid $12.7
million in conversion premiums to the note holders, which we recorded as a
non-recurring debt conversion expense.
INCOME TAXES
THREE MONTHS ENDED SEPTEMBER 30, 2000
The income tax benefit was $15.5 million in the third quarter of 2000, compared
to an income tax expense of $3.8 million in the third quarter of 1999. The
income tax benefit for the third quarter of 2000 includes the effects of:
non-deductible, one-time write-offs of in-process research and development
related to the purchases of Systems/Link and CardAlert; Retek minority interest;
stock-based compensation expense; non-deductible acquisition related
amortization expense; and the Notes conversion inducement payments. The income
tax expense for the third quarter of 1999 includes non-deductible acquisition
related amortization expense. These provisions are based on our estimates of the
effective tax rates during those respective full fiscal years.
NINE MONTHS ENDED SEPTEMBER 30, 2000
The income tax benefit was $25.6 million in the nine months ended September 30,
2000, compared to an income tax expense of $8.3 million in the nine months ended
September 30, 1999. The income tax benefit for the nine months ended September
30, 2000 includes the effects of: non-deductible, one-time write-offs of
in-process research and development related to the purchases of CASA, Onyx,
Celerity, HighTouch, Systems/Link and CardAlert; Retek minority interest
stock-based compensation expense; non-deductible acquisition related
amortization expense; and the Notes conversion inducement payments. The income
tax expense for the nine months ended September 30, 1999 includes non-deductible
acquisition related amortization expense. These provisions are based on our
estimates of the effective tax rates during those respective full fiscal years.
LIQUIDITY AND CAPITAL RESOURCES
NINE MONTHS ENDED SEPTEMBER 30, 2000
Net cash used in operating activities was $27.7 million for the nine months
ended September 30, 2000, compared to net cash provided by operating activities
of $16.9 million during the same period in 1999. Cash used in operating
activities during the first nine months of 2000 includes $33.0 million of net
cash used in operations, offset by a $5.3 million increase due to working
capital cash flows. The net working capital cash flows primarily reflect
increases of accounts payable, accrued liabilities and deferred revenue, offset
by increases in trade accounts receivable and deferred income taxes.
Net cash used in investing activities was $81.6 million for the nine months
ended September 30, 2000, compared to net cash used in investing activities of
$8.0 million during the same period in 1999. Cash used in investing activities
during the first nine months of 2000 included $29.6 million in net investment
purchases, $21.9 million expended for the purchase of property and equipment,
$23.0 million paid in connection with our business acquisitions, net of cash
acquired, and $7.0 million paid out in connection with equity investments and
employee loans made.
Net cash provided by financing activities was $58.2 million for the nine months
ended September 30, 2000, compared to net cash used in financing activities of
$39.9 million during the same period in 1999. Cash provided by financing
activities during the first nine months of 2000 includes $83.0 million in
proceeds resulting from stock option exercises and employee stock purchase plan
contributions under both HNC and Retek plans and $32.0 million in proceeds from
the sale of trade receivables, offset by $18.6 million in cash expended to
repurchase HNC common stock for treasury, $7.7 million used to repay debt and
capital lease obligations, and the $30.5 million reduction of Retek's cash and
cash equivalent balance occurring as of the September 29, 2000 spin-off date.
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HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
As of September 30, 2000, we had $190.2 million in cash, cash equivalents and
investments available for sale. We believe that our current cash, cash
equivalents and investments available for sale balances, borrowings under our
credit facility and net cash provided by operating activities, will be
sufficient to meet our working capital and capital expenditure requirements for
at least the next 12 months. We expect to continue making significant
investments in capital assets, including computer equipment and building
improvements, during 2000 and 2001. We intend to invest our cash in excess of
current operating requirements in short-term, interest-bearing, investment-grade
securities. A portion of our cash could also be used to acquire or invest in
complementary businesses or products or otherwise to obtain the right to use
complementary technologies or data. The proceeds from the Notes will continue to
be used for general corporate purposes, including working capital and possibly
to acquire complementary businesses, products or technologies.
During March 1998, we completed an offering of $100,000 of 4.75% Convertible
Subordinated Notes, or the Notes, due on March 1, 2003. The Notes were
convertible into our common stock at any time prior to the close of business on
the maturity date at a conversion rate of 22.30 shares per $1,000 principal
amount of the Notes (equivalent to a conversion price of $44.85 per share).
During the quarter ending September 30, 2000, we converted $83.5 million of the
Notes into HNC common stock using the conversion rate described above. In
connection with these note conversions, we issued approximately 1,862 shares of
our common stock. Additionally, we paid approximately $12.7 million in cash
inducements to the converting note holders, which we recorded during the quarter
ended September 30, 2000. As of September 30, 2000, $16.5 million of the Notes
remain outstanding. In connection with the spin-off of our Retek subsidiary that
was completed on September 29, 2000, the indenture governing the Notes required
an automatic adjustment of the conversion price of the remaining Notes that were
not converted prior to the Retek spin-off. This conversion price adjustment was
based on a formula that calculated an adjusted conversion rate using the
relative per common share values of HNC and Retek as of the date of the
spin-off. As a result of this adjustment, the remaining Notes outstanding are
now convertible into our common stock at a conversion rate of 100.20 shares per
$1,000 principal amount of the Notes (equivalent to a conversion price of $9.98
per share). We have the right to redeem the remaining Notes outstanding, in
whole or in part, on or after March 6, 2001, at redemption prices (plus accrued
interest) as follows: a premium of 101.9 after one year, 100.95 after two years,
and at par as of the third year.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities", or FAS 133. This statement establishes a new model for
accounting for derivatives and hedging activities. Under FAS 133, all
derivatives must be recognized as assets and liabilities and measured at fair
value. In July 1999, the FASB issued Statement of Accounting Standards No. 137
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133" which defers the requirement to adopt
FAS 133 to the first quarter of 2001. We have not yet determined the impact of
the adoption of this new accounting standard on our consolidated financial
position, results of operations or disclosures.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements", or SAB 101,
which provides additional guidance in applying generally accepted accounting
principles for the recognition and reporting of revenue for certain transactions
that existing accounting rules do not specifically address. An amendment in June
2000 delayed SAB 101's effective date until the fourth quarter of 2000. We have
not yet determined the impact of the adoption of this new accounting standard on
our consolidated financial position, results of operations or disclosures.
27
<PAGE> 28
HNC SOFTWARE INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--(CONTINUED)
In January 2000, the Financial Accounting Standards Board's Emerging Issues Task
Force published Issue No. 00-2 "Accounting for Web Site Development Costs", or
EITF 00-2. EITF 00-2 applies the guidance given in the American Institute of
Certified Public Accountants's Statement of Position 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use", or SOP 98-1,
to Web site development costs. Under SOP 98-1, software development costs,
consisting of internally developed software and Web site development costs,
including internal and external costs incurred to develop internal-use computer
software during the application development stage are capitalized. Application
development stage costs generally include software configuration, coding,
installation to hardware and testing. Costs of significant upgrades and
enhancements that result in additional functionality are also capitalized. Costs
incurred for maintenance and minor upgrades and enhancements are expensed as
incurred. The estimated useful lives are based on planned or expected
significant modification or replacement of software applications, in response to
the rapid rate of change in the internet industry and technology in general.
Adoption of EITF 00-2 was required for the third quarter of 2000. The adoption
of EITF 00-2 did not have a significant impact on our consolidated financial
position, results of operations or disclosures.
28
<PAGE> 29
RETEK INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
-------------- ----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................ $ 30,463 $ 83,680
Investments...................................... 10,964 --
Accounts receivable, net......................... 24,792 24,383
Deferred income taxes............................ 1,589 1,612
Other current assets............................. 14,972 5,560
--------- --------
Total current assets.......................... 82,780 115,235
Investments........................................ 6,197 --
Deferred income taxes.............................. 42,031 21,716
Property and equipment, net........................ 27,144 8,291
Intangible assets, net............................. 30,434 8,958
Other assets....................................... 55 33
--------- --------
$ 188,641 $154,233
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................. $ 10,236 $ 5,946
Accrued liabilities.............................. 4,655 3,030
Deferred revenue................................. 42,526 5,883
Note payable..................................... 533 --
Payable to HNC Software Inc...................... 596 15,399
--------- --------
Total current liabilities..................... 58,546 30,258
Deferred revenue, net of current portion........... 5,873 --
--------- --------
Total liabilities............................. 64,419 30,258
Stockholders' equity:
Preferred stock, $0.01 par value -- 5,000 shares
authorized; no shares issued and outstanding.. -- --
Common stock, $0.01 par value -- 150,000 shares
authorized, 47,656 shares and 46,503 shares
issued and outstanding at September 30,
2000 and December 31, 1999, respectively.... 477 465
Paid-in capital.................................... 170,624 140,089
Deferred stock-based compensation.................. (13,260) (19,978)
Accumulated other comprehensive loss............... (1,593) (582)
(Accumulated deficit) retained earnings............ (32,026) 3,981
--------- --------
Total stockholders' equity.................... 124,222 123,975
--------- --------
Total liabilities and stockholders' equity......... $ 188,641 $154,233
========= ========
</TABLE>
See accompanying notes to consolidated financial statements.
29
<PAGE> 30
RETEK INC.
CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999 2000 1999
---------------- ---------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenue:
License and maintenance....................... $ 17,291 $14,078 $ 35,229 $41,392
Services and other............................ 9,071 5,991 24,686 16,367
--------- ------- --------- -------
Total revenue.............................. 26,362 20,069 59,915 57,759
--------- ------- --------- -------
Cost of revenue:
License and maintenance (1) (2)............... 6,942 821 16,415 4,079
Services and other (1)........................ 6,605 4,180 17,992 11,642
--------- ------- --------- -------
Total cost of revenue...................... 13,547 5,001 34,407 15,721
--------- ------- --------- -------
Gross profit............................... 12,815 15,068 25,508 42,038
Operating expenses:
Research and development (1).................. 9,404 5,012 26,198 14,749
Sales and marketing (1)....................... 9,923 4,574 28,236 12,948
General and administrative (1)................ 2,876 1,525 7,894 4,076
Amortization of stock-based compensation...... 2,837 -- 8,261 --
Acquired in-process research and
development................................. -- -- 4,000 --
Acquisition related amortization of
intangibles................................. 2,398 264 4,940 780
--------- ------- --------- -------
Total operating expenses................... 27,438 11,375 79,529 32,553
--------- ------- --------- -------
Operating (loss) income......................... (14,623) 3,693 (54,021) 9,485
Other income, net............................... 75 (344) 1,526 (330)
--------- ------- --------- --------
(Loss) income before income tax (benefit)
provision................................... (14,548) 3,349 (52,495) 9,155
Income tax (benefit) provision.................. (5,041) 1,716 (16,488) 4,062
--------- ------- --------- -------
Net (loss) income............................. $ (9,507) $ 1,663 $ (36,007) $ 5,093
======== ====== ======== ======
Basic and diluted net loss per common share $ (0.20) $ (0.77)
======== ========
Weighted average shares used in computing
basic and diluted net loss per common share... 47,441 46,995
========= =========
Pro forma basic net income per common share..... $ 0.04 $ 0.13
======= =======
Weighted average shares used in computing pro
forma basic net income per common share....... 40,000 40,000
======= =======
(1) Excludes non-cash, amortization of
stock-based compensation as follows:
Cost of revenue:
License and maintenance........................ 173 -- 504 --
Services and other............................. 409 -- 1,190 --
Operating expenses:
Research and development....................... 1,347 -- 3,924 --
Sales and marketing............................ 624 -- 1,817 --
General and administrative..................... 284 -- 826 --
--------- ------- --------- -------
Total amortization of stock-based
Compensation............................. $ 2,837 $ -- $ 8,261 $ --
========= ======= ========= =======
(2) Excludes non-cash, acquisition related
amortization of intangibles..................... $ 903 $ 149 $ 2,177 $ 684
========= ======= ========= =======
</TABLE>
See accompanying notes to consolidated financial statements.
30
<PAGE> 31
RETEK INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
2000 1999
--------------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income................................... $(36,007) $ 5,093
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Provision for doubtful accounts..................... 1,847 1,899
Depreciation and amortization expense............... 8,529 2,782
Amortization of stock-based compensation............ 8,261 --
Acquired in-process research and development........ 4,000 --
Deferred tax benefit................................ (22,153) 318
Tax benefit from stock option transactions.......... 5,666 190
Changes in assets and liabilities, excluding
business acquisitions:
Accounts receivable.............................. (2,256) (10,430)
Other assets..................................... (9,389) 171
Accounts payable................................. 4,069 1,080
Accrued liabilities.............................. 1,625 (483)
Deferred revenue................................. 41,904 (439)
-------- --------
Net cash provided by operating activities...... 6,096 181
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash purchased in business acquisition.............. 166 --
Cash paid for business acquisition.................. (18,694) --
Net purchases of investments........................ (17,161) --
Acquisitions of property and equipment.............. (12,032) (3,656)
-------- --------
Net cash used in investing activities.......... (47,721) (3,656)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from the issuance of common stock...... 5,635 --
Repayment of debt................................... (1,411) --
Borrowings from HNC Software Inc.................... 596 46,892
Repayments to HNC Software Inc...................... (15,399) (43,331)
-------- --------
Net cash (used in) provided by financing
activities................................... (10,579) 3,561
-------- --------
Effect of exchange rate changes on cash............. (1,013) (2)
-------- --------
Net (decrease) increase in cash and cash
equivalents....................................... (53,217) 84
Cash and cash equivalents at beginning of
period............................................ 83,680 415
-------- --------
Cash and cash equivalents at end of period.......... $ 30,463 $ 499
======== ========
SIGNIFICANT NON-CASH FINANCING ACTIVITIES:
Business acquisition through issuance of Retek
common stock and stock options...................... $ 7,503 $ --
======== ========
Acquisition of property and equipment under
capital leases.................................... $ 10,200 $ --
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
31
<PAGE> 32
RETEK INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
AND COMPREHENSIVE LOSS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
(IN THOUSANDS)
(unaudited)
<TABLE>
<CAPTION>
COMMON STOCK
-------------------------------- ACCUMULATED
DEFERRED OTHER
PAID-IN STOCK-BASED COMPREHENSIVE
SHARES AMOUNT CAPITAL COMPENSATION LOSS
--------------- --------------- --------------- ----------------- ---------------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1999......... 46,503 $ 465 $140,089 $(19,978) $ (582)
Tax benefit from exercise of HNC
Software Inc. stock options........ 5,666
Common stock issuance costs.......... (287)
Common stock issued under Employee
Stock Purchase Plan.................. 464 5 5,917
Common stock and stock options
issued for acquisition of
HighTouch.......................... 389 4 7,499
Common stock issued.................. 300 3 10,197
Deferred stock-based compensation.... 1,543 (1,543)
Amortization of stock-based
Compensation....................... 8,261
Unrealized gain on investments....... 2
Foreign currency translation
Adjustment......................... (1,013)
Net loss.............................
------ ----- -------- -------- -------
BALANCE AT SEPTEMBER 30, 2000........ 47,656 $ 477 $170,624 $(13,260) $(1,593)
====== ===== ======== ======== =======
</TABLE>
<TABLE>
<CAPTION>
RETAINED TOTAL
EARNINGS STOCKHOLDERS' COMPREHENSIVE
(DEFICIT) EQUITY LOSS
------------- ----------------- ---------------------
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1999......... $ 3,981 $ 123,975
Tax benefit from exercise of HNC
Software Inc. stock options........ 5,666
Common stock issuance costs.......... (287)
Common stock issued under Employee
Stock Purchase Plan................ 5,922
Common stock and stock options
issued for acquisition of
HighTouch.......................... 7,503
Common stock issued.................. 10,200
Deferred stock-based compensation....
Amortization of stock-based
Compensation....................... 8,261
Unrealized loss on investments....... 2 $ 2
Foreign currency translation
Adjustment......................... (1,013) (1,013)
Net loss............................. (36,007) (36,007) (36,007)
-------- --------- ---------
BALANCE AT SEPTEMBER 30, 2000........ $(32,026) $ 124,222 $ (37,018)
======== ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
32
<PAGE> 33
RETEK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- THE COMPANY AND BASIS OF PRESENTATION
The Company
Retek Inc. and its wholly owned subsidiaries, Retek Information Systems,
Inc., WebTrak Limited and HighTouch Technologies, Inc. ("we" "us" or the
"Company"), develop application software that provides a complete information
infrastructure solution to the global retail industry. Our offerings include
traditional merchandising capabilities such as inventory management and
purchasing; logistics capabilities including warehouse and distribution
management; enhanced supply chain solutions such as forecasting, planning, and
supply chain visibility; and customer relationship and order management
applications. We also provide Internet-based business-to-business commerce
applications that offer collaborative capabilities enabling retailers and their
trading partners to interact in real-time on a wide variety of tasks. Many of
our products incorporate proprietary neural-network predictive technology that
enhances the usefulness, accuracy, and adaptability of our applications enabling
better decision-making by retailers. We are headquartered in Minneapolis,
Minnesota.
Separation from HNC Software Inc.
On October 2, 2000, HNC Software Inc. ("HNC") announced it had completed its
separation of Retek Inc. from HNC through a distribution (the "Distribution") of
HNC's entire holding of Retek shares, which consisted of 40 million shares of
common stock. HNC previously received a private letter ruling from the Internal
Revenue Service that HNC's pro rata distribution of its shares of Retek common
stock would be tax-free to HNC and its stockholders for U.S. federal income tax
purposes. After the close of the Nasdaq National Market on September 29, 2000,
HNC stockholders who were stockholders of record as of September 15, 2000 were
distributed 1.243 shares of Retek common stock for each share of HNC stock held
as of the record date.
For periods prior to the Distribution, our taxable income or losses were
included in the consolidated tax returns of HNC. For financial reporting
purposes, we computed income taxes on a stand-alone basis. Upon the
Distribution, we became responsible for our income taxes and the filing of our
own income tax returns. Pursuant to a tax sharing agreement with HNC for periods
prior to the Distribution, we were required to pay HNC an amount equal to the
tax liability we would have incurred on a separate return basis had we not
joined with HNC in filing a consolidated return. To the extent we determine that
we would have no tax liability on a separate return basis, HNC will pay us an
amount equal to the difference between HNC's consolidated tax liability with us
included in its consolidated tax return and the consolidated tax liability that
would have been due had we not been included in the consolidated tax return.
Similar provisions are defined under the tax sharing agreement for state tax
returns, which are filed on a group or unitary basis. As of September 30, 2000,
we had a net deferred tax asset of $43.6 million, which includes a net operating
loss carryforward incurred prior to the Distribution. Any amounts owed to us by
HNC upon final determination of tax benefits received by HNC through the
Distribution are classified as deferred income tax assets until such
determination is made.
Basis of Presentation
We have prepared the accompanying interim consolidated financial statements,
without audit, in accordance with the instructions to Form 10-Q and, therefore,
the accompanying interim consolidated financial statements do not necessarily
include all information and footnotes necessary for a fair presentation of our
financial position, results of operations and cash flows in accordance with
accounting principles generally accepted in the United States of America.
We believe the accompanying unaudited financial information for interim
periods presented reflects all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation. These consolidated financial
statements and notes thereto should be read in conjunction with our audited
financial statements and notes thereto presented in our Annual Report on Form
10-K for the fiscal year ended December 31, 1999. The interim financial
information contained in this Report on Form 10-Q is not necessarily indicative
of the results to be expected for any other interim period or for an entire
fiscal year.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and
33
<PAGE> 34
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Accounting Standards No. 133 ("FAS 133"), "Accounting for
Derivative Instruments and Hedging Activities" which is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. This statement
establishes a new model for accounting for derivatives and hedging activities.
Under FAS 133, all derivatives must be recognized as assets and liabilities and
measured at fair value. In July 1999, the FASB issued Statement of Accounting
Standards No. 137 "Accounting for Derivative Instruments and Hedging Activities
-- Deferral of the Effective Date of FASB Statement No. 133" which defers the
effective date to all fiscal quarters of fiscal years beginning after June 15,
2000. In 2000, the FASB issued Statement of Accounting Standards No. 138 (FAS
138) "Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an amendment of FASB Statement No. 133", which is effective for all
fiscal quarters after June 15, 2000. FAS 138 amends the accounting and reporting
standards of FAS 133 for certain derivative instruments and certain hedging
activities. The adoption of FAS 133 and the amendments thereof in FAS 138 are
not expected to have a significant impact on our consolidated financial position
or results of operations.
In January 2000, the Financial Accounting Standards Board's Emerging Issues
Task Force published Issue No. 00-2 "Accounting for Web Site Development Costs",
or EITF 00-2. EITF 00-2 applies the guidance given in the American Institute of
Certified Public Accountants' Statement of Position 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use", or SOP 98-1,
to Web site development costs. Under SOP 98-1, software development costs,
consisting of internally developed software and Web site development costs,
include internal and external costs incurred to develop internal-use computer
software during the application development stage are capitalized. Application
development stage costs generally include software configuration, coding,
installation to hardware and testing. Costs of significant upgrades and
enhancements that result in additional functionality are also capitalized. Costs
incurred for maintenance and minor upgrades and enhancements are expensed as
incurred. The estimated useful lives are based on planned or expected
significant modification or replacement of software applications, in response to
the rapid rate of change in the Internet industry and technology in general.
Adoption of EITF 00-2 was required for the third quarter of 2000. The adoption
of EITF 00-2 did not have a significant impact on our consolidated financial
position or results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition." Amendments to the Bulletin
delayed the effective date until the fourth quarter of 2000. Adoption of Staff
Accounting Bulletin No. 101 is not expected to have a significant impact on our
consolidated financial position or results of operations.
NOTE 2 -- PER SHARE DATA
Basic net loss per share is calculated based only on the weighted average
common shares outstanding during the period. Diluted earnings per share is
computed on the basis of the weighted average basic shares outstanding plus the
dilutive effect of outstanding stock options using the "treasury stock" method.
For periods prior to our initial public offering, the weighted average basic
shares outstanding is a pro forma amount which reflects the September 1999
reincorporation of Retek Inc. and the 40 for .001 stock split of Retek Inc.
common shares.
For the three months and nine months ended September 30, 2000, the
calculation of diluted loss per share excludes the impact of the potential
exercise of 8,399,533 stock options outstanding at September 30, 2000 because
the effect would be antidilutive.
Pro forma unaudited income per common share for the three months and nine
months ended September 30, 1999 is calculated for basic income per share only
since we had no outstanding stock options during those periods.
NOTE 3 - ACQUISITION
On May 10, 2000, we acquired HighTouch Technologies, Inc. ("HighTouch") for
a cash payment of $18.7 million, including direct acquisition costs and 389,057
shares of our common stock. The application of the purchase method of accounting
for the acquisition resulted in an excess of cost over net assets acquired of
approximately $30.6 million, of which $26.6 million has been allocated to
intangible assets and $4.0 million has been allocated to in-process research and
development.
34
<PAGE> 35
In conjunction with these purchases, we recorded various intangible assets.
Intangible assets are comprised of purchased software and other rights that are
stated at lower of cost or net realizable value. Intangible assets are amortized
as follows:
<TABLE>
<CAPTION>
AMORTIZATION METHOD ESTIMATED USEFUL LIFE
<S> <C> <C>
Purchased software costs..... Straight-line 36 to 42 months
Assembled work force......... Straight-line 3 years
Customer base................ Straight-line 3 to 5 years
Noncompetition agreements.... Straight-line 5 years
Trademarks................... Straight-line 5 years
Goodwill..................... Straight-line 5 years
</TABLE>
In connection with our acquisition of HighTouch, acquired research and
development of $4.0 million was charged to operations on the acquisition date.
HighTouch's products provide real-time transaction management and customer
service solutions that support multi-channel customer interactions. HighTouch
owns certain direct consumer management technologies that we have incorporated
into Retek CRM, our enterprise-level customer interaction system. 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 Standards No. 2 and Financial Accounting
Standards Board Interpretation No. 4. At the time of the acquisition, HighTouch
had three products under development including Customer Order Management, which
was subsequently completed by Retek in July of 2000 and Customer Direct
Marketing and Customer Loyalty and Retention, which are still in development.
The following table presents the consolidated results of operations on an
unaudited pro forma basis as if the acquisition of HighTouch had taken place at
the beginning of each year (dollars in thousands).
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER SEPTEMBER
30, 2000 30, 1999
<S> <C> <C>
Net revenues..................... $ 59,948 $ 59,306
Net (loss) income................ (40,156) 2,883
Basic and Pro forma net (loss)
income per share................. (0.85) 0.07
</TABLE>
The unaudited pro forma results of operations are for comparative purposes
only and do not necessarily reflect the results that would have occurred had the
acquisition occurred at the beginning of the periods presented or the results
which may occur in the future.
NOTE 4 -- STRATEGIC ALLIANCE WITH IBM
On September 5, 2000 we entered into a strategic relationship with
International Business Machines Corporation ("IBM"). Pursuant to this
relationship, Retek and IBM will jointly market, sell, and service a
comprehensive retail e-business solution consisting of Retek applications and
IBM software and hardware technologies. In connection with entering into this
relationship, we and IBM entered into a Common Stock Purchase Agreement ("Stock
Agreement") pursuant to which we issued 300,000 shares of our common stock to
IBM in exchange for IBM entering into the relationship and providing to us IBM
hardware and software for use by us during the initial term of the relationship.
This IBM hardware and software will be used by us to adapt our retail
applications Retail Server exchange platform and on-line marketplace to IBM's DB
Universal Database. This arrangement has been accounted for as a capital lease
of the hardware and software. Accordingly, the aggregate fair value of our
common shares issued of $10.2 million has been included in property and
equipment and is being amortized using the straight line method over the
twenty-seven month term of this portion of the arrangement.
The Stock Agreement also requires us to issue shares of our common stock to
IBM upon reaching certain revenue targets related to our software applications
sold under the joint marketing and selling arrangements in 2001, 2002 and 2003.
Under the Stock Agreement, we will be obligated to pay IBM $5 million, $10
million and $15 million related to 2001, 2002 and 2003, respectively, in shares
of our common stock if annual revenue targets, as stated in the Stock Agreement,
are met. The Stock Agreement provides for increases or decreases of the amounts
to be paid to IBM in the event these revenue targets are exceeded or are
partially met.
35
<PAGE> 36
NOTE 5 -- SALE OF FUTURE ACCOUNTS RECEIVABLE
During the quarter ended September 30, 2000, we sold our interest in $10 million
of future accounts receivable due to us under contracts with various customers.
These balances were sold to a financial institution. The amount received for
these future balances due are included in deferred revenue as of September 30,
2000.
NOTE 6 -- RECLASSIFICATIONS
Certain reclassifications have been made to our December 31, 1999
consolidated balance sheet to conform with the presentation at September 30,
2000. These reclassifications had no impact on previously reported stockholders'
equity.
36
<PAGE> 37
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and the related notes, and the other financial information included
in this Quarterly Report on Form 10-Q. This discussion and analysis contains
forward-looking statements that involve risks and uncertainties. Our actual
results may differ materially from those anticipated in these forward-looking
statements as a result of specified factors, including those set forth in the
section below entitled "Factors That May Impact Future Results of Operations"
and elsewhere in this Quarterly Report on Form 10-Q.
OVERVIEW
We completed our initial public offering on November 23, 1999. Prior to the
completion of our initial public offering, we were a wholly owned subsidiary of
HNC Software Inc., a business-to-business software company that develops and
markets predictive software solutions. On October 2, 2000, HNC announced it had
completed its separation of Retek Inc. from HNC through a distribution to HNC's
stockholders (the "Distribution") of HNC's entire holding of Retek shares, which
consisted of 40 million shares of common stock. HNC previously received a
private letter ruling from the Internal Revenue Service that HNC's pro rata
distribution of its shares of Retek common stock would be tax-free to HNC and
its stockholders for U.S. federal income tax purposes. After the close of the
Nasdaq National Market on September 29, 2000, HNC stockholders who were
stockholders of record as of September 15, 2000 were distributed 1.243 shares of
Retek common stock for each share of HNC stock held as of the record date.
Our business combines the business activities of Retek Information Systems,
Inc. and Retek Inc., formerly Retek Logistics, Inc. Founded in 1995, Retek
Information Systems, a developer and marketer of Internet-based,
business-to-business software solutions for retailers, was acquired by HNC in
1996. Founded in 1985 as Practical Control Solutions, Inc., Retek Logistics, a
developer of warehouse management software solutions, was acquired by HNC in
1998. The acquisition of Retek Information Systems by HNC allowed us to
integrate HNC's patented predictive technology into our software solutions for
retailers. On September 9, 1999, Retek Logistics was reincorporated as a
Delaware corporation and renamed "Retek Inc." Immediately prior to the
completion of our initial public offering on November 23, 1999, in connection
with the separation of our business from HNC, HNC contributed all of the
outstanding capital stock of Retek Information Systems to Retek Inc. Retek
Information Systems currently operates as a wholly owned subsidiary.
We generate revenue from the sale of software licenses, maintenance and
support contracts, and professional consulting and contract development
services. Until the fourth quarter of 1999, we generally licensed products to
customers on a perpetual basis and recognized revenue upon delivery of the
products. Starting in the fourth quarter of 1999, we revised the terms of our
software licensing agreements for the majority of our software products sold.
Under the revised terms, we provide technical advisory services after the
delivery of our products to help customers exploit the full value and
functionality of our products. Revenue from the sale of software licenses under
these agreements will be recognized as the technical advisory services are
performed. We expect the periods of technical advisory services will generally
range from 12 to 24 months, as determined by the customers' objectives. As we
continue to recognize license and service revenue over a period of time, rather
than upon delivery of the product, we will recognize significantly less revenue,
have lower associated margins for several quarters, as compared to previous
quarters, have higher operating expenses as a percentage of total revenues and
incur operating losses for several quarters. Deferred revenue consists
principally of the unrecognized portion of revenue received under license and
maintenance service agreements. Deferred license revenue is recognized ratably
or as a percentage of completion based on the contract terms. Deferred
maintenance revenue is recognized ratably over the term of the service
agreement.
Customers who license our software generally purchase maintenance contracts,
typically covering renewable annual periods. In addition, customers may purchase
consulting services, which are customarily billed at a fixed daily rate plus
out-of-pocket expenses. Contract development services, including new product
development services, are typically performed for a fixed fee. We also offer
training services that are billed on a per student or per class session basis.
The growth of our customer base is primarily attributable to our increased
market penetration and our expanding product offering. Our investment in
research and development, and recent acquisitions and alliances have helped us
bring new software solutions to market. These investments produced a suite of
decision support solutions in 1997; the retooling of our applications for the
web in 1998; the delivery of Internet-based business-to-business collaborative
planning, critical path and product design solutions in 1999; and several
additional collaborative offerings available for delivery through public
marketplaces, private exchanges and Retek's own hosted service through 2000. To
support our growth during these periods, we also continued to invest in internal
infrastructure by hiring employees across various departments.
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We market our software solutions worldwide through direct and indirect sales
channels. Revenue generated from our direct sales channel accounted for
approximately 93.6% and 91.5% for the quarter and nine months ended September
30, 2000, respectively, as compared to 74.8% and 74.0% for the same periods as
of September 30, 1999. Indirect sales channel revenue primarily arises from our
relationship with Oracle.
On October 29, 1999, we completed the purchase of all the outstanding
capital stock of WebTrak Limited. WebTrak owns the WebTrack Critical Path and
Portfolio Private Label products that we currently distribute. In connection
with the purchase of WebTrak, we issued to former WebTrak shareholders notes,
which were due on November 26, 1999, in the principal amount of $5.33 million
and a convertible note, which was due on November 26, 1999, in the principal
amount of $2.67 million. The convertible note was, at the option of the holder,
convertible at the time of payment into the number of shares of the Company's
common stock equal to the principal amount of the note divided by the initial
offering price of $15.00. On November 29, 1999 we issued 177,778 shares of our
common stock to the holder of the convertible note in full satisfaction of our
obligations. The remaining notes were paid in full on their due date.
On May 10, 2000, we completed our acquisition of HighTouch Technologies,
Inc., a provider of real-time transaction management and customer service
solutions that support multi-channel customer interactions. HighTouch owns
certain direct consumer management technologies that we have incorporated into
Retek Retail CRM, our enterprise-level customer interaction system. In
connection with the purchase of HighTouch, we paid $18.7 million in cash,
including direct acquisition costs, and issued 389,057 shares of our common
stock to the former sole shareholder of HighTouch.
On September 5, 2000 we entered into a strategic relationship with International
Business Machines Corporation ("IBM"). Pursuant to this relationship, Retek and
IBM will jointly market, sell, and service a comprehensive retail e-business
solution consisting of Retek applications and IBM software and hardware
technologies. In connection with entering into this relationship, we and IBM
entered into a Common Stock Purchase Agreement ("Stock Agreement") pursuant to
which we issued 300,000 shares of our common stock to IBM in exchange for IBM
entering into the relationship and IBM providing to us, at no cost, IBM hardware
and software for use by us during the initial term of the relationship. The
Stock Agreement requires us to issue shares of our common stock to IBM upon
reaching certain revenue targets related to Retek software applications sold
under the joint marketing and selling arrangements in 2001, 2002 and 2003. Under
the Stock Agreement, we will be obligated to pay IBM $5 million, $10 million and
$15 million related to 2001, 2002 and 2003, respectively, in shares of our
common stock if annual revenue targets, as stated in the Stock Agreement, are
met. The Stock Agreement provides for increases or decreases of the amounts to
be paid to IBM in the event these revenue targets are exceeded or are partially
met.
Revenue attributable to customers outside of North America accounted for
approximately 17.3 % and 24.3% for the quarter and nine months ended September
30, 2000, respectively as compared to 33.3% and 39.4% for the same periods as of
September 30, 1999. Approximately 9.6% and 8.8% of our sales were denominated in
currencies other than the U.S. dollar for the quarter and nine months as of
September 30, 2000, respectively as compared to 5.9% and 14.7% for the same
periods as of September 30, 1999.
We primarily sell perpetual licenses for which we recognize revenue in
accordance with generally accepted accounting principles, upon meeting each of
the following criteria:
- execution of a written purchase order, license agreement or contract;
- delivery of software authorization keys;
- the license fee is fixed and determinable;
- collectibility of the proceeds is assessed as being probable; and
- vendor-specific objective evidence exists to allocate the total fee to
elements of the arrangement.
Vendor-specific objective evidence is based on the price charged when an
element is sold separately, or if not yet sold separately, is established by
authorized management. All elements of each order are valued at the time of
revenue recognition. We recognize revenue:
- for sales made through our distributors, resellers and original equipment
manufacturers, at the time these partners report to us that they have sold
the software to the end-user and after all revenue recognition criteria have
been met;
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- from maintenance agreements related to our software, over the respective
maintenance periods;
- from customer modifications, as the services are performed using the
percentage of completion method; and
- from services, using the percentage of completion method, based on costs
incurred to date compared to total estimated costs at completion.
We record amounts received under contracts in advance of performance as
deferred revenue and generally recognize these amounts within one year from
receipt. Any amount that will not be recognized within one year of receipt is
recorded in non-current deferred revenue.
RESULTS OF OPERATIONS
The following table presents selected financial data for the periods
indicated as a percentage of our total revenue. Our historical reporting results
are not necessarily indicative of the results to be expected for any future
period.
<TABLE>
<CAPTION>
AS A PERCENTAGE OF AS A PERCENTAGE OF
TOTAL REVENUE TOTAL REVENUE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------------- ----------------------------------
2000 1999 2000 1999
----------------- ----------------- ----------------- ---------------
<S> <C> <C> <C> <C>
Revenue:
License and maintenance................. 65.6% 70.1% 58.8% 71.7%
Services and other...................... 34.4 29.9 41.2 28.3
Total revenue................... 100.0 100.0 100.0 100.0
Cost of revenue:
License and maintenance................. 26.3 4.1 27.4 7.1
Services and other...................... 25.1 20.8 30.0 20.2
Total cost of revenue........... 51.4 24.9 57.4 27.3
Gross margin.............................. 48.6 75.1 42.6 72.7
Operating expenses:
Research and development................ 35.7 25.0 43.7 25.4
Sales and marketing..................... 37.6 22.8 47.1 22.4
General and administrative.............. 10.9 7.6 13.2 7.1
Amortization of stock-based
compensation 10.8 - 13.8 -
Acquired in-process research and
Development........................... - - 6.7 -
Acquisition related amortization of
intangibles........................... 9.1 1.3 8.2 1.4
Total operating expenses........ 104.1 56.7 132.7 56.3
Operating (loss) income................... (55.5) 18.4 (90.1) 16.4
Other income, net......................... 0.3 (1.7) 2.5 (0.6)
(Loss) income before income tax (benefit)
provision............................... (55.2) 16.7 (87.6) 15.8
Income tax (benefit) provision............ (19.1) 8.6 (27.5) 7.0
Net (loss) income......................... (36.1) 8.1 (60.1) 8.8
Cost of license and maintenance revenue,
as a percentage of license and
maintenance revenue..................... 40.1 5.8 46.6 9.9
Cost of services and other revenue, as a
percentage of services and other
revenue................................. 72.8 69.8 72.9 71.1
</TABLE>
Three Months Ended and Nine Months Ended September 30, 2000 and 1999
Revenue
Total revenue. Total revenue increased 31.4% and 3.7% to $26.4 and $59.9
million for the quarter and nine months ended September 30, 2000, respectively,
from $20.1 and $57.8 million for the same periods in 1999.
License and maintenance revenue. License and maintenance revenue was $17.3
and $35.2 million for the quarter and nine months ended September 30, 2000,
respectively, an increase of 22.8% and a decrease of 14.9% from comparable
periods in 1999. As noted above in the section entitled "Overview", we recently
revised the terms of our software license agreements so that revenue is
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recognized over a number of quarters rather than upon delivery. The increase in
license revenue for the three months ended September 30, 2000 compared to the
same period in 1999 was due to the growing number of customers that have
installed our software solutions and had concurrent advisory periods during the
three months ended September 30, 2000. The decrease in license revenue for the
nine months ended September 30, 2000 was primarily due to the revised terms used
in negotiating our license contracts. As a result, year over year period revenue
decreased in the nine month period ended September 30, 2000 compared to the same
period in 1999. Maintenance revenue increased $2.2 and $7.3 million for the
quarter and nine months ended September 30, 2000, respectively, due to the
growing base of customers that have installed our software solutions.
Services and other revenue. Services and other revenue totaled $9.1 and
$24.7 million for the quarter and nine months ended September 30, 2000,
respectively, an increase of 51.4% and 50.8% from comparable periods in prior
year. The increases were due to $3.1 and $10.0 million increases in consulting
services and custom development projects for the quarter and nine months ended
September 30, 2000, respectively. Our number of billable employees increased to
90 as of September 30, 2000 from 69 as of September 30, 1999. In addition, third
party consultants are used on an as needed basis depending upon our allocation
of internal resources.
Cost of Revenue
Cost of license and maintenance revenue. Cost of license and maintenance
revenue consists primarily of fees for third party software products that are
integrated into our products; third party license consultant costs; salaries and
related expenses of our customer support organization; and an allocation of our
facilities and depreciation expense. Cost of license and maintenance revenue was
$6.9 and $16.4 million for the quarter and nine months ended September 30, 2000,
respectively, an increase of 746.6% and 302.4% over comparable periods in 1999.
As license and maintenance revenue increases, we expect to experience increased
costs resulting from increased royalty fees and an increase in the number of
support personnel required to service our growing customer base. The number of
cost of license and maintenance revenue personnel increased to 38 as of
September 30, 2000 from 7 as of September 30, 1999. In addition, we incurred
higher third party license consultant costs. We expect the cost of license and
maintenance revenue to continue to increase in absolute dollars as license and
maintenance revenue increases.
Cost of services and other revenue. Cost of services and other revenue
includes salaries and related expenses of our consulting organization; cost of
third parties contracted to provide consulting services to our customers; and an
allocation of facilities and depreciation expense. Cost of services and other
revenue was $6.6 and $18.0 million for the quarter and nine months ended
September 30, 2000, respectively, an increase of 58.0% and 54.5% over comparable
periods in 1999. As a percentage of services and other revenue, cost of services
and other revenue was 72.8% and 69.8% in the quarters ended September 30, 2000
and 1999, respectively, and 72.9% and 71.1% for the nine months ended September
30, 2000 and 1999, respectively. During the third quarter of 2000, we continued
to expand our consulting services business, increasing the number of personnel
to 90 as of September 30, 2000 from 69 as of September 30, 1999.
Operating Expenses
Research and development. Research and development expenses, which are
expensed as incurred, consist primarily of salaries and related costs of our
engineering organization; fees paid to third-party consultants; and an
allocation of facilities and depreciation expenses. We have increased investment
in research and development in absolute dollars each year since 1995. Research
and development expenses were $9.4 and $26.2 million for the quarter and nine
months ended September 30, 2000, respectively, an increase of 87.6% and 77.6%
over comparable periods in 1999. The absolute dollar increases in research and
development expenses were due to significant increases in personnel costs, which
included costs related to hired personnel and third party consultants. Research
and development personnel increased to 298 in the third quarter of 2000 from 184
in the third quarter of 1999. We invested heavily in the development of new
product solutions during the first three quarters of 2000, including the
integration of HighTouch Technologies, Inc.'s product suite into our own. Also,
the allocation for facilities and depreciation expense increased as a result of
expenditures for additional office space and capital equipment required to
support the additional personnel. We expect the absolute dollar increase in
research and development expenses to continue as we invest in the development of
other new solutions.
Sales and marketing. Sales and marketing expenses consist primarily of
salaries and related costs of the sales and marketing organization; sales
commissions; costs of marketing programs, including public relations,
advertising, trade shows and sales collateral; and an allocation of facilities
and depreciation expenses. Sales and marketing expenses were $9.9 and $28.2
million for the quarter and nine months ended September 30, 2000, respectively,
an increase of 116.9% and 118.1% over comparable periods in 1999. The increases
were primarily due to increases in personnel and related costs of $3.1 and $7.1
million for the quarter and nine months ended September 30, 2000, respectively,
increases in third party consulting of $774,000 and $2.3 million for the quarter
and nine months
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ended September 30, 2000, respectively, and increases in marketing costs of
$746,000 and $3.8 million for the quarter and nine months ended September 30,
2000, respectively. In the third quarter of 2000, personnel and related costs
increased due to an increase in the number of sales and marketing employees to
138 from 74 in the third quarter of 1999. The increase in personnel and related
costs in 2000 was due to the continued build up of our sales force and marketing
operations. Also, the allocation for facilities and depreciation expense
increased as a result of expenditures required for additional office space and
capital equipment to support the additional personnel.
General and administrative. General and administrative expenses consist
primarily of costs from our finance and human resources organizations; legal and
other professional service fees; and an allocation of facilities costs and
depreciation expenses. General and administrative expenses were $2.9 million and
$7.9 million for the quarter and nine months ended September 30, 2000,
respectively, increases of 88.6% and 93.7% over comparable periods in 1999. The
increases in absolute dollars in general and administrative expenses in the
quarter and nine months ended September 30, 2000 were attributable to the growth
of the administrative organization required to support our overall growth.
Personnel and related costs increased $334,000 and $1.4 million for the quarter
and nine months ended September 30, 2000, respectively. In the third quarter of
2000 our total number of general and administrative employees increased to 63
from 35 in the third quarter of 1999. The increase was also due to us incurring
additional compliance expenses and other professional fees associated with being
an independent public company. In addition, the allocation for facilities and
depreciation expense increased as a result of expenditures for additional office
space and capital equipment required to support the additional personnel. We
expect general and administrative expenses to increase in absolute dollars in
the foreseeable future to support infrastructure growth.
Amortization of stock-based compensation. Deferred stock-based compensation
represents the difference between the exercise price and the fair value of our
common stock for accounting purposes on the date that certain stock options were
granted. This deferred amount is included as a component of stockholders' equity
and is being amortized on an accelerated basis by charges to operations over the
vesting period of the options, consistent with the method described in Financial
Accounting Standards Board Interpretation No. 28. We granted stock options to
our employees under the 1999 Equity Incentive Plan and the HighTouch
Technologies, Inc. 1999 Stock Option Plan and to members of our board of
directors through both the 1999 Equity Incentive Plan and the 1999 Directors
Stock Option Plan. Amortization of stock-based compensation was $2.8 and $8.3
million for the quarter and nine months ended September 30, 2000, respectively.
Acquired in-process research and development. In connection with our
acquisition of HighTouch Technologies, Inc. in May 2000, acquired in-process
research and development of $4.0 million was charged to results of operation on
the acquisition date. HighTouch is a provider of customized software and
services relating to customer relationship management ("CRM"). The
classification of the technology as complete or under development was made in
accordance with the guidelines of Statement of Financial Accounting Standards
No. 86, Statement of Financial Accounting Standards No. 2 and Financial
Accounting Standards Board Interpretation No. 4. Prior to its acquisition,
HighTouch primarily sold customized software and services to a variety of
customers in the retail industry. At the time of acquisition, HighTouch had
technology under development relating to the creation of the company's first
fully integrated standardized off-the-shelf CRM product. This in-process
research and development project was estimated to achieve technological
feasibility in 2000.
We used an independent appraisal firm to assist us with our valuation of the
fair market value of the purchased assets of HighTouch. Fair market value is
defined as the estimated amount at which an asset might be expected to be
exchanged between a willing buyer and willing seller assuming the buyer
continues to use the assets in its current operations. The in-process research
and development projects were valued through the use of a discounted cash flow
analysis, taking into account projected future cash flows associated with these
projects once they achieve technological feasibility, their stage of completion
as of the acquisition date, and the expected return requirements (i.e. discount
rate) for present valuing of the projected cash flows. Stage of completion was
estimated by considering time, cost, and complexity of tasks completed prior to
the acquisition as a percentage of total time, cost and effort required for the
total project up to achieving technological feasibility.
With respect to the projected financial information provided to the
appraiser, Retek prepared a detailed set of projections forecasting revenue from
the CRM technology as well as gross profit and operating profit margins. These
projections were made based on an assessment of customer needs and the expected
pricing and cost structure.
With respect to the discount rates used in the valuation approach, the
incomplete technology represents a mix of near and mid-term prospects for the
business and imparts a level of uncertainty to its prospects. A reasonable
expectation of return on the incomplete technology would be higher than that of
completed technology due to these inherent risks. As a result, the earnings
associated with incomplete technology were discounted at a rate of 26.2% based
upon the following methodology:
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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 21.2%, which was used for valuing
completed technology. Since incomplete technology would require a higher return
than completed technology, the valuation report prepared by our appraiser used a
rate of 26.2% to present value cash flows (in excess of a return on other assets
of the business) attributable to in-process research and development projects.
The HighTouch in-process research and development project continues to
progress, in all material respects, consistently with our original assumptions
that were provided to the independent appraiser and used to value the in-process
research and development.
These statements regarding revenues and expenses are forward-looking
statements, which are subject to risks and uncertainties. Actual results may
differ materially from those anticipated. Our inability to complete the
in-process technologies within the expected timeframes could materially impact
future revenues and earnings, which could have a material adverse effect on our
business, financial condition and results of operations.
Acquisition-related amortization of intangibles. Acquisition-related
amortization of intangibles increased to $2.4 and $4.9 million for the quarter
and nine months ended September 30, 2000, respectively, from $264,000 and
$780,000 for the comparable periods in 1999. In connection with our purchase of
HighTouch in 2000, the application of the purchase method of accounting for the
acquisition resulted in an excess of cost over net assets acquired of $30.6
million, of which $26.6 million was allocated to intangibles and $4.0 million
was allocated to in-process research and development. In conjunction with the
purchase, we recorded various intangible assets, which are being amortized over
estimated useful lives ranging from three to five years. In connection with the
purchase of WebTrak in 1999, the application of the purchase method of
accounting for the acquisition resulted in an excess of cost over net assets
acquired of $8.1 million, of which $6.6 million was allocated to intangibles and
$1.5 million was allocated to in-process research and development. In
conjunction with the purchase, we recorded various intangible assets, which are
being amortized over estimated useful lives ranging from three to five years. In
connection with the purchase of Retek Logistics in 1998, the application of the
purchase method of accounting for the acquisition resulted in an excess of cost
over net assets acquired of approximately $5.8 million, of which $4.0 million
was allocated to intangibles and $1.8 million was allocated to in-process
research and development. In conjunction with the purchase, we recorded various
intangible assets, which are being amortized over estimated useful lives ranging
from three to five years.
Other income, net. Other income, net increased to $75,000 and $1.5 million
for the quarter and nine months ended September 30, 2000, respectively, up from
($344,000) and ($330,000) for the same periods in 1999. The increase was due to
interest income earned on cash equivalents and investments.
Income tax (benefit) provision. The income tax (benefit)/provision was
($5.0) and ($16.5) million for the quarter and nine months ended September 30,
2000, respectively, down from $1.7 million and $4.1 million for the same periods
in 1999. These amounts are based on management's estimates of the effective tax
rates to be incurred by us during those respective full fiscal years.
LIQUIDITY AND CAPITAL RESOURCES
Prior to our initial public offering, we funded operations primarily through
HNC in the form of intercompany advances. Since our initial public offering, we
have not obtained further funding from HNC. At September 30, 2000, our cash and
cash equivalent balance was $30.5 million. In addition, we had investments of
$17.2 million.
Net cash provided by operating activities was $6.1 million for the nine
months ended September 30, 2000 and $181,000 for the comparable period in 1999.
Principal operating cash flow adjustments that offset our net loss were
amortization of stock-based compensation, acquired in-process research and
development, depreciation and amortization, increases in deferred revenue,
accounts payable, and accrued liabilities. Uses of cash for the nine months
ended September 30, 2000 were due to increases in deferred tax benefit, and
other assets, which was partially offset by an increase in the provision for
doubtful accounts. accounts receivable.
Net cash used in investing activities was $47.7 million for the nine months
ended September 30, 2000 and $3.7 million for the comparable period in 1999. In
the nine months ended September 30, 2000, uses of cash were due to the cash paid
for business acquisitions, acquisition of capital equipment, primarily computer
equipment and software, purchase of investments and the purchase of
investments for sale.
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Net cash used by financing activities was $10.6 million in the nine months
ended September 30, 2000. Net cash provided by financing activities was $3.6
million for the nine months ended September 30, 1999. Net cash used in 2000
included repayment of debt, $596,000 in borrowings from HNC and $15.4 million in
payments to HNC. Beginning in 1997, HNC implemented a cash management policy
that all cash balances were transferred daily from all of HNC's subsidiaries,
including us, into a centralized cash management account at HNC. The financing
activities with HNC include borrowings and payment from these cash management
activities in 1999. Starting in November 1999, these daily transfers to HNC
ceased. Net cash provided by financing activities in 2000 included proceeds from
the issuance of common stock.
We believe that our current cash and cash equivalents, investments and net
cash provided by operating activities will be sufficient to meet our working
capital and capital expenditure requirements for at least the next 12 months.
Management has invested the excess of current operating requirements in
interest-bearing, investment-grade securities.
As discussed in the financial statement footnotes, during the quarter ended
September 30, 2000 we sold our interest in $10 million future accounts
receivable balances due to us under contracts with various customers. The amount
received for these future balances due are included in the deferred revenue
balances as of September 30, 2000. These sales did not impact our days sales
outstanding (DSO) calculation as the amounts collected related to balances due
in the future that were not yet recorded as accounts receivable in our financial
statements as of September 30, 2000.
A portion of our cash could also be used to acquire or invest in
complementary businesses or products or otherwise to obtain the right to use
complementary technologies or data. We regularly evaluate, in the ordinary
course of business, potential acquisitions of such businesses, products,
technologies or data.
In addition, our ability to enter into any acquisition of a business or
assets may be limited pursuant to the terms of a corporate rights agreement
between HNC and us. Our ability to issue common stock in connection with
acquisitions, offerings or otherwise will be limited until September 29, 2002,
and possibly longer.
FACTORS THAT MAY IMPACT FUTURE RESULTS OF OPERATIONS
An investment in our common stock involves a high degree of risk. Investors
evaluating our company and its business should carefully consider the factors
described below and all other information contained in this Quarterly Report on
Form 10-Q before purchasing our common stock. Any of the following factors could
materially harm our business, operating results and financial condition.
Additional factors and uncertainties not currently known to us or that we
currently consider immaterial could also harm our business, operating results
and financial condition. Investors could lose all or part of their investment as
a result of these factors, in addition to others.
While management is optimistic about our long-term prospects, the following
factors, among others, could materially harm our business, operating results and
financial condition and should be considered when evaluating us.
Industry's rapid pace of change. If we are unable to develop new software
solutions or enhancements to our existing products on a timely and
cost-effective basis, or if new products or enhancements do not achieve market
acceptance, our sales may decline. The life cycles of our products are difficult
to predict because the business-to-business electronic commerce market for our
products is new and emerging and is characterized by rapid technological change
and changing customer needs. The introduction of products employing new
technologies could render our existing products or services obsolete and
unmarketable.
In developing new products and services, we may:
- fail to respond to technological changes in a timely or cost-effective
manner;
- encounter products, capabilities or technologies developed by others that
render our products and services obsolete or noncompetitive or that shorten
the life cycles of our existing products and services;
- experience difficulties that could delay or prevent the successful
development, introduction and marketing of these new products and services;
or
- fail to achieve market acceptance of our products and services.
Fluctuations in quarterly operating results. Our quarterly operating results
have fluctuated in the past and are expected to continue to fluctuate in the
future. If our quarterly operating results fail to meet analysts' expectations,
the trading price of our common stock could decline. In addition, significant
fluctuations in our quarterly operating results may harm our business operations
by making it difficult to implement our budget and business plan. Factors, many
of which are outside of our control, which could cause our operating results to
fluctuate include:
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- the size and timing of customer orders, which can be affected by customer
budgeting and purchasing cycles;
- the demand for and market acceptance of our software solutions;
- competitors' announcements or introductions of new software solutions,
services or technological innovations;
- our ability to develop, introduce and market new products on a timely
basis;
- customer deferral of material orders in anticipation of new releases or
new product introductions;
- our success in expanding our sales and marketing programs;
- technological changes or problems in computer systems; and
- general economic conditions which may affect our customers' capital
investment levels.
In addition, we have incurred, and will continue to incur, compensation
expense in connection with our grant of options under our 1999 Equity Incentive
Plan and our 1999 Directors Stock Option Plan. This expense will be amortized
over the vesting period of these granted options, which is generally four years,
resulting in lower quarterly income.
Quarterly expense levels are relatively fixed and are based, in part, on
expectations as to future revenue. As a result, if revenue levels fall below our
expectations, net income will decrease because only a small portion of our
expenses vary with revenue.
New type of license agreement. Until recently, we generally licensed our
products to customers on a perpetual basis, and recognized revenue upon delivery
of the products. In the fourth quarter of 1999, we entered into software
licensing agreements with revised terms for the majority of new sales of
software products. Under the revised agreements, we provide technical advisory
services after the delivery of our product to help customers exploit the full
value and functionality of our products. Revenue from the sale of software
licenses and technical advisory services under these agreements is recognized as
the services are performed over the contract period, which is generally 12 to 24
months, as determined by our customers' objectives. As we continue to recognize
license and service revenues over a period of time, rather than upon the
delivery of our products, we will recognize significantly less revenue, have
lower associated margins for several quarters, as compared to previous quarters,
have higher operating expenses as a percentage of total revenues and will incur
operating losses for several quarters.
Early stage of development of the retail.com network. We began operation of
the retail.com network on September 26, 1999. We incurred, and will continue to
incur, significant infrastructure costs in establishing this network. We will
continue to invest in new products and services to be offered over the
retail.com network in the foreseeable future. Broad and timely acceptance of the
retail.com network is subject to a number of significant risks. These risks
include:
- our need to provide value-enhancing software solutions and services on the
retail.com network to achieve widespread commercial acceptance of this
network;
- whether our network will be able to support large numbers of retailers and
the members of their supply chains; and
- our need to significantly expand internal resources and incur associated
expenses to support planned growth of the retail.com network.
We have established a subscription pricing model for the software solutions
provided on our retail.com network, whereby members pay an annual fee based on
the number of the member's employees who will have access to the network. As
additional services are added to the retail.com network, we will need to
establish pricing models for these new services. If the pricing models for the
retail.com network fail to be competitive and profitable or if they are not
acceptable to customers, our network will not be commercially successful, which
could harm our revenue and business.
Increased operating expenses. We intend to significantly increase operating
expenses as we:
- increase research and development activities;
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- increase services activities;
- develop and build the retail.com network;
- expand our distribution channels;
- increase sales and marketing activities, including expanding our direct
sales force;
- build our internal information technology system; and
- operate as an independent public company.
We will incur expenses before we generate any revenue from this increase in
spending. If we do not significantly increase revenue from these efforts, our
business and operating results could be seriously harmed.
Competitive pressures. The market for our software solutions is highly
competitive and subject to rapidly changing technology. Competition could
seriously impede our ability to sell additional products and services on terms
favorable us. Competitive pressures could reduce our market share or require us
to reduce prices, which would reduce our revenues and/or operating margins. Many
of our competitors have substantially greater financial, marketing or other
resources, and greater name recognition than us. In addition, these companies
may adopt aggressive pricing policies that could compel us to reduce the prices
of our products and services in response. Our competitors may also be able to
respond more quickly than we can to new or emerging technologies and changes in
customer requirements. Our current and potential competitors may:
- develop and market new technologies that render our existing or future
products obsolete, unmarketable or less competitive;
- make strategic acquisitions or establish cooperative relationships among
themselves or with other solution providers, which would increase the
ability of their products to address the needs of our customers; and
- establish or strengthen cooperative relationships with our current or
future strategic partners, which would limit our ability to sell products
through these channels.
As a result, we may not be able to maintain a competitive position against
current or future competitors.
Loss of key personnel. We believe that our future success will depend upon
our ability to attract and retain highly skilled personnel, including John
Buchanan, our chairman and chief executive officer; Gordon Masson, our
president; John L. Goedert, our chief operating officer; Gregory A. Effertz, our
vice president, finance and administration and chief financial officer and
Jeremy Thomas, our chief technology officer. We currently do not have any
key-man life insurance relating to key personnel, who are employees at-will and
are not subject to employment contracts except for Jeremy Thomas who has an
employment contract that expires in October 2001. The loss of the services of
any one or more of these key persons could harm our ability to grow our
business.
We also must attract, integrate and retain skilled sales, research and
development, marketing and management personnel. Competition for these types of
employees is intense, particularly in our industry. Failure to hire and retain
qualified personnel would harm our ability to grow the business.
Relationships with third parties who implement our products. We rely, and
expect to continue to rely, on a number of third parties to implement our
software solutions at customer sites. If we are unable to establish and maintain
effective, long-term relationships with these implementation providers, or if
these providers do not meet the needs or expectations of our customers, our
revenue will be reduced and our customer relationships will be harmed. Our
current implementation partners are not contractually required to continue to
help implement our software solutions. If the number of product implementations
continues to increase, we will need to develop new relationships with additional
third-party implementation providers to provide these services.
We may be unable to establish or maintain relationships with third parties
having sufficient qualified personnel resources to provide the necessary
implementation services to support our needs. If third-party services are
unavailable, we will be required to provide these services internally, which
would significantly limit our ability to meet customers' implementation needs
and would increase our operating expenses and could reduce gross margins. A
number of our competitors, including SAP, have significantly more established
relationships with these third parties and, as a result, these third parties may
be more likely to
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recommend competitors' products and services rather than our own. In addition,
we cannot control the level and quality of service provided by our current and
future implementation partners.
Intellectual property of third parties. We must now, and may in the future
have to, license or otherwise obtain access to the intellectual property of
third parties and related parties, including HNC, Lucent, MicroStrategy and
Oracle. Our business would be seriously harmed if the providers from whom we
license such software cease to deliver and support reliable products or enhance
their current products. In addition, the third-party software may not continue
to be available to us on commercially reasonable terms or prices or at all. Our
inability to maintain or obtain this software could result in shipment delays or
reduced sales of our products. Furthermore, we might be forced to limit the
features available in our current or future product offerings. Either
alternative could seriously harm business and operating results.
Confidentiality of intellectual property. We depend on our ability to
develop and maintain the proprietary aspects of our technology. To protect
proprietary technology, we rely primarily on a combination of contractual
provisions, confidentiality procedures, trade secrets, and copyright and
trademark laws.
We seek to protect our software, documentation and other written materials
under trade secret and copyright laws, which afford only limited protection. In
addition, we cannot assure investors that any of our proprietary rights with
respect to the retail.com network will be viable or of value in the future
because the validity, enforceability and type of protection of proprietary
rights in Internet-related industries are uncertain and still evolving.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or obtain and use information that
we regard as proprietary. Policing unauthorized use of our products is difficult
and expensive, and while we are unable to determine the extent to which piracy
of its software products exists, software piracy may be a problem. In addition,
the laws of some foreign countries do not protect our proprietary rights to the
same extent as do the laws of the United States. We intend to vigorously protect
intellectual property rights through litigation and other means. However, such
litigation can be costly to prosecute and we cannot be certain that we will be
able to enforce our rights or prevent other parties from developing similar
technology, duplicating our products or designing around our intellectual
property.
Potential third party claims that our products infringe on their
intellectual property. There has been a substantial amount of litigation in the
software industry and the Internet industry regarding intellectual property
rights. It is possible that in the future third parties may claim that our
current or potential future products infringe their intellectual property. We
expect that software product developers and providers of electronic commerce
solutions will increasingly be subject to infringement claims as the number of
products and competitors in our industry segment grow and the functionality of
products in different industry segments overlap. Any claims, with or without
merit, could be time-consuming, result in costly litigation, cause product
shipment delays or require us to enter into royalty or licensing agreements.
Royalty or licensing agreements, if required, may not be available on terms
acceptable to us or at all, which could seriously harm our business.
International sales. Since we sell products worldwide, our business is
subject to risks associated with doing business internationally. To the extent
that our sales are denominated in foreign currencies, the revenue we receive
could be subject to fluctuations in currency exchange rates. If the effective
price of the products we sell to our customers were to increase due to
fluctuations in foreign currency exchange rates, demand for our technology could
fall, which would, in turn, reduce our revenue. We have not historically
attempted to mitigate the effect that currency fluctuations may have on our
revenue through use of hedging instruments, and we do not currently intend to do
so in the future.
We anticipate that revenue from international operations will continue to
represent a substantial portion of our total revenue. Accordingly, our future
results could be harmed by a variety of factors, including:
- changes in foreign currency exchange rates;
- greater risk of uncollectible accounts;
- changes in a specific country's or region's political or economic
conditions, particularly in emerging markets;
- trade protection measures and import or export licensing requirements;
- potentially negative consequences from changes in tax laws;
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- difficulty in staffing and managing widespread operations;
- international variations in technology standards;
- differing levels of protection of intellectual property; and
- unexpected changes in regulatory requirements.
Acceptance of the Internet. As our software solutions are Internet-based, we
depend on the acceptance of the Internet as a communications protocol. However,
this acceptance may not continue. Rapid growth of the Internet is a recent
phenomenon. The Internet may not be accepted as a viable long-term
communications protocol for businesses for a number of reasons. These reasons
include:
- potentially inadequate development of the necessary communications and
computer network technology, particularly if rapid growth of the Internet
continues;
- delayed development of enabling technologies and performance improvements;
- increased security risks in transmitting and storing confidential
information over public networks; and
- potentially increased governmental regulation.
Errors and defects in our products. Our products are complex and,
accordingly, may contain undetected errors or failures when we first introduce
them or as we release new versions. This may result in loss of, or delay in,
market acceptance of our products and could cause us to incur significant costs
to correct errors or failures or to pay damages suffered by customers as a
result of such errors or failures. In the past, we have discovered software
errors in new releases and new products after their introduction. We have
incurred costs during the period required to correct these errors, although to
date such costs, including costs incurred on specific contracts, have not been
material. We may in the future discover errors in new releases or new products
after the commencement of commercial shipments.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("FAS 133"), which is effective for all fiscal quarters
of fiscal years beginning after June 15, 1999. This statement establishes a new
model for accounting for derivatives and hedging activities. Under FAS 133, all
derivatives must be recognized as assets and liabilities and measured at fair
value. In July 1999, the FASB issued Statement of Accounting Standards No. 137
"Accounting for Derivative Instruments and Hedging Activities -- Deferral of the
Effective Date of FASB Statement No. 133," which defers the effective date to
all fiscal quarters of fiscal years beginning after June 15, 2000. In 2000, the
FASB issued Statement of Accounting Standards No. 138 (FAS 138) "Accounting for
Certain Derivative Instruments and Certain Hedging Activities -- an amendment of
FASB Statement No. 133", which is effective for all fiscal quarters after June
15, 2000. FAS 138 amends the accounting and reporting standards of FAS 133 for
certain derivative instruments and certain hedging activities. The adoption of
FAS 133 and the amendments thereof in FAS 138 are not expected to have a
significant impact on our consolidated financial position or results of
operations.
In January 2000, the Financial Accounting Standards Board's Emerging Issues
Task Force published Issue No. 00-2 "Accounting for Web Site Development Costs",
or EITF 00-2. EITF 00-2 applies the guidance given in the American Institute of
Certified Public Accountants' Statement of Position 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use", or SOP 98-1,
to Web site development costs. Under SOP 98-1, software development costs,
consisting of internally developed software and Web site development costs,
include internal and external costs incurred to develop internal-use computer
software during the application development stage are capitalized. Application
development stage costs generally include software configuration, coding,
installation to hardware and testing. Costs of significant upgrades and
enhancements that result in additional functionality are also capitalized. Costs
incurred for maintenance and minor upgrades and enhancements are expensed as
incurred. The estimated useful lives are based on planned or expected
significant modification or replacement of software applications, in response to
the rapid rate of change in the Internet industry and technology in general.
Adoption of EITF 00-2 was required for the
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third quarter of 2000. The adoption of EITF 00-2 did not have a significant
impact on our consolidated financial position or results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition." Amendments to the Bulletin
delayed the effective date until the fourth quarter of 2000. Adoption of Staff
Accounting Bulletin No. 101 is not expected to have a significant impact on our
consolidated financial position or results of operations.
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HNC SOFTWARE INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discusses our exposure to market risk related to changes in
interest rates, foreign currency exchange rates and equity prices.
INTEREST RATE RISK
The fair value of our cash, cash equivalents and investments available for sale
at September 30, 2000 was $190.2 million. The objectives of our investment
policy are safety and preservation of invested funds and liquidity of
investments that is sufficient to meet cash flow requirements. It is our policy
to place cash, cash equivalents and investments available for sale with high
credit quality financial institutions and commercial companies and government
agencies in order to limit the amount of credit exposure. It is also our policy
to maintain certain concentration limits and to invest only in certain
"allowable securities" as determined by management. The investment policy also
provides that our investment portfolio must not have an average portfolio
maturity of beyond eighteen months. Investments are prohibited in certain
industries and speculative activities. Investments must be denominated in U.S.
dollars. An increase in market interest rates would not directly affect our
financial results, as we have no short- or long-term debt.
FOREIGN CURRENCY EXCHANGE RATE RISK
We develop products in the United States and sell them in North America, Asia
and Europe. As a result, our financial results could be affected by various
factors, including changes in foreign currency exchange rates or weak economic
conditions in foreign markets. Our 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 our subsidiaries are kept in local currencies in which
they do business, with excess funds transferred to our offices in the United
States. Approximately 7.9% and 6.0% of our sales were denominated in currencies
other than the U.S. dollar for the three and nine months ended September 30,
2000, respectively, as compared to 2.0% and 5.2% for the same periods during
1999.
EQUITY PRICE RISK
We have several equity investments we entered into for strategic business
purposes, and therefore are exposed to direct equity price risk. We mitigate
this risk by monitoring the financial performance of our investments. However,
many of our equity investments are in the common stock of privately held,
non-public companies and thus we may be unable to sell or achieve liquidity in
those investments prior to an adverse change in their values.
IMPACT OF EUROPEAN MONETARY CONVERSION
We are aware of the issues associated with the changes in Europe resulting from
the formation of a European economic and monetary union, or EMU. One change
resulting from this union required EMU member states to irrevocably fix their
respective currencies to a new currency, the euro, as of January 1, 1999, at
which date the euro became a functional legal currency of these countries.
Through December 31, 2002, business in the EMU member states will be conducted
in both the existing national currencies, such as the French franc or the
Deutsche mark, and the euro. As a result, companies operating or conducting
business in EMU member states will need to ensure that their financial and other
software systems are capable of processing transactions and properly handling
these currencies, including the euro. We are still assessing the impact that
conversion to the euro will have on our internal systems, the sale of our
solutions and the European and global economies. We will take appropriate
corrective actions based on the results of our assessment. We have not yet
determined the cost related to addressing this issue although we do not expect
these costs to be significant.
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PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) eHNC, Inc. ("eHNC") was a former subsidiary of HNC that was
merged into HNC on July 7, 2000 in a short-form merger. Immediately
prior to that merger, HNC owned all the outstanding preferred stock
and approximately 99.99% of the outstanding common stock of eHNC.
Pursuant to the merger, we issued approximately 20 shares of our
common stock to the 4 former stockholders of eHNC in exchange for
all their outstanding shares of eHNC common stock, which were
valued at $2.98 per share. The shares of HNC common stock issued in
the merger were not registered under the Securities Act of 1933, as
amended (the "1933 Act"), in reliance upon the exemptions from
registration provided by Section 4(2) and/or Rule 506 of Regulation
D under the 1933 Act. In relying upon these exemptions, we took
into account the limited number of eHNC stockholders, their
relationships to HNC, the limitation of our offering to these
stockholders, the information regarding eHNC, HNC and the merger
available to eHNC stockholders, and other factors. In the merger,
all outstanding eHNC stock options were assumed by HNC and
converted into options to purchase an aggregate of 232,259 shares
of HNC Common stock at an exercise price of [$55.00] per share,
having substantially the same terms as the eHNC options into which
they were converted. The merger conversion ratio was determined by
dividing the value per share ascribed to eHNC common stock by the
closing price per share of HNC Common Stock on the date of the
merger. HNC filed a registration statement on Form S-8 under the
1933 Act on July 13, 2000 to register the issuance of the shares of
HNC Common Stock upon exercise of these options.
On September 8, 2000, we acquired all the stock of Systems/Link
Corporation ("Systems/Link") in a merger transaction, pursuant to
which we issued approximately 593,964 shares of our common stock and
paid approximately $5.5 million in cash to the former stockholders
of Systems/Link in exchange for all the outstanding shares of
Systems/Link's stock. Under the merger agreement, Systems/Link was
valued at approximately $36 million on a fully diluted basis, with
approximately 94% of the merger consideration (or $33.7 million)
being allocated to the stockholders of Systems/Link for their
Systems/Link shares. The shares of HNC Common Stock issued in the
merger were not registered under the 1933 Act in reliance upon the
exemptions from registration provided by Section 4(2) and/or Rule
506 of Regulation D under the 1933 Act. In relying upon these
exemptions, we took into account the limited number of Systems/Link
stockholders (13), their relationship to Systems/ Link and to its
executive officers, the limitation of our offering to these
stockholders, the information regarding Systems/Link, HNC and the
merger furnished to Systems/Link's stockholders prior to the merger,
and representations made by Systems/Link's stockholders to HNC
regarding their investment intent and related matters in connection
with the merger. In the short-form merger all the outstanding
Systems/Link stock options were assumed by HNC and converted into
options to purchase an aggregate of approximately 40,090 shares of
HNC common stock with substantially the same terms as the
Systems/Link options into which they were converted, except that the
exercise prices of the new HNC options were the exercise prices of
the converted Systems/Link options divided by the option merger
exchange ratio of approximately 0.0819. HNC filed a registration
statement on Form S-8 under the 1933 Act on September 8, 2000 to
register the issuance of the shares of HNC Common Stock upon
exercise of these options. For further information regarding our
acquisition of Systems/Link, please see our report on Form 8-K filed
with the Securities and Exchange Commission on September 22, 2000,
which is incorporated herein by this reference.
On September 8, 2000, we acquired all the stock of CardAlert
Services, Inc. ("CardAlert"), in a merger transaction, pursuant to
which we issued approximately 208,000 shares of our common stock to
the former stockholders of CardAlert in exchange for all the
outstanding shares of CardAlert's stock. Under the Merger Agreement,
CardAlert was valued at approximately $12.6 million. The shares of
HNC Common Stock issued in the merger were not registered under the
1933 Act, in reliance upon the exemptions from registration provided
by Section 4(2) and/or Rule 506 of Regulation D under the 1933 Act.
In relying upon these exemptions, we took into account the limited
number of CardAlert stockholders, their relationships to
CardAlert, the limitation of our offering to these stockholders, the
information regarding CardAlert, HNC and the merger furnished to
CardAlert's stockholders prior to the merger, and representations
and warranties made by CardAlert's stockholders to HNC regarding
their investment intent and related matters in connection with the
merger.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
2.01 Agreement and Plan of Reorganization dated as of September
7, 2000 among HNC Software Inc., Systems/Link Corporation
and SLC Merger Corp.(1)
10.01 Employee Option Exercise Assistance Documents Used under
HNC's Option Plans, consisting of:
Form of Secured Full Recourse Promissory Note(2)
Form of Stock Pledge Agreement(2)
Form of Stock Power(2)
Form of Spousal Consent(2)
27.01 Financial Data Schedule(2)
-------------------
(1) Incorporated by reference to Exhibit 2.01 of HNC
Software Inc.'s Report on Form 8-K filed on
September 22, 2000.
(2) Filed herewith.
(b) REPORTS FILED ON FORM 8-K
Report on Form 8-K, dated and filed August 25, 2000, reporting
under Item 5 the declaration by HNC's Board of Directors of a
dividend of all HNC's shares of common stock of Retek Inc. to HNC
stockholders of record as of 5:00 p.m. Eastern Daylight Time on
September 15, 2000.
Report on Form 8-K dated and filed September 22, 2000, reporting
under Item 5 the distribution ratio of the Retek Inc. common
stock dividend and filing as an exhibit under Item 7 a related
Information Statement that was distributed to our stockholders.
Report on Form 8-K dated September 20, 2000 and filed on
September 22, 2000, reporting under Item 2 HNC's acquisition of
Systems/Link Corporation. We also reported in this Form 8-K that
the financial statements and pro forma financial information
required pursuant to paragraphs (a) and (b) of Item 7 would be
filed within 60 days of September 22, 2000.
Report on Form 8-K dated and filed September 26, 2000, reporting
under Item 5 an adjustment to the conversion price of HNC's
remaining $16.5 million 4.75% Convertible Notes due 2003
resulting from the Retek spin-off and filing as an exhibit under
Item 7 a related press release.
Report on Form 8-K dated and filed October 6, 2000, reporting
under Item 5 the completion of HNC Software Inc.'s separation of
Retek Inc. through the payment of the dividend of Retek Inc.
common stock to HNC's stockholders, and filing as exhibits under
Item 7 a related press release and tax information statement.
Report on Form 8-K dated and filed October 13, 2000, reporting
under Item 2 completion of HNC Software Inc.'s separation of
Retek Inc. through its disposition and dividend of Retek Inc.
common stock to HNC's stockholders, and filing as exhibits under
Item 7 the following pro forma financial statements:
Unaudited pro forma balance sheet of HNC Software Inc. as of June
30, 2000
Unaudited pro forma statement of operations of HNC Software Inc.
for the six months ended June 30, 2000
Unaudited pro forma statement of operations of HNC Software Inc.
for the year ended December 31, 1999
Notes to unaudited pro forma financial information
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report on Form 10-Q to be signed on its behalf
by the undersigned thereunto duly authorized.
HNC SOFTWARE INC.
Date: November 14, 2000 By: /s/ Kenneth J. Saunders
----------------------------------------
Kenneth J. Saunders
Chief Financial Officer and Secretary
(for Registrant as duly authorized officer
and as Principal Financial Officer)
/s/ Russell C. Clark
----------------------------------------
Russell C. Clark
Vice President, Corporate Finance and
Assistant Secretary
(for Registrant as Principal Accounting
Officer)
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EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibits
--------
<S> <C>
2.01 Agreement and Plan of Reorganization dated as of September 7, 2000
among HNC Software Inc., Systems/Link Corporation and SLC
Merger Corp.(1)
10.01 Employee Option Exercise Assistance Documents Used under HNC's
Option Plans, consisting of:
Form of Secured Full Recourse Promissory Note(2)
Form of Stock Pledge Agreement(2)
Form of Stock Power(2)
Form of Spousal Consent(2)
27.01 Financial Data Schedule(2)
----------
(1) Incorporated by reference to Exhibit 2.01 of HNC Software Inc.'s
Report on Form 8-K filed on September 22, 2000.
(2) Filed herewith.
</TABLE>
53
