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SECURITIES AND EXCHANGE
COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

OR

FROM            TO           .

COMMISSION FILE NUMBER 0-28121

RETEK INC.

(Exact Name of Registrant as Specified in its Charter)

(Address, including zip code, and telephone number, including area code, of Registrant’s Principal Executive Offices)

     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 o

     As of August 1, 2002, the number of shares of the Registrant’s common stock outstanding was 52,671,306.

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RETEK INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2002

INDEX

SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION

     This Quarterly Report on Form 10-Q contains forward-looking statements in “Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Item 3 — Quantitative and Qualitative Disclosures About Market Risk,” and elsewhere. These statements relate to future events or our future financial performance. In some cases, forward-looking statements may be identified by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue” or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Such risks, uncertainties and other factors include, among other things, the matters described in “Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

     Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these statements. We are under no duty to update any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q to conform these statements to actual future results.

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PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

RETEK INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE DATA)

See accompanying notes to consolidated financial statements.

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Retek Inc.
Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)

See accompanying notes to consolidated financial statements.

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Retek Inc.
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

See accompanying notes to consolidated financial statements.

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RETEK INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – The Company and its Significant Accounting Policies

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-enabled 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.

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, 2001. The interim financial information contained in this Quarterly 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.

Financial Statement Preparation

     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 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.

Note 2 – Accounting Changes

     In June 2001, the Financial Accounting Standards Board issued FAS 142, Goodwill and Other Intangible Assets (“FAS 142”). Under FAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed as least annually for impairment. With respect to goodwill amortization, we adopted FAS 142 effective January 1, 2002. Actual results of operations for the three months and six months ended June 30, 2002, and pro forma results of operations for the three months and six months ended June 30, 2001, had we applied the non-amortization provisions of FAS 142, follow (in thousands except per share data):

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     At June 30, 2002 we had goodwill of $13.5 million. Pursuant to FAS 142, we completed a test for goodwill impairment and determined that no impairment exists as of June 30, 2002. We will continue to test goodwill for impairment and if impairment is indicated we will record the impairment against the goodwill balance.

     Estimated amortization expense of identified intangible assets for the next five years are as follows (in thousands):

Note 3 – Per Share Data

     Basic earnings per share is calculated using 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 and warrants using the treasury stock method.

     For the three and six months ended June 30, 2002, the calculation of diluted earnings per share includes the impact of the potential exercise of 7,440 and 7,496 stock options and warrants outstanding, respectively. In addition, for the three and six months ended June 30, 2002, the calculation of diluted earnings per share excludes the impact of the potential exercise of 3,009 and 2,703 stock options outstanding, respectively, because their effect would be anti-dilutive. The three and six months ended June 30, 2001 calculation excludes 8,657 stock options and warrants outstanding, because their effect would be anti-dilutive.

Note 4 – Asset Acquisition

     On March 31, 2002, we acquired the intellectual property of Chelsea Market Systems, LLC (“Chelsea”) and certain other assets and liabilities for a net cash purchase price of $8.9 million, of which $8.9 million has been allocated to purchased software, an intangible asset. This purchased software is stated at the lower of cost or net realizable value and is being amortized over 36 months.

Note 5 – Reclassifications

     Certain prior period amounts have been reclassified to conform with current period presentation.

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 generate revenue from the sale of software licenses, maintenance and support contracts, and professional consulting and contract development services. We generally 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 agreements with technical advisory services is recognized over the period the technical advisory services are performed if all other criteria for recognition of revenue are met. These periods of technical advisory services generally range from 12 to 24 months, as determined by each customer’s objectives. Deferred revenue consists principally of the unrecognized portion of amounts received under license and maintenance service agreements. Deferred license revenue is recognized ratably over the technical advisory period (if applicable), or on a percentage of completion basis, or when all criteria for recognition of revenue are met based on the contract terms. Revenue from contracts without technical advisory services are recognized when all other criteria for recognition of revenue are met. 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.

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     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 investments 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-enabled business-to-business collaborative planning, critical path and product design solutions in 1999; several additional collaborative offerings available for delivery through public marketplaces, private exchanges and Retek’s own hosted service through 2000 and message-based integration in 2001 that enables near real time visibility to inventory and sales, reduced application complexity, maintenance and upgrade overhead, and rapid deployment of new modules. To support our growth during these periods, we also continued to invest in internal infrastructure by hiring employees across various departments.

     We market our software solutions worldwide through direct and indirect sales channels. Indirect sales channels represent sales contracted by other entities on our behalf. Revenue generated from our direct sales channel accounted for approximately 98% of total revenue for the three and six month periods ended June 30, 2002, compared to 96% for the corresponding prior year periods.

     Revenue attributable to customers outside of North America accounted for approximately 43% and 34% of total revenue for the three and six month periods ended June 30, 2002, compared to 35% and 32% for the corresponding prior year periods, respectively. Approximately 36% and 27% of our sales were denominated in currencies other than the U.S. dollar for the three and six month periods ended June 30, 2002, compared to 31% and 28% for the corresponding prior year periods.

Acquisitions and Strategic Relationships

     On March 31, 2002, we acquired the intellectual property of Chelsea Market Systems, LLC (“Chelsea”) and certain other assets and liabilities for a net cash purchase price of $8.9 million, of which $8.9 million has been allocated to purchased software, an intangible asset. This purchased software is stated at the lower of cost or net realizable value and is being amortized over 36 months.

     On May 16, 2001, we established a strategic relationship with Accenture LLP (“Accenture”) pursuant to which Accenture became a development partner for our predictive applications. In connection with entering into this relationship, we issued 976 shares of our common stock valued at $30.2 million to Proquire LLC (“Proquire”), an affiliate of Accenture, in exchange for the license from Proquire to us of certain intellectual property that will enable us to enhance our suite of retail-specific software.

     The agreement with Accenture also requires us to issue to Accenture warrants to purchase our common stock upon our achievement of certain revenue milestones in fiscal years 2002, 2003, 2004, and 2005. The maximum number of warrants to be issued in each fiscal year is limited to 2% of the number of shares of our common stock then outstanding. For any amounts earned by Accenture in excess of 2% of our common stock then outstanding, we may elect to pay in cash, rather than issue additional warrants. To date no warrants have been issued and no amounts have been paid to Accenture under this agreement.

     On April 2, 2001, we signed a stock purchase agreement, a warrant agreement, and a software development and distribution agreement with Henderson Ventures, Inc. (“Henderson”), a retail enterprise solution developer. In connection with these agreements, we issued a warrant to purchase 750 shares of our common stock in exchange for an ownership interest of approximately 7.7% of the outstanding common stock of Henderson and a distribution agreement to resell the developed software. Under the software development and distribution agreement, we will pay royalties to Henderson for any software sold by us that we developed in conjunction with Henderson.

     The warrant issued to Henderson is fully vested with a term of five years and is exercisable at $18.625 per share. The fair value of the warrant of $12.1 million was calculated using the Black-Scholes valuation model using the following assumptions: dividend yield of 0%, risk-free interest rate of 5.83%, contractual life of five years and a volatility of 137.27%. The fair value of the common stock of Henderson of $0.4 million is accounted for under the cost method and is included as a component of other assets. The value of the development and distribution rights of $12.1 million is included as a component of intangible assets and is being amortized using the straight-line method over the life of the agreement.

     On September 5, 2000, we entered into a strategic relationship with International Business Machines Corporation (“IBM”). Pursuant to this relationship, Retek and IBM agreed to jointly market, sell, and service a comprehensive retail e-business solution consisting of Retek applications and IBM software and hardware technologies. The Stock Purchase 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

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joint marketing and selling arrangements through 2003. Under the Stock Purchase Agreement, we will be obligated to pay IBM $10 million and $15 million related to 2002 and 2003, respectively, in shares of our common stock if annual revenue targets, as stated in the Stock Purchase Agreement, are met. The Stock Purchase 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. To date, no amounts have been paid to IBM under this agreement.

Critical Accounting Policies and Estimates

     For discussion on critical accounting policies and estimates, see our Annual Report on Form 10-K for the fiscal year-ended December 31, 2001.

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.

Three Months and Six Months ended June 30, 2002 and 2001

Revenue

     Total Revenue. Total revenue increased 39.2% and 41.7% to $60.8 and $114.3 million for the three and six month periods ended June 30, 2002, respectively, from $43.6 and $80.7 million for the corresponding prior year periods.

     License and maintenance revenue. License and maintenance revenue increased 44.7% and 51.2% to $45.7 and $87.4 million for the three and six month periods ended June 30, 2002, respectively, from $31.6 and $57.8 million for the corresponding prior year periods. The increase in license and maintenance revenue was primarily due to sales to new customers as well as additional sales to existing customers and the introduction of new products.

     Services and other revenue. Services and other revenue increased 24.8% and 17.6% to $15.0 and $26.7 million for the three and six month periods ended June 30, 2002, respectively, from $12.0 and $22.9 million for the corresponding prior year periods. The

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increase in services and other revenue was due to our expanding customer base. Consulting revenues increased $1.5 and $3.8 million for the three and six month periods ended June 30, 2002, respectively. During the second quarter of 2002, we continued to expand our consulting services business by increasing the number of personnel to 165 as of June 30, 2002 from 145 as of June 30, 2001.

     Non-Cash Charges. Non-cash charges included with cost of sales, research and development, sales and marketing and general and administrative are amortization of stock-based compensation and amortization of certain purchased intangible assets. Deferred stock-based compensation represents the difference between the exercise price and fair value of our common stock for accounting purposes on the date that certain stock options were granted. This 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. Amortization of stock-based compensation was $0.8 million and $1.5 million for the three month periods ended June 30, 2002 and 2001, respectively, and $1.6 million and $2.8 million for the six month periods ended June 30, 2002 and 2001, respectively. Amortization of certain purchased intangible assets stems from our purchase of certain core technologies as a result of our acquisitions of WebTrak, Inc., HighTouch Technologies, Inc., and Chelsea. Amortization of certain purchased intangible assets is included in non-cash cost of license and maintenance revenues and was $1.6 million and $0.8 million for the three month periods ended June 30, 2002 and 2001, respectively, and $2.4 million and $1.7 million for the six month periods ended June 30, 2002 and 2001, respectively.

     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 increased 30.6% and 27.6% to $11.9 million and $22.4 million for the three and six month periods ended June 30, 2002, respectively, from $9.1 million and $17.5 million for the corresponding prior year periods. 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. Personnel and related costs increased $1.7 and $3.3 million for the three and six month periods ended June 30, 2002, respectively, due to the increase in funded license development projects We expect the cost of license and maintenance revenue to continue to increase in absolute dollars as license and maintenance revenue increases and as we continue to increase funded license development projects.

     Cost of services and other revenue. Cost of services and other revenue includes salaries and related expenses of our consulting organization; costs 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 increased 17.2% and 12.9% to $10.8 million and $19.6 million for the three and six month periods ended June 30, 2002, respectively, from $9.2 million and $17.4 million for the corresponding prior year periods. The increase in cost of services and other revenue for the three month period ended June 30, 2002 was due to a $2.6 million increase in personnel and related costs which was offset by a $0.9 million decrease in consulting expenses. The increase for the six month period ended June 30, 2002 was due to a $2.3 million increase in personnel related costs. For both the three and six month periods ended June 30, 2002, we continued to expand our employee base and outsourced fewer third party consultants. As a percentage of services and other revenue, cost of services and other revenue was 71.7% and 76.3% for the three month periods ended June 30, 2002 and 2001, respectively, and 73.0% and 76.1% for the six month periods ended June 30, 2002 and 2001, respectively. The increase in margins for the three months ended June 30, 2002, was due to our continued expansion of our service organization and an increase in higher margin consulting services being completed by our personnel versus third party consultants.

     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. Research and development expenses increased 36.8% and 29.3% to $13.9 and $26.3 million for the three and six month periods ended June 30, 2002, respectively, from $10.2 and $20.4 million for the corresponding prior year periods. Research and development expenses increased in the three month period ended June 30, 2002, mostly due to an increase in third party consulting costs. During the second quarter, consultants were utilized to complete various components and enhance the capabilities of Retek 10, our new integrated modular retail solution. Research and development costs increased for the six months ended June 30, 2002 due to a $3.7 million increase in third party consulting expenses and a $1.6 million increase in personnel related costs. The increase in third party consulting costs and personnel related costs were due to expenses incurred to support the development and introduction of Retek 10 as well as later capability enhancements. In addition, occupancy charges were higher for the three months and six months ended

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June 30, 2002, due to our move to our new corporate facilities. We believe that research and development expenditures are essential to maintaining our competitive position and we expect these costs to continue to constitute a significant percentage of our revenues.

     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 increased 10.1% and 11.1% to $14.3 and $27.8 million for the three and six month periods ended June 30, 2002, respectively, from $13.0 and $25.0 million for the corresponding prior year periods. The increases in sales and marketing expense for the three and six month periods ended June 30, 2002 were due to increases of $1.3 and $2.0 million, respectively, in personnel related costs. These increases are a result of the expansion of our sales and marketing organization. Additional increases of $0.8 million and $1.7 million were due to the allocation of facilities and depreciation for equipment used for marketing our solutions, the opening of new sales offices worldwide and an increase due to the move to our new corporate headquarters. These increases were offset by a decrease in marketing expenses for trade shows and advertising in both the three and six month periods ended June 30, 2002.

     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 increased 30.9% and 22.2% to $4.4 and $8.1 million for the three and six month periods ended June 30, 2002, respectively, from $3.4 and $6.6 million for the corresponding prior year periods, respectively. The increase in general and administrative expense for the three and six month periods ended June 30, 2002, was mostly due to increases facilities and depreciation expense related to our move to our new corporate headquarters. We expect general and administrative expenses to increase in absolute dollars in the foreseeable future to support infrastructure growth.

     Acquisition-related amortization of intangibles. Acquisition-related amortization of intangibles decreased to $2.0 million for the three month period ended June 30, 2002, from $2.3 million for the corresponding prior year period. The decrease is attributable to our adoption of FAS 142, which requires goodwill and intangible assets with indefinite lives to no longer be amortized but are reviewed at least annually for impairment. Acquisition-related amortization of intangibles increased to $4.5 million for the six month period ending June 30, 2002, from $3.8 million for the corresponding prior year period. The increase was primarily due to the increase in amortization of intangible assets created from our transactions with Chelsea. In March 2002, we acquired the intellectual property of Chelsea and certain other assets and liabilities for a net cash purchase price of $8.9 million, of which $8.9 million has been allocated to purchased software, an intangible asset. This purchased software is stated at the lower of cost or net realizable value and is being amortized over 36 months. In addition in May 2001, we issued 976 shares of our common stock valued at $30.2 million to Proquire LLC (“Proquire”), an affiliate of Accenture, in exchange for the license from Proquire to us of certain intellectual property that will enable us to enhance our suite of retail-specific software. The value of our common shares issued for the specified intellectual property of Accenture is included as a component of intangible assets and is being amortized using the straight-line method over the life of the agreement, which is five years. In April 2001, we issued a warrant to purchase 750 shares of our common stock valued at $12.1 million in exchange for an ownership interest of approximately 7.7% of the outstanding common stock of Henderson Ventures, Inc (“Henderson”) and a distribution agreement to resell the developed software. These intangible assets are being amortized using the straight-line method over five years.

     Other income, net. Other income, net was $0.8 and $1.2 million for the three and six month periods ended June 30, 2002, respectively, compared to $0.4 and $0.5 million for the corresponding prior year periods. The increase was primarily due to the interest earned on our higher average cash, cash equivalents and investment balances.

     Income tax provision (benefit). The income tax provision was $2.0 and $3.0 million for the three and six month periods ended June 30, 2002, respectively, compared to a $2.1 and $1.5 million benefit for the corresponding prior year periods. These amounts are based on management’s estimates of the effective tax rates to be incurred by us during those respective full fiscal years. For the tax provision calculation for the periods presented differences between the U.S. statutory rate and our effective tax rate included research and development credits and cheap stock deductions, which were offset by the non-deductibility of meals and entertainment and certain cheap stock expenses.

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Liquidity and Capital Resources

     At June 30, 2002, our balance of cash, cash equivalents, and investments was $98.7 million.

     Net cash provided by operating activities was $12.8 million for the six-month period ended June 30, 2002, compared to $10.0 million for the corresponding prior year period. Sources of cash for the six-month period ended June 30, 2002 include net income, operating cash flow adjustments for depreciation and amortization expense, deferred income taxes and amortization of stock based compensation, as well as a decrease in a other current assets. Uses of cash for the six-month period ended June 30, 2002, were due to increases in accounts receivable and long term other assets and decreases in accounts payable, accrued liabilities and deferred revenue.

     Net cash used in investing activities was $21.1 million for the six month period ended June 30, 2002, compared to $4.2 million provided by investing activities for the corresponding prior year period. Uses of cash for the six-months ended June 30, 2002 included asset acquisitions, acquisitions of property and equipment and net purchases of investments for sale.

     Net cash provided by financing activities was $11.7 million for the six-month period ended June 30, 2002, compared to $17.0 million for the corresponding prior year period. The significant items that affected our net cash provided by financing activities during the six months ended June 30, 2002 were net proceeds from the exercise of stock options and proceeds from the sale of shares through our Employee Stock Purchase Program.

     We believe that our current cash, 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. One of the major components of our positive operating cash flow is our collection on receivables from our customers. Operating cash flows would be negatively impacted if we were unable to sign new customer contracts or if a significant number of customers were unable to pay for our solutions and services. Consumer spending, consumer confidence and other economic measures in the U.S. economy impact our customer base in the retail industry and negative trends in these measures may impact the amount and type of capital expenditures made by them.

     Management intends 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. 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 due to HNC distribution of our stock. Specifically, pursuant to the terms of a corporate rights agreement between HNC and us, until at least September 29, 2002, and possibly longer, our ability to issue common stock in connection with acquisitions, offerings or otherwise will be limited.

Factors That May Impact Future Results of Operations

     An investment in our common stock involves a high degree of risk. Investors evaluating us and our business should carefully consider the factors described below and all other information contained in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended December 31, 2001, 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.

IF WE DO NOT RESPOND ADEQUATELY TO OUR INDUSTRY’S RAPID PACE OF CHANGE, SALES OF OUR PRODUCTS MAY DECLINE.

     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 market for our products 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;

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	•		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 OUR QUARTERLY OPERATING RESULTS COULD CAUSE OUR STOCK PRICE TO DECLINE.

     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:

	•		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.

     Additionally, our reporting period operating results would be impacted if our customers did not purchase technical advisory support with our software solutions. Since we sell solutions with technical advisory support, revenues are recognized ratably over the advisory period, if all other revenue recognition criteria are met. Without the advisory services, revenues would be recognized when we execute the license agreement or contract; deliver the software; determine that collections of the proceeds is probable; and VSOE exists to allocate revenue to undelivered elements of the arrangement. Using these criteria, rather than our current revenue recognition policy with advisory services, could materially impact period over period results in our consolidated financial statements.

     We have incurred, and will continue to incur, compensation expense in connection with our grants of options under our 1999 Equity Incentive Plan, our HighTouch Technologies, Inc. 1999 Stock Option 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.

     Our 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 our revenue.

COMPETITIVE PRESSURES COULD REDUCE OUR MARKET SHARE OR REQUIRE US TO REDUCE OUR PRICES, WHICH WOULD REDUCE OUR REVENUE AND/OR OPERATING MARGINS.

     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 to 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:

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	•		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.

IF WE LOSE KEY PERSONNEL OR ARE UNABLE TO ATTRACT AND RETAIN ADDITIONAL PERSONNEL, OUR ABILITY TO GROW OUR BUSINESS COULD BE HARMED.

     We believe that our future success will depend upon our ability to attract and retain highly skilled personnel, including Steve Ladwig, our chief executive officer and president; John L. Goedert, our chief operating officer, and Gregory A. Effertz, our vice president, finance and administration and chief financial 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. 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.

IF WE FAIL TO ESTABLISH, MAINTAIN AND EXPAND OUR RELATIONSHIPS WITH THIRD PARTIES WHO IMPLEMENT OUR PRODUCTS, OUR ABILITY TO MEET OUR CUSTOMERS’ NEEDS COULD BE HARMED.

     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 have significantly more established relationships with these third parties and, as a result, these third parties maybe more likely to 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.

IF WE FAIL TO OBTAIN ACCESS TO THE INTELLECTUAL PROPERTY OF THIRD PARTIES, OUR BUSINESS AND OPERATING RESULTS COULD BE HARMED.

     We must now, and may in the future have to, license or otherwise obtain access to the intellectual property of third parties, including HNC Software, MicroStrategy, IBM 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.

IF OUR INTELLECTUAL PROPERTY IS NOT ADEQUATELY PROTECTED, OUR COMPETITORS MAY GAIN ACCESS TO OUR TECHNOLOGY AND WE MAY LOSE CUSTOMERS.

     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.

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     We seek to protect our software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection.

     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.

IF, IN THE FUTURE, THIRD PARTIES CLAIM THAT OUR PRODUCTS INFRINGE ON THEIR INTELLECTUAL PROPERTY, WE MAY INCUR SIGNIFICANT COSTS.

     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.

OUR BUSINESS IS SUBJECT TO ECONOMIC, POLITICAL AND OTHER RISKS ASSOCIATED WITH 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 uncollectable 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;
	•		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.

ERRORS AND DEFECTS IN OUR PRODUCTS COULD RESULT IN SIGNIFICANT COSTS TO US AND COULD IMPAIR OUR ABILITY TO SELL OUR PRODUCTS.

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     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.

INCREASED OPERATING EXPENSES MAY IMPACT OUR PROFITABILITY.

     We may increase operating expenses as we:

	•		increase research and development activities;
	•		increase services activities;
	•		expand our distribution channels;
	•		increase sales and marketing activities, including expanding our direct sales force; and
	•		build our internal information technology system.

     We may incur expenses before we generate any revenue from an increase in spending. If we do not significantly increase revenue from these efforts, our business and operating results could be seriously harmed.

WE ARE SUBJECT TO CONTRACTUAL LIMITATIONS THAT COULD LIMIT THE CONDUCT OF OUR BUSINESS AND OUR ABILITY TO PURSUE OUR BUSINESS OBJECTIVES.

     Our ability to enter into any acquisition of a business or assets or any merger, reorganization or other business combination transaction may be limited until September 29, 2002, and possibly longer, pursuant to the terms of a separation agreement between HNC Software, Inc. and us. In addition, our ability to issue common stock in connection with acquisitions, offerings or otherwise will be limited until September 29, 2002, and possibly longer.

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 June 30, 2002 was $98.7 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. Our policy is to place our 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 our management. Our investment policy also provides that our investment portfolio must not have an average portfolio maturity of beyond one year. 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 materially affect our financial results as our $0.2 million in notes payable are at a fixed interest rate.

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Foreign Currency Exchange Rate Risk

     We develop products in the United States and sell 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 U.S. dollars and maintaining only nominal foreign currency cash balances. Working funds necessary to facilitate the short-term operations of our subsidiaries are kept in local currencies in which they do business, with excess funds transferred to our offices in the United States. Approximately 36% and 27% of our sales were denominated in currencies other than the U.S. dollar for the three and six month periods ended June 30, 2002, compared to 31% and 28% for the corresponding prior year periods, respectively.

Equity Price Risk

     We own several investments in the common stock of certain companies that we have entered into for strategic business purposes. As of June 30, 2002, our total investments of this type were $0.4 million. We mitigate risk of loss by monitoring our investments, however, many of these investments are in the common stock of privately held, non-public companies and thus we may be unable to sell or achieve liquidity in them 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 need to ensure that their financial and other software systems are capable of processing transactions and properly handling these currencies, including the euro. We have assessed the impact that conversion to the euro will have on our internal systems, the sale of its solutions and the European and global economies and do not expect it to have a material impact on our financial statements.

PART II — OTHER INFORMATION

ITEM 1: LEGAL PROCEEDINGS

     Between June 11 and June 26, 2001, three class action complaints alleging violations of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 were filed in the Southern District of New York against us, certain of our officers and directors and certain underwriters of our initial public offering. The complaints allege that the prospectus was false or misleading in that it failed to disclose (i) that the underwriters allegedly were paid excessive commissions by certain customers in return for receiving shares in the initial public offering and (ii) that certain of the underwriters’ customers allegedly agreed to purchase additional shares of our common stock in the aftermarket in return for an allocation of shares in the initial public offering. Plaintiffs contend that, as a result of these omissions from the prospectus, the price of our common stock was artificially inflated between November 18, 1999 and December 6, 2000 and that the defendants are liable for unspecified damages to those persons who purchased our common stock during that period. On August 9, 2001, these actions were consolidated for pre-trial purposes before a single judge along with similar actions involving the initial public offerings of numerous other issuers.

     On February 14, 2002, the parties signed and filed a stipulation dismissing the consolidated action without prejudice against us and the individual officers and directors, which the Court approved and entered as an order on March 1, 2002. On April 20, 2002, the plaintiffs filed an amended complaint in which they elected to proceed with their claims against us and the individual officers and directors only under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.

     On July 15, 2002, the Company and the individual defendants, along with the rest of the issuers and related officer and director defendants, filed a joint motion to dismiss based on common issues. We intend to defend against these claims vigorously.

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     In addition to the matters discussed above, we are subject to various legal proceedings and claims that arise in the ordinary course of business. We believe that the resolution of such matters will not have a material impact on our financial position, results of operations or cash flows.

ITEM 2: CHANGES IN SECURITIES AND USES OF PROCEEDS

     (c)  Changes in Securities

	Not applicable.

     (d)  Use of Proceeds

	Not applicable.

ITEM 3: DEFAULTS UPON SENIOR SECURITIES

     Not applicable.

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     We held our annual meeting of stockholders in Minneapolis, Minnesota on June 4, 2002. Of the 52,107,159 shares outstanding as of the record date for the meeting, 46,820,716 shares were present or represented by proxy at the meeting on June 4, 2002. At these meetings the following actions were voted upon:

a.

To elect the following directors to serve for a term ending upon the 2005 Annual Meeting of Stockholders or until their successors are elected and qualified:

     Following the meeting John Buchanan, N. Ross Buckenham, Glen A. Terbeek, and Stephen E. Watson continued as our directors.

b.

To ratify the appointment of PricewaterhouseCoopers LLP as our independent public accountants for the fiscal year ending December 31, 2002.

ITEM 5: OTHER INFORMATION

     None.

ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS

     None.

(b)  REPORTS ON FORM 8-K.

     None.

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SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: August 14, 2002

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