San Diego, California-based HNC Software (Nasdaq: HNCS) is a provider of predictive software that allows companies to examine their individual customers' transactions in real-time. With the advent of the Web and e-commerce, the company's know-how in this area has taken on new meaning, and HNC is attacking the Internet opportunity through its eHNC unit. We talked with recently appointed president and CEO John Mutch about the firm's market opportunities and the potential for growth that lies ahead.

TMF: For investors such as myself that may be new to HNC, could you just give us a quick overview of the business and what the market opportunity is?

"In my mind, for a technology company our size, HNC has as many technology products and assets that have been locked up as any other technology company in America."

Mutch: Sure. Really what our products do -- what we call predictive software solutions -- is improve and enhance a company's interactions with their customers, prospects, and business partners by predicting outcomes of behavior. What we do is look at transaction-specific detail in real-time and based on some prior history of the transaction pattern. Based on the characteristics of the real-time transaction happening and based on some prediction of the future, we optimize the ability of our customer to manage the interaction or relationship with their customer.

The market opportunity for these types of technologies is very, very large. We've estimated in excess of $11 billion over the next five years. When you think about it, the availability of the Internet -- the increasing availability of an electronic architecture to facilitate customer interactions -- and broadband architectures are driving a higher number of electronic interactions and decreasing costs. So we see demand for the solutions and the size of the market simply accelerating in growth.

TMF: It's easy to see the opportunity for the insurance sector -- the portion of business you used to run before being elevated to CEO. How does the telecom and financial areas play into your strategy? How's the demand there?

Mutch: The rationale for the product there is very, very compelling. Essentially, if you look at the telecom marketplace with the availability of wireless access to the Web via handheld devices, what these providers want to do is figure out is who are the right customers to acquire, how do I acquire them, how do I retain them, and how do I manage them over the lifecycle to optimize the relationship with that customer. What our products do is allow them to do this very effectively based on this pattern recognition of the relationship and the current interaction with the customer. What we've done really is taken a core set of solutions and extended them into each one of these industries with the objective of helping our customers manage their customer relationships.

TMF: You recently reported your year-end results. What are the two or three elements that stood out most in your mind?

Mutch: I think the most important element for us in the prior quarter is really the unlocking of value of our solutions through the spinout of our retail subsidiary called Retek (Nasdaq: RETK). In the fourth quarter of the year we executed an IPO with them. The company went out at approximately $3.5 billion in market capitalized value. I think that overall it sets a new tenor for our management team -- the fact that we are going to approach the unlocking of the technology assets, the ability to drive shareholder value very, very aggressively.

I think we continue to have strong, solid, recurring revenue growth in our core service markets with our predictive customer relationship management product line. We are looking at opportunities with our spinout, our eHNC spinout, in a more aggressive way. We've really begun to examine the idea of how many potential spinouts we have in the electronic commerce market through eHNC. So overall, we've really had a much more aggressive tenor as a management team.

TMF: The value creation story has been interesting. I read an interview that you had done a few months ago where you said HNC is really a long-term play in your mind. That doesn't seem to be the case -- you've gone from $750 million in market cap to $3 billion. Has that happened too fast? And what's been driving that value creation?

Mutch: I think that we've only seen the beginning, to be honest. In my mind, for a technology company our size, HNC has as many technology products and assets that have been locked up as any other technology company in America. Our core expertise is this group of pattern recognition scientists, Ph.D. statisticians who've been working from research grants and our own funded R&D to develop and bring products out. And I don't think that historically we have been aggressive enough about getting them to market.

"I think three to five years from now, we're going to be working in a very, very different type of interactive world."

I think the market cap increase from $750 million to approximately $3 billion that we've seen in the past quarter is really the first step. It's the first recognition that we are going to do whatever we need to do in terms of structural changes, partnering, and investments from outside entities to unlock the value. And I think people are looking down the road for continued growth.

TMF: The eHNC unit, is that going to be pretty critical to that growth?

Mutch: Very critical. When you think about the dynamics that I spoke to earlier -- the advent of the Web, the interaction capacity -- what we've done is form a separate subsidiary with its own business model, its own operating platform to aggressively attack that market. We're leveraging the core value that we've delivered in our other industries -- fraud and risk protection, customer relationship management, customer assistance -- and then building a series of services that can be sold to merchant service providers to effectively increase electronic commerce and the optimization of electronic commerce on the Web.

So the only questions we have about eHNC are really how big can we take this thing. Do we have potentially more than one company with eHNC? We're examining those issues today and thinking about them and planning to execute on them over the course of the next year or so.

TMF: The revenue model is a little bit different than what some software investors might be used to -- you have a per customer transaction revenue model. Is that a major competitive advantage?

Mutch: It really is. And if you look at where the software industry is going, every company is essentially trying to migrate to what we call a recurring revenue model. This is a model where we derive our revenue on essentially a per click, per transaction, or specific solution per credit card covered in the financial industry. Every time there is a click or every time there is a transaction we get either a few cents or a few dollars, whatever the pricing may be. And what that does is really create a very predictable, highly visible revenue stream.

Approximately 70% of our revenue is on a recurring basis, so we really understand where our cash flow is coming from. That allows us to calibrate our business model in terms of R&D very effectively. And I think that, ultimately, it's a better relationship with your customers. We see a lot of major companies trying to migrate to this type of business model that HNC has successfully executed on.

TMF: What are your initial priorities as the new CEO? What are you devoting your most time to?

Mutch: There really are three specific tasks that I'm focused on and one sort of overarching message for investors. The first one is unlocking value through eHNC. I think that we have a huge opportunity in the Internet and electronic commerce space. A key focus for the management team is structuring and getting to market the eHNC entity as quickly as we can in the right structure.

The second initiative is what we call an ASP model, the application service provider model. We see the ability in our core business to extend the reach of our solutions in the medium- and small-sized customers by delivering the products in a service environment. We're rapidly executing models to make that happen.

The third thing is just simply expanding the breadth and depth of our product line. I think historically our product line has been very, very narrow. We're working very hard to build out new solutions whether we need to partner, acquire, or internally develop. The overall position for the company is really migrating to an Internet-centric company. The electronic architecture through the Web is really going to be the way that customer interactions can be effectively optimized. We want to have our company ideally positioned to capitalize and take advantage of that.

TMF: Do you think the Web is ready for that? Is the technology in place to do that?

Mutch: When we look at the strategy of the company, we look out three to five years. When I look at the past three years and the progress that we've made on the Web in terms of electronic commerce -- the financing of the loan space, the selling of insurance, access to IP telephony, and service plans for the wireless world -- I see the viability, the robustness, and scalability of the architecture only improving dramatically in the next three years. I think three to five years from now, we're going to be working in a very, very different type of interactive world and I think we want to have HNC positioned to capitalize on the progress that will be made.

TMF: Sounds like it's going to be interesting to watch.

Mutch: It's going to be a lot of fun and a lot of benefit to consumers. It's a very exciting time to be in the technology industry and really to be alive and participate in what's going on.

TMF: Thanks again for talking with us.

Mutch: It's been great speaking with you.

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