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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
or
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER 1-14036
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DST SYSTEMS, INC.
(Exact name of Company as specified in its charter)
DELAWARE 43-1581814
(State or other jurisdiction (I.R.S. Employer identification
of incorporation or organization) no.)
333 WEST 11TH STREET, KANSAS CITY, 64105
MISSOURI (Zip code)
(Address of principal executive offices)
Company's telephone number, including area code (816) 435-1000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of exchange on which registered
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COMMON STOCK, $0.01 PER SHARE PAR VALUE NEW YORK STOCK EXCHANGE
CHICAGO STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the Company (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 Company was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES /X/ NO / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Company's knowledge, in a definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
Aggregate market value of the voting and non-voting stock held by non-affiliates
of the Company as of
February 26, 1999:
Common Stock, $.01 par value--$3,416,836,267
Number of shares outstanding of the Company's common stock as of February 26,
1999:
Common Stock, $.01 par value--62,983,157
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the following documents are incorporated herein by reference into
Part of the Form 10-K as indicated:
PART OF FORM 10-K INTO WHICH
DOCUMENT INCORPORATED
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Company's Definitive Proxy Statement for the 1999 Annual Meeting of Part III
Stockholders, which will be filed no later than 120 days after December 31,
1998
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DST SYSTEMS, INC.
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Cautionary Statement With Respect To Forward-Looking Comments................ 2
PART I
Item 1. Business..................................................................... 2
Item 2. Properties................................................................... 21
Item 3. Legal Proceedings............................................................ 22
Item 4. Submission of Matters to a Vote of Security Holders.......................... 22
Executive Officers and Significant Employees of the Company.................. 23
PART II
Item 5. Market for the Company's Common Stock and Related Stockholder Matters........ 24
Item 6. Selected Consolidated Financial Data......................................... 25
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................... 26
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................... 42
Item 8. Financial Statements and Supplementary Data.................................. 43
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................... 76
PART III
Item 10. Directors and Executive Officers of the Company.............................. 76
Item 11. Executive Compensation....................................................... 76
Item 12. Security Ownership of Certain Beneficial Owners and Management............... 76
Item 13. Certain Relationships and Related Transactions............................... 76
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............. 77
Signatures................................................................... 84
ALLIANT-TM-, AUTOMATED WORK DISTRIBUTOR-REGISTERED TRADEMARK-,
AWD-REGISTERED TRADEMARK-, CLASSROM-REGISTERED TRADEMARK-, CUSTIMA-TM-,
CYBERCSR-REGISTERED TRADEMARK-, DDP/SQL-TM-, DIRECT ACCESS-TM-,
DST-REGISTERED TRADEMARK-, ENCORR-REGISTERED TRADEMARK-, ENTERPRISE REAL-TIME
RATING SYSTEM-TM-, ERTRS-TM-, EXACT VIEW(SM), FAN-REGISTERED TRADEMARK-,
FANMAIL-REGISTERED TRADEMARK-, FAST2000-TM-, FINANCIAL ACCESS
NETWORK-REGISTERED TRADEMARK-, GLOBAL PORTFOLIO SYSTEM-REGISTERED TRADEMARK-,
GPS-REGISTERED TRADEMARK-, HIPORTFOLIO/2-TM-, IMPART/2-TM-, INTEGRATED PHARMACY
NETWORK SYSTEM-TM-, INTELECABLE-REGISTERED TRADEMARK-,
IPNS-REGISTERED TRADEMARK-, OPENDATAWAREHOUSE-TM-, OPENFRONTOFFICE-TM-,
OPENMARKETDATAFEEDS-TM-, OPENMESSENGER-TM-, OPENORDERS-TM-,
OPENPERFORMANCESYSTEM-TM-, OPENPRODUCTS-TM-, OPENREPORTING-TM-, OPS-TM-,
OTI-REGISTERED TRADEMARK-, PALADIGN-TM-, PAS-TM-, PORTFOLIO ACCOUNTING
SYSTEM-TM-, POWERSTORE-REGISTERED TRADEMARK-,
RAPIDCONFIRM-REGISTERED TRADEMARK-, SECURITIES TRANSFER SYSTEM-TM-, STS-TM-,
TA2000-REGISTERED TRADEMARK-, TECHCONNECT-TM-, TRAC-2000-REGISTERED TRADEMARK-,
UPTIX-TM-, VISION MUTUAL FUND GATEWAY-REGISTERED TRADEMARK- referred to in this
Report are included among the Company's trademarks and service marks. AIX,
AS/400-REGISTERED TRADEMARK-,Challenge, COLD, DIRECTV-TM-, FUND/SERV-TM-,
NETWORKING-TM-, ORACLE, OS/2-REGISTERED TRADEMARK-, SYBASE,
UNIX-REGISTERED TRADEMARK-, WINDOWS-REGISTERED TRADEMARK-, WINDOWS
NT-REGISTERED TRADEMARK- and any other brand, service or product names or marks
referred to in this Report are trademarks or services marks, registered or
otherwise, of their respective holders.
1
CAUTIONARY STATEMENT WITH RESPECT TO FORWARD-LOOKING COMMENTS
The discussions set forth in this Annual Report on Form 10-K contain statements
concerning potential future events. Such forward-looking statements are based
upon assumptions by the Company's management, as of the date of this Annual
Report, including assumptions about risks and uncertainties faced by the
Company. Readers can identify these forward-looking statements by their use of
such verbs as expects, anticipates, believes or similar verbs or conjugations of
such verbs. If any of management's assumptions prove incorrect or should
unanticipated circumstances arise, the Company's actual results could materially
differ from those anticipated by such forward-looking statements. The
differences could be caused by a number of factors or combination of factors
including, but not limited to, those factors identified in the Company's amended
Current Report on Form 8-K dated March 25, 1999, which is hereby incorporated by
reference. This report has been filed with the United States Securities and
Exchange Commission ("SEC") in Washington, D.C. and can be obtained by
contacting the SEC's Public Reference Branch. Readers are strongly encouraged to
obtain and consider the factors listed in the March 25, 1999 Current Report and
any amendments or modifications thereof when evaluating any forward-looking
statements concerning the Company. The Company will not update any
forward-looking statements in this Annual Report to reflect future events or
developments.
PART I
ITEM 1. BUSINESS
This discussion of the business of DST Systems, Inc. ("DST" or the "Company")
should be read in conjunction with, and is qualified by reference to,
Management's Discussion and Analysis of the Company's Financial Condition and
Results of Operations ("MD&A") under Item 7 herein. In addition, pursuant to
rule 12b-23 under the Securities Exchange Act of 1934, as amended, the
information set forth under the headings "Introduction" and "Seasonality" in the
MD&A and the segment and geographic information included in Item 8, Note 13 are
incorporated herein by reference in partial response to this Item 1.
The Company was originally established in 1969. Through a reorganization in
August 1995, the Company is now a corporation organized in the State of
Delaware.
RECENT DEVELOPMENTS IN THE COMPANY'S BUSINESS
The recent business developments of the Company and the Company's subsidiaries
follow.
USCS MERGER
On December 21, 1998, the Company and USCS International, Inc. completed their
merger (USCS Merger) through the issuance of .62 shares of DST common stock for
each outstanding share of USCS common stock. DST issued approximately 13.8
million shares of common stock in the transaction. The USCS Merger was accounted
for under the pooling of interests accounting method. Accordingly, the DST
financial results have been restated to combine the historical results of
operations of DST and USCS, adjusted for conformity of accounting policies
relating primarily to USCS' depreciation and amortization policies and
accounting for the costs of software developed for internal USCS use. In
connection with the USCS Merger, the Company incurred $26.0 million ($19.4
million after taxes) of merger-related costs which were charged to operations in
December 1998.
Both DST and USCS provide sophisticated information processing and computer
software services and products. DST primarily serves mutual funds, investment
managers, insurance companies, banks and other financial services organizations.
USCS primarily serves cable television, multi-service providers,
telecommunications and utilities companies. As a result of the Merger, the
combined companies have a significant presence in terms of market share in
financial services (primarily the mutual funds industry),
2
customer management processing, and output solutions. Management believes the
combined knowledge and expertise of DST and USCS should result in increased
service capabilities and product offerings and should facilitate more rapid
expansion into new markets.
EQUISERVE
In December 1998, Boston EquiServe LP ("Boston EquiServe") and First Chicago
Trust Company of New York completed a transaction creating EquiServe LP
("EquiServe"), the largest securities transfer agent in the U.S. Prior to the
transaction, Boston EquiServe was a limited partnership, 50% owned by Boston
Financial Data Services, Inc. ("BFDS") (a 50% owned joint venture of DST and
State Street Corporation) and 50% by BankBoston Corporation. DST is currently
developing a new securities transfer system ("Fairway") to be used by EquiServe
to process all of its accounts. DST has also agreed with EquiServe to provide
the data processing services for EquiServe to use Fairway. Upon acceptance of
defined components of Fairway, DST will contribute Fairway and its non-EquiServe
securities transfer processing business (approximately 2 million accounts) to
EquiServe for a 20% direct ownership interest in EquiServe (the "EquiServe
Contribution"). DST will also have a 10% indirect ownership interest in
EquiServe through BFDS after the EquiServe Contribution. DST believes that an
ownership in EquiServe provides the most effective participation in the
opportunities presented by the continued consolidation of the securities
transfer industry. The acceptance of the defined components of Fairway is
currently expected to occur in three stages beginning in the second quarter of
1999 and completing in the third quarter of 2000, at which time DST's
non-EquiServe stock transfer business will be transferred to EquiServe.
CUSTIMA
In August 1998, USCS purchased 100% of the stock of United Kingdom based Custima
International Holdings, plc ("Custima") for approximately $15.4 million
("Custima Acquisition"). Custima provides customer management software for the
utilities industry and positions the Company to expand into and provide software
and services to the U.S. utilities industry.
NARRATIVE DESCRIPTION OF BUSINESS
The Company has several operating business units that offer sophisticated
information processing and software services and products. These business units
have been aggregated into three operating segments (Financial Services, Customer
Management and Output Solutions). In addition, certain investments in equity
securities, financial interests and real estate holdings have been aggregated
into an Investments and Other Segment. A summary of each of the Company's
segments follows:
FINANCIAL SERVICES
The Financial Services Segment provides sophisticated information processing and
computer software services and products primarily to mutual funds, investment
managers, insurance companies, banks and other financial services organizations.
The Company's proprietary software systems include shareowner accounting and
recordkeeping systems offered to the U.S. mutual fund industry; a shareowner
accounting and recordkeeping system offered to non-U.S. mutual funds and unit
trusts; a securities transfer system offered primarily to corporate trustees and
securities transfer agents; a variety of portfolio accounting and investment
management systems offered to U.S. and international fund accountants and
investment managers; an image-based work management system offered primarily to
mutual funds, insurance companies and other financial services organizations;
and securities exchange and broker order systems offered to brokers and
companies involved in the exchange of equity, bond and derivative securities
primarily outside the U.S.
3
The Financial Services Segment distributes its services and products on a direct
basis and through subsidiaries and joint venture affiliates in the U.S., Canada,
United Kingdom, Europe, Australia, South Africa and Asia-Pacific, and to a
lesser degree distributes such services and products through various strategic
alliances.
CUSTOMER MANAGEMENT
The Customer Management Segment provides sophisticated customer management
processing and computer software services and products to cable television,
direct broadcast satellite ("DBS"), wireless and wire-line telephony, utilities
and multi-service providers in more than 30 countries. The Company's proprietary
software systems enable its clients to manage mission-critical customer
relationship functions, including new account set-up, order processing, customer
support, customer billing, management reporting and marketing analysis.
The Customer Management Segment distributes its services and products on a
direct basis and through subsidiaries in North America, the United Kingdom and
parts of Europe and with international alliance partners in other regions of the
world. As a result of the Custima Acquisition, the Segment is offering its
software systems and services to the utilities industry.
OUTPUT SOLUTIONS
The Output Solutions Segment provides complete statement processing services and
solutions, including electronic presentment, which include generation of
customized statements that are produced in sophisticated automated facilities
designed to minimize turnaround time and mailing costs. This Segment provides
statement processing services and solutions in North America to customers of the
Company's Financial Services and Customer Management Segments, and to
telecommunications, utilities and other high volume industries which require
high quality, accurate and timely statement processing.
INVESTMENTS AND OTHER
The Investments and Other Segment holds certain investments in equity
securities, financial interests, the Company's real estate subsidiaries and the
Company's hardware leasing subsidiary. The Company holds certain investments in
equity securities with a market value of approximately $1.0 billion at December
31, 1998, including approximately 8.6 million shares of Computer Sciences
Corporation ("CSC") with a market value of $554.6 million and 6.0 million shares
of State Street Corporation ("State Street") with a market value of $420.8
million. Additionally, the Company owns and operates real estate in North
America which is held primarily for lease to the Company's other business
segments.
4
INDUSTRY REVENUE
The Company's sources of revenue by major industries served are presented below.
The industries listed may be served by more than one of the Company's business
segments.
YEAR ENDED DECEMBER 31,
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1998 1997 1996
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(DOLLARS IN MILLIONS)
U.S. REVENUES
Mutual fund / investment
management..................... $ 429.1 39.1% $ 374.0 39.3% $ 335.7 39.8%
Other financial services......... 126.9 11.6 109.2 11.5 91.1 10.8
Cable/satellite TV............... 211.6 19.3 197.6 20.8 172.1 20.4
Telecommunications and
utilities...................... 127.8 11.7 104.5 11.0 93.9 11.1
Other............................ 46.7 4.3 47.1 5.0 55.6 6.6
--------- --------- --------- --------- --------- ---------
Total U.S. revenues.......... 942.1 86.0 832.4 87.6 748.4 88.7
--------- --------- --------- --------- --------- ---------
INTERNATIONAL REVENUES
Mutual fund / investment
management..................... 98.7 9.0 67.4 7.1 57.5 6.8
Other financial services......... 23.6 2.1 24.2 2.5 18.0 2.1
Cable/satellite TV............... 21.6 2.0 16.7 1.8 11.2 1.3
Telecommunications and
utilities...................... 3.1 0.3 1.7 0.2 1.9 0.2
Other............................ 7.0 0.6 7.6 0.8 7.0 0.9
--------- --------- --------- --------- --------- ---------
Total international
revenues................... 154.0 14.0 117.6 12.4 95.6 11.3
--------- --------- --------- --------- --------- ---------
TOTAL REVENUES................... $ 1,096.1 100.0% $ 950.0 100.0% $ 844.0 100.0%
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
FINANCIAL SERVICES SEGMENT
The Financial Services Segment attributes its growth to the expansion of the
mutual fund industry and to the Segment's business strategy. The primary
components of the Segment's ongoing business strategy are: (i) enhancement of
its technology base and development of new services and products to strengthen
its position as the leading provider of information processing services to the
U.S. mutual fund market; (ii) expansion into markets where it can provide
similar information processing and computer software services and products; and
(iii) formation of strategic alliances and joint ventures with or acquisitions
of established companies operating in target markets, both in the U.S. and
internationally.
The growing volume and complexity of transactions in the financial services
market and other markets have resulted in increasing demand for more
sophisticated systems to timely and accurately process information. Computer
technology has provided an effective means of addressing this demand, but
requires significant capital investment and expertise. As a result, many
financial service organizations
5
have relied on outside providers, such as the Company. The Company expects the
information processing needs of these organizations to grow in volume and
complexity presenting the Financial Services Segment with significant
opportunities to sell its services and products.
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
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FINANCIAL SERVICES OPERATING DATA
Revenues (in millions)
U.S............................................................ $ 390.1 $ 338.0 $ 308.2
International.................................................. 117.5 87.0 70.0
--------- --------- ---------
$ 507.6 $ 425.0 $ 378.2
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--------- --------- ---------
Mutual fund shareowner accounts processed (millions)
U.S............................................................ 49.8 45.0 41.1
Canada......................................................... 1.6 0.9 0.3
United Kingdom (1)............................................. 1.4 1.0 0.4
TRAC-2000 mutual fund accounts (millions) (2).................... 2.5 1.9 1.3
TRAC-2000 participants (thousands)............................... 905 696 560
IRA mutual fund accounts (millions) (2).......................... 12.0 9.6 8.7
Portfolio Accounting System portfolios........................... 1,962 1,925 1,725
Automated Work Distributor workstations.......................... 45,300 35,100 19,700
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(1) Processed by EFDS, an unconsolidated affiliate of the Company
(2) Included in U.S. mutual fund shareowner accounts processed
U.S. MUTUAL FUND SHAREOWNER PROCESSING
Most of the Financial Services Segment's mutual fund clients are "open-end"
mutual fund companies, which obtain funds for investment by making a continuous
offering of their shares. Purchases and sales (referred to as "redemptions") of
open-end mutual fund shares are typically effected between shareowners and the
fund, rather than between shareowners. These transactions are based on the net
asset value of the mutual funds on the date of purchase or redemption, which
requires that the assets of the fund and the interests of its shareowners be
valued daily. Accordingly, timely and accurate accounting and recordkeeping of
shareowner and fund investment activity is critical.
In addition, investors' attraction to a wide array of mutual fund investment
products with increasingly specialized features has significantly increased the
number of mutual fund shareowner accounts, the volume of transactions and the
complexity of recordkeeping. The Company has made significant investments in
computer capacity and systems to handle the increasing volumes, to maintain its
leadership position and to improve quality and productivity.
The Company typically enters into multi-year written agreements with its
clients. Most of the shareowner accounts serviced by the Company are at mutual
fund organizations that have been clients of the Company for more than five
years.
SHAREOWNER ACCOUNTING AND RECORDKEEPING
The proprietary applications system for U.S. mutual fund recordkeeping and
accounting is TA2000, which performs shareowner related functions for mutual
funds, including processing purchases, redemptions, exchanges and transfers of
shares; maintaining shareowner identification and share ownership records;
reconciling cash and share activity; calculating and disbursing commissions to
broker-dealers
6
and other distributors; processing dividends; creating and tabulating proxies;
reporting sales; and providing information for printing of shareowner
transaction and statement data and year-end tax statements. The system processes
load, no-load, multi-class and money funds. TA2000 also performs many
specialized tasks, such as asset allocation, wrap fee calculations and broker
commissions. At December 31, 1998, the Company provided shareowner accounting
processing services for approximately 49.8 million U.S. mutual fund shareowner
accounts.
Mutual fund shareowner services are offered on a wide range of levels. "Full"
service processing includes all necessary administrative and clerical support to
process and maintain shareowner records, answer telephone inquiries from
shareowners, broker-dealers and others, and handle the TA2000 functions
described above. "Remote" service processing is designed to allow clients to
have their own administrative and clerical staff access TA2000 at the Winchester
Data Center using the Company's telecommunications network.
Selection by a client of the level of service is influenced by a number of
factors, including cost and level of desired control over interaction with fund
shareowners. To address clients' desires to control shareowner interaction, the
Company structured its services to allow the clients' personnel to handle
customer telephone inquiries while the Company's or an affiliate's personnel
retain transaction processing functions. This service was facilitated by the
implementation of Automated Work Distributor ("AWD"), which creates electronic
images of transactions and enables such images, together with the status of the
related transactions, available to the personnel handling the telephone calls.
The Company derives revenues from its mutual fund shareowner accounting services
through fees charged for use of the Company's proprietary software systems,
clerical processing services and other related products. These fees are
generally charged on a per account and number of funds basis for system
processing services and on a per account, number of fund and transaction basis
for clerical services. The Company's policy is not to license TA2000.
RETIREMENT PLAN ACCOUNTING AND RECORDKEEPING
The Company's TRAC-2000 product provides recordkeeping and administration for
defined contribution plans, including 401(k), 403(b), money purchase and profit
sharing plans that invest in mutual funds, company stock, guaranteed investment
contracts and other investment products. TRAC-2000 interfaces directly with
TA2000 thereby eliminating the potential for reconciliation problems that occur
when different systems are used for participant recordkeeping and mutual fund
shareowner accounting. TRAC-2000 is offered on a full-service basis through BFDS
and on a remote basis by the Company. The Company regards the retirement plan
market as a significant growth opportunity for its services and products because
(i) that market is relatively new and experiencing significant expansion as more
employers shift away from defined benefit programs; (ii) mutual funds, because
of their features, are increasingly popular selections for investment by such
plans; and (iii) each retirement plan participant normally elects to use
multiple mutual fund investment accounts. Revenues from these services are based
generally on the number of participants in the defined contribution plans.
ADDITIONAL MUTUAL FUND SERVICES AND PRODUCTS
The Company has developed products to meet the changing service requirements and
distribution channels of the mutual fund market as well as the increasing
regulatory requirements affecting that market.
The Company maintains a high volume interface with Fund/Serv and Networking, two
systems developed by the National Securities Clearing Corporation for
broker-dealer distributed mutual funds. The Company has also developed systems
and communication infrastructure products that facilitate emerging channels of
mutual fund sales and distribution. One of these systems, FanMail, provides
independent financial planners with trade confirmations, account positions and
other data via public network
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access. A Windows-based enhancement to FanMail called Vision Mutual Fund Gateway
provides real-time inquiry capabilities for broker-dealers and the financial
planning community through the Internet.
The Company has developed the Financial Access Network ("FAN") to support
emerging forms of electronic distribution for mutual funds. FAN enables mutual
fund companies to transmit mutual fund literature via the Internet to
shareowners and potential investors who visit their proprietary web pages and
enables the shareowners to review their accounts and direct mutual fund
transactions, such as purchases, redemptions and exchanges from personal
computers.
Revenues from these new services and products are based generally on the number
of transactions processed.
BOSTON FINANCIAL DATA SERVICES, INC. ("BFDS")
BFDS, a 50% owned joint venture with State Street, is an important distribution
channel for the Company's services and products. BFDS combines use of the
Company's proprietary applications and output solutions capabilities with the
marketing capabilities and custodial services of State Street to provide
full-service shareowner accounting and recordkeeping services to over 138 U.S.
mutual fund companies. BFDS also offers remittance and proxy processing, class
action administration services, teleservicing and full-service support for
defined contribution plans using the Company's TRAC-2000 system. BFDS is the
Financial Services Segment's largest customer, accounting for approximately
12.2% of the Segment's revenues in 1998.
AUTOMATED WORKFLOW MANAGEMENT
The Company's Automated Work Distributor ("AWD") system is a document based,
intelligent workflow and customer relationship management system. AWD captures
transactions at their source (such as paper, phone calls or faxes), converts
them into electronic documents, stores and electronically moves them to the
appropriate work area and person for processing. AWD integrates high-speed
scanning, character recognition, digitized voice, call center technology,
optical storage and automated correspondence to automate work processes
traditionally performed by hand. AWD also performs statistical quality control
sampling and provides productivity reporting for each individual using the
system.
Initially introduced to enhance the Company's mutual fund shareowner
recordkeeping system, AWD was designed to interface with a wide range of high
volume application processing systems. AWD utilizes a client server architecture
that enables it to operate on AS/400, Windows NT or UNIX servers utilizing
Windows, OS/2 and thin client desktops. AWD interfaces with existing mainframe
or other server lines of business applications. AWD is primarily installed in
investment management firms, insurance companies and banks located in the U.S.,
Canada, United Kingdom, Europe, Australia, South Africa and Asia-Pacific. In
addition, Computer Sciences Corporation Financial Services Group ("CSC-FSG")
distributes the Company's AWD product to life and property and casualty
insurance companies worldwide.
The Company has developed modular components enabling AWD to support various
means of customer interaction. These products include EnCorr, which automates
the creation and printing of correspondence; PowerStore, which enables optical
media access for AWD users; AWD/RIP, which imports work into AWD from other
computer systems and external networks; AWD/ST which fully automates transaction
processing; and AWD/NetServer to extend AWD functionality to intranet and
Internet environments. AWD/Voice was developed to support the infrastructure
requirements of mid-to-high volume call centers. AWD/Voice integrates call
record/playback technology and computer-telephony integration technology into
the AWD system. AWD/Voice supports various call center desktop applications and
has been implemented in insurance and mutual funds environments.
8
The Company derives AWD revenues from multi-year bundled service and usage
agreements based on the number of workstations accessing the software and fixed
fee perpetual license agreements that may include provisions for additional
license payments in the event the number of users increases. The Company also
derives AWD revenues from fees for customized installation and programming
services and annual maintenance fees.
PORTFOLIO ACCOUNTING AND INVESTMENT MANAGEMENT PRODUCTS
The Company offers products that support the portfolio accounting and investment
management functions of the financial services industry. These products include
the Portfolio Accounting System ("PAS"), HiPortfolio/2, OpenProducts and Global
Portfolio System ("GPS"). The Company offers a complete solution to firms
managing mutual funds, institutional advisory accounts, or both.
PAS is an integrated multi-currency fund accounting system that maintains
accounting records for mutual funds and unit investment trusts with U.S. and
international assets, computes daily income and expense for each portfolio and
calculates the fund's daily net asset value ("NAV") which appears in the
financial media. The Company derives revenues generally based on the number of
mutual fund portfolios processed by PAS.
HiPortfolio/2 is also designed for medium and large investment management firms
that are seeking a turnkey system for investment accounting that can meet their
local and international requirements with a minimum amount of customization.
HiPortfolio/2 is a scalable, comprehensive front, middle and back office
solution.
The range of OpenProducts include OpenFrontOffice (a front office GUI-based
trading system), OpenPerformance (a performance measurement and attribution
system), OpenDataWarehouse, OpenOrders (automated order management),
OpenReporting (high quality desktop publishing and client reporting),
OpenMessenger (Straight Through Processing), OpenMarketDataFeeds (management of
external market data) and a number of others under development.
GPS is designed for medium and large investment management companies with
advisory accounts that want a customized solution. The system is a rules-based,
multi-currency transaction processing and portfolio accounting system with a
Windows-based graphical user interface ("GUI") and a variety of reporting
alternatives. With its client server, relational database architecture (Sybase
or Oracle), GPS can seamlessly integrate with the Company's range of
OpenProducts or can interface with a wide range of third-party systems.
The Company derives revenues from HiPortfolio/2, OpenProducts and GPS, from
license fees, fees for customized installation and programming services and
annual maintenance fees.
SECURITIES TRANSFER PRODUCTS
The Company's existing system to support the securities transfer market, the
Securities Transfer System ("STS"), provides a wide array of corporate stock and
bond security holder recordkeeping services, including maintaining ownership
records, recording ownership changes, issuing certificates, issuing and
tabulating proxies, calculating and disbursing dividends and interest,
processing dividend reinvestments, tax reporting and responding to shareowner
inquiries through on-line data access. STS also maintains shareowner activity
for closed-end mutual funds and unit investment trusts. EquiServe currently uses
STS to process approximately 5.4 million accounts.
See "Recent Developments" above for further discussion of EquiServe.
9
WINCHESTER INFORMATION PROCESSING SERVICES
Winchester Information Processing Services primarily supports the computing
needs of the Company's Financial Services Segment with two data centers in
Kansas City, Missouri.
The Winchester Data Center ("Winchester") is the Company's primary central
computer operations and data processing facility. Winchester has a total of
163,000 square feet, of which 76,000 square feet is raised floor computer room
space. Winchester has mainframe computers with a combined processing capacity of
over 4.3 billion instructions per second and direct access storage devices with
an aggregate storage capacity that exceeds 21 trillion bytes. Winchester also
contains over 150 servers supporting NT, UNIX, and AS/400 small and midrange
computing environments. These servers are used to support DST's products and
processing for certain of the Company's affiliates. The physical facility is
designed to withstand natural disasters including tornado-force winds.
The Poindexter Data Center ("Poindexter") supports the Company's AWD Image
processing services. Poindexter has a total of 11,500 square feet, of which
8,500 are currently used for the computer room. The computer room houses IBM
AS/400 computers and optical storage systems, which support over 2,000 AWD Image
users. AWD users include DST's Full-Service area as well as several of the
Company's remote AWD customers. Poindexter also houses over 250 servers
supporting various Company products and Winchester's remote tape storage using
IBM's automated tape libraries.
Both data centers are staffed 24-hours-a-day, seven-days-a-week and have
self-contained power plants with mechanical and electrical systems designed to
operate virtually without interruption in the event of commercial power loss.
The data centers utilize fully redundant telecommunications networks serving the
Company's clients. The network, which serves more than 96,000 computer users,
has redundant pathing and software which provide for automatic rerouting of data
transmission in the event of carrier circuit failure.
The Company has an agreement with a commercial disaster recovery provider for
computer processing in the event of a computer failure at Winchester. The
Company's data communications network is linked to the disaster recovery
provider's facility and network to enable client access to the disaster recovery
facility. Poindexter's AS/400 processors and the AS/400 processors at Winchester
provide contingency plan capabilities for each other's processing needs. The
Company regularly tests the disaster recovery processes for both data centers.
ARGUS HEALTH SYSTEMS, INC. ("ARGUS")
Argus is a 50% owned joint venture of the Company and a privately held life
insurance holding company. Argus provides managed care pharmaceutical claim
processing services using its proprietary computer processing system, Integrated
Pharmacy Network System ("IPNS"). IPNS is an interactive, database managed
processing system for administration of prescription drug claims, pharmacy and
member reimbursement and drug utilization review. IPNS, which provides
substantial flexibility to accommodate varying provider requirements, allows
point-of-sale monitoring and control of pharmacy plan benefits with on-line
benefit authorization and alerts dispensing pharmacists to potential medication
problems arising from such factors as duplicate prescriptions, incorrect dosage
and drug interactions. Argus is currently developing a new client/server based
claims processing system which will replace IPNS.
The Company provides data processing, telecommunications and output solutions
services to Argus, and Argus operates IPNS at Winchester and Poindexter. Its
primary clients are providers of pharmacy benefit plans including insurance
companies, health maintenance organizations, preferred provider organizations
and other pharmacy benefit managers.
10
INTERNATIONAL BUSINESSES
DST INTERNATIONAL LIMITED ("DST INTERNATIONAL")
DST International, a United Kingdom company, provides investment management and
portfolio accounting software and services with over 500 installations in 40
countries worldwide, serviced by offices in the United Kingdom, U.S., Australia,
New Zealand, Hong Kong, Singapore, Thailand, and the South Africa. Its primary
applications include HiPortfolio/2, a client server based investment management
system and OpenProducts, a series of high technology products directly
integrated with HiPortfolio/2. Among DST International's other products are
Impart/Uptix, Paladign and GPS. In addition to investment management and
portfolio accounting software and services, DST International distributes and
supports AWD outside North America.
EUROPEAN FINANCIAL DATA SERVICES LIMITED ("EFDS")
A United Kingdom joint venture of the Company and State Street, EFDS provides
full and remote service processing for unit trusts and related products serving
1.4 million unitholder accounts at December 31, 1998. During 1998, EFDS began
implementation of FAST2000, a new unit trust accounting system. The Company
believes that the successful conversion of clients onto the new system, which is
expected to be completed by the end of 1999, should improve the profitability of
the joint venture in 2000 and allow it to pursue new clients in the United
Kingdom market.
DST CANADA, INC. ("DST CANADA")
DST Canada provides remote mutual fund shareowner processing and licenses its
mutual fund shareowner system to mutual fund companies primarily in the Canadian
financial services market. Revenues are derived from providing remote mutual
fund shareowner processing services and time and material fees for
client-specific enhancements and support to the remote processing system, and to
a lesser degree from licensing its mutual fund shareowner system to mutual fund
companies. DST Canada is currently enhancing its system for operation in the
Japanese marketplace in anticipation of a developing Japanese mutual fund
market.
CFDS LIMITED ("CFDS")
A Canadian subsidiary of BFDS, CFDS provides full-service processing to the
Canadian mutual fund industry using DST Canada's mutual fund system and
full-service processing for U.S. off-shore mutual funds using TA2000.
DST CATALYST, INC. ("DST CATALYST")
DST Catalyst develops, markets, installs, and maintains computer systems to
support securities exchanges and brokerage firms and performs research and
consulting related to the development of financial markets and institutions.
Headquartered in Chicago, DST Catalyst principally derives its revenues from
international locations where its software systems are being operated or are
installed. The Chicago Stock Exchange holds a 19% interest in DST Catalyst.
CUSTOMER CONCENTRATION
The Financial Services Segment's five largest clients accounted for 29.6%,
30.1%, and 29.9% of segment revenues in 1998, 1997 and 1996, respectively. BFDS,
the Segment's largest customer, accounted for 12.2%, 10.9%, and 11.4% of segment
revenues in 1998, 1997 and 1996, respectively.
11
MARKETING / DISTRIBUTION
In the U.S. and Canada, the Financial Services Segment identifies potential
users of its products and services and tailors its marketing programs to focus
on their needs. The Segment's marketing efforts also include cross-selling the
Company's wide range of services and products to its existing clients. The
Segment's sales efforts are closely coordinated with its joint venture and
strategic alliance partners.
Sources of new business for the Segment include (i) existing clients,
particularly with respect to complementary and new services and products; (ii)
companies relying on their own in-house capabilities and not using outside
vendors; (iii) companies using competitors' systems; and (iv) new entrants into
the markets served by the Company. The Company considers its existing client
base to be one of its best sources of new business.
The Company's mutual fund systems and related services and products are marketed
to mutual fund management firms and to distributors of mutual fund shares, such
as banks, insurance companies, brokerage firms and third party administration
firms. Increasingly, such firms manage multiple mutual fund products to address
different investment objectives. Generally, mutual fund products are promoted
and distributed in fund groups which provide investors with a variety of mutual
fund investments and the ability to exchange investments from one fund to
another within the group. This often means that a single service agent, such as
the Company, is used for all funds in the group.
DST International markets its investment management and portfolio accounting
software and services directly to medium and large investment management firms.
Generally, DST International's customers are seeking a turnkey system for
investment accounting that can meet their requirements with a minimum amount of
customization. Each of DST International's offices has a dedicated sales force
and a team of consultants that can sell, install and implement these products.
COMPETITION
The Company believes that competition in the markets in which the Financial
Services Segment operates is based largely on quality of service, features
offered including the ability to handle rapidly changing transaction volumes,
commitment to hardware capacity and software development, and price. The Company
believes there is significant existing competition in its markets. The Company's
ability to compete effectively is dependent on the availability of capital. Some
of the Company's competitors have greater resources and greater access to
capital than the Company and its affiliates.
The Company's shareowner accounting systems compete not only with third-party
providers but also with in-house systems and broker-dealer firms that perform
sub-accounting services for the brokerage firms' customers that purchase or sell
shares of mutual funds of the Company's clients. Financial institutions
competing with the Company may have an advantage because they can take into
consideration the value of their clients' funds on deposit in pricing their
services. The Company believes its most significant competitors for third party
shareowner accounting systems are First Data Investor Services, Inc. and Sungard
Data Systems, Inc.
The Company has significant competition with its portfolio accounting and
investment management systems. Principal competitors are third-party software
service providers and those companies that license their products. The key
competitive factors in the investment management systems are the accuracy and
timeliness of processed information provided to customers, features and
adaptability of the software, level and quality of customer support, level of
software development expertise and price. The Company believes that it competes
effectively in the market by its ongoing investment in its products and the
development of new products to meet the needs of the portfolio accountants and
investment managers. The Company believes its most significant competitors for
portfolio accounting
12
and investment management systems are Sungard Data Systems, Inc., State Street
Corporation (including Princeton Financial Systems, Inc.), Misys plc, SS&C
Technologies, Inc., and Datastream Systems, Inc.
The Company's automated workflow system competes with other data processing and
financial software vendors. Competitive factors include features and
adaptability of the software, level and quality of customer support, level of
software development expertise and price. The Company believes that it can
compete effectively in those markets the Company chooses to pursue. The Company
believes its most significant competitors for automated workflow systems are
Filenet Corporation, Pegasystems Inc., and Staffware plc.
CUSTOMER MANAGEMENT SEGMENT
The Customer Management Segment provides sophisticated customer management
processing and computer software services and products to cable television,
direct broadcast satellite ("DBS"), wireless and wire-line telephony,
multi-service providers and utilities which serve more than 44 million end-users
worldwide. The Company's proprietary software systems enable its clients to
manage mission critical customer relationship functions, including new account
set-up, order processing, customer support, customer billing, management
reporting and marketing analysis. The Company's software currently supports more
than 40% of U.S. cable and satellite television subscribers and is used by many
of the largest cable television service providers and the largest DBS provider
in the U.S.
The Segment primarily derives its revenues for customer management processing
and computer software services and products based on the number of end-users of
the services offered by its clients, the number of bills mailed and/or the
number of images produced under multi-year bundled service and usage agreements.
These agreements are typically subject to periodic renewals and inflation-based
fee adjustments. Certain of the Company's customers license the customer
management software under term license agreements.
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
CUSTOMER MANAGEMENT OPERATING DATA
Revenues (in millions)
U.S............................................................... $ 198.4 $ 186.2 $ 161.1
International..................................................... 23.3 16.7 11.2
--------- --------- ---------
$ 221.7 $ 202.9 $ 172.3
--------- --------- ---------
--------- --------- ---------
Cable/satellite TV subscribers processed (millions)
Total before discontinued customer................................ 35.6 30.8 26.9
Discontinued customer(1).......................................... 2.4 10.9 11.4
--------- --------- ---------
38.0 41.7 38.3
--------- --------- ---------
--------- --------- ---------
- ------------------------
(1) See also discussion in Customer Management Segment--Customer Concentration
The Company offers a variety of customer management services and products
designed to meet the needs of both global and local service providers. Most of
the Company's products are scaleable and are available in basic systems with
optional modules, including the Company's new Internet-based customer support
products, CyberCSR and TechConnect, which allow the service provider to design a
customized system which can effectively manage a growing customer base.
13
SYSTEMS AND SERVICES
INTELECABLE
Intelecable is designed to support single and multi-service providers worldwide.
Intelecable is available on either a standalone or service bureau basis and
supports a diverse array of communications services, including cable television,
telephony, combined cable/telephony, interactive video and DBS. Intelecable is
based on an open systems, relational database architecture, which facilitates
customization and interoperability with other information systems without
complex code changes. Intelecable may be operated in a variety of foreign
languages, including Japanese and Chinese. First installed in 1993, Intelecable
is now installed in over 100 locations worldwide.
DDP/SQL
The Company's primary software system for the traditional North American cable
television provider market is DDP/SQL. Many of the largest cable television
service providers in the U.S. use the DDP/ SQL system. The Company offers
DDP/SQL on either a stand-alone or a service bureau basis. Stand-alone systems
currently support approximately 84% of the DDP/SQL client subscriber base, while
approximately 16% are supported on a service bureau basis. For stand-alone
clients, the Company installs a complete DDP/ SQL system at the provider's
facility, including necessary hardware and peripherals. Clients using a service
bureau arrangement access the Company's on-line processors via wide area
networks. DDP/SQL runs on parallel processing hardware manufactured by Tandem.
The Company is a value-added reseller of Tandem equipment. The Company also
sells to its clients peripheral hardware made by manufacturers other than
Tandem, and generally enters into hardware maintenance agreements with its
clients. The Company's Investments and Other Segment also provides lease
financing and maintenance services primarily for companies operating systems on
a stand-alone basis.
SUBSCRIBER TRANSACTION MANAGEMENT SYSTEM ("STMS")
The Subscriber Transaction Management System was developed to manage the
customer management and output solutions related activities for DirecTV, Inc.,
the largest DBS provider in the U.S. The Company is expanding the scope of STMS
to address the needs of other direct broadcast satellite operators that provide
non-television and interactive services and to international providers.
ALLIANT
The Company markets its Alliant PC-based customer management software product to
domestic and international cable operators that have lower transaction volume
requirements than operators supported by DDP/SQL or Intelecable. Alliant is
designed to introduce smaller cable operators to the Company's products, with
the expectation that such operators will migrate to Intelecable or DDP/SQL as
their businesses grow.
ENTERPRISE REAL-TIME RATING SYSTEM ("ERTRS")
The Enterprise Real-Time Rating System is a rating engine designed to rate
cellular, wireline, data and Internet services, providing a complete convergence
rating system for carriers that bundle multiple service offerings to meet
customers' needs. The Company is currently marketing the ERTRS system on a
stand-alone basis and has integrated the ERTRS capability into the Intelecable
product.
CUSTIMA
The Company's CUSTIMA software system supports the customer management
activities of electric, gas, water and waste utilities. Functionality of the
application includes customer marketing, meter
14
management, complex billing, credit management and customer contact processing.
CUSTIMA is an open system product that runs on six hardware platforms.
PROFESSIONAL SERVICES, TRAINING AND SUPPORT
The Company maintains various professional services groups to provide global
consulting services to its software customers, including assistance with
database definition and initialization, system operations, network
consolidation, and performance and decision support services. These groups also
provide clients with assistance in developing custom-tailored applications and
interfaces that operate with the Company's customer management software to
enhance client operations. The Company provides complete product documentation
and training services to users of its software products, including CD-ROM-based
product documentation and training. The Company's ClassROM software provides
interactive instruction and product training on CD-ROM. The Company maintains
training facilities in California and the U.K.
CLIENT SUPPORT AND CARE
The Company provides worldwide training and support to its clients including
broad-based, 24-hour, 7-day support and technical assistance. Internationally,
Intelecable is supported by teams located in the U.S. and the U.K. as well as by
alliance partners.
CUSTOMER CONCENTRATION
The Customer Management Segment's five largest clients accounted for 54.8%,
58.5%, and 57.4% of segment revenues in 1998, 1997 and 1996, respectively.
Tele-Communications, Inc. ("TCI"), the Customer Management Segment's largest
customer, accounted for $35.9 million or 16.2%, $48.7 million or 24.0%, and
$52.0 million or 30.2% of total revenue in 1998, 1997, and 1996, respectively.
See also discussion of the Customer Management Segment's revenues and TCI under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in Item 7 in this Form 10-K.
MARKETING / DISTRIBUTION
Software and services are sold primarily to cable, DBS, utility and
multi-service providers through direct sales channels and in conjunction with
international alliance partners. In North America, the Company operates a
software and services sales and marketing team, including account management,
product management and technical support teams.
The Segment's international sales staff is coordinated by geographic area,
including dedicated account and technical support personnel located in the U.S.,
U.K., Brazil and Australia. In addition to direct sales, the Company has
contracted with alliance partners throughout the world who are responsible for
sales, marketing, support and local customization.
COMPETITION
The market for the Company's products and services in the Customer Management
Segment is highly competitive, and competition is increasing as additional
market opportunities arise. The Company competes with both independent providers
and developers of in-house systems. The Company believes its most significant
competitors for customer management software systems are Convergys, Inc. and CSG
Systems International, Inc.
The Company believes that to remain competitive it will require significant
financial resources in order to market its existing products and services, to
maintain customer service and support and to invest in research and development.
Many of the Company's existing and potential competitors may have greater
resources than the Company. The Company expects its competitors to continue to
improve the design and performance of their current systems and processes and to
introduce new systems and processes with improved price/performance
characteristics.
15
OUTPUT SOLUTIONS SEGMENT
The Output Solutions Segment provides statement processing services and
solutions to customers of the Company's Financial Services and Customer
Management business segments, other parties in the telecommunications and
utilities industries as well as other industries which require high quality,
accurate and timely statement processing. The segment also offers a variety of
complementary professional services, including consulting, application
development and client training, as well as statement design and formatting
services that allow clients to use the statements as a communication and
marketing tool.
The Company is among the largest first class mailers in the U.S., mailing nearly
1.5 billion items in 1998. Revenues are generally dependent on the volume of
statements processed. The sources of revenue by major industry served are listed
below.
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
OUTPUT SOLUTIONS OPERATING DATA
Revenues (in millions)
U.S. revenues
Mutual fund/investment management............................. $ 94.8 $ 84.5 $ 77.7
Other financial services...................................... 63.5 57.3 39.2
Cable/satellite TV............................................ 67.0 62.2 56.4
Telecommunications and utilities.............................. 126.0 104.5 93.9
Other......................................................... 50.2 44.0 52.7
--------- --------- ---------
401.5 352.5 319.9
--------- --------- ---------
International revenues
Mutual fund/investment management............................. 1.6 0.3 0.1
Other financial services...................................... 3.2 4.4 6.2
Telecommunications and utilities.............................. 1.4 1.7 1.9
Other......................................................... 7.0 7.5 6.1
--------- --------- ---------
13.2 13.9 14.3
--------- --------- ---------
$ 414.7 $ 366.4 $ 334.2
--------- --------- ---------
--------- --------- ---------
Images produced (millions)...................................... 5,087 4,221 3,806
Items mailed (millions)......................................... 1,490 1,331 1,206
OUTPUT SERVICES AND SOLUTIONS
Statement processing services and solutions are provided in a fully integrated
and automated production environment that rapidly and cost-effectively transform
electronic data received from the client into informative, accurate and
customized statements. Because of its highly automated production environment,
the Company is able to maximize postal savings while minimizing delivery time
for its clients.
For the financial services industry, the Company performs electronic printing,
variable and selective insertion, presorted mailing and distribution of custom
designed shareowner and other account based communications, including
transaction confirmations, dividend checks, account statements and year-end tax
reports.
16
The Company provides statement processing services and solutions to the
cable/satellite TV, telecommunications, utilities, transportation and other
service industries. The Company cost-effectively transforms electronic data
received from the client into informative, accurate and customized billing
statements.
To address the needs of multi-service providers, the Company also offers
consolidated statements, which combine data from multiple services, such as
wireless and wire-line telephony, into a single integrated statement.
Consolidated statements can offer clients significant savings both in paper and
mailing costs. Consolidated statements can also be a powerful marketing tool for
companies seeking to establish brand name recognition and sell combined
services.
The Company offers a full range of technical support for the Company's statement
processing clients. Customized programming tools have been developed that allow
it to receive electronic information streams from a variety of client systems
without the need to make changes to the customer's system. These tools allow for
rapid and smooth transitions when clients outsource statement processing
functions to the Company.
To attract clients who want to take advantage of the Company's advanced
processing and functions in their own facilities, rather than on an outsourced
basis, the Company has licensed its statement processing technology. AT&T and
Bell Atlantic currently license the Company's statement processing software. The
Company intends to pursue additional technology licensing opportunities
domestically as well as in international markets.
ELECTRONIC DELIVERY ALTERNATIVES
The Company's automated information and technology infrastructure, which
electronically prepares and monitors the statement until final printing,
provides the basis for the development of electronic statement presentment. The
proliferation of on-line services and the Internet provides an opportunity for
service providers to provide statements to customers electronically through
personal computers or related devices. The Company believes that, as electronic
statements and payment solutions become more accepted, communications service
providers, utilities, financial services and other industries will require
electronic statement presentment capabilities. The Company has developed an
electronic statement-processing product and has announced marketing alliances
with several companies including CyberCash, Checkfree, Microsoft, Intuit,
NETdelivery and others to begin actively marketing an electronic statementing
alternative. Because of its existing volume, state-of-the-art processing
systems, and client relationships, the Company believes it is in a unique
position to become a one-stop, full-service supplier of either paper-based or
electronically delivered statements.
RAPID CONFIRM
For the brokerage industry, the Company offers Rapid Confirm, one of the fastest
ways to deliver trade confirmations. Utilizing MailNet, the largest domestic
distributive print network, the Company provides speed of delivery through the
United States Postal Service (USPS). With distributive print-mail sites
strategically located throughout the U.S., 90 percent of the Company's mail is
delivered in two days or less at discounted presort rates. Confirmations can be
consolidated, householded, and may be printed with dynamic highlight color for
greater visual impact.
STATEMENT-BASED MARKETING SERVICES
The Company provides statement-based marketing services that allow its clients
to transform regular customer statements into communication tools. The statement
is often the only form of regular communication between a service provider and
its customers. Many clients have the opportunity, through the Company's
statement-based marketing and creative design services, to use the paper or
electronic
17
statement to reinforce a corporate image, advertise special offers and features,
deliver customer-specific messages and otherwise market their services to their
customers.
COMPUTER OUTPUT LASER DISC
Info-Disc allows clients to access accurate images of printed customer documents
on-line as they appear on paper, including logos, personalized pie charts and
custom graphics. Info-Disc can index up to 255 data fields and can utilize up to
five criteria at a time, making search and retrieval of information quick and
efficient. Info-Disc also allows the flexibility to transfer customer
information to spreadsheets and create reports from indexed data. The Company
also holds a 20% interest in PSI Technologies Corporation ("PSI"), the developer
of the Info-Disc software technology. In conjunction with this investment, the
Company exclusively markets PSI's software technology to the mutual fund
industry.
EXACT VIEW
An alternative viewing mechanism to the Computer Output Laser Disc is Exact
View, which combines the Company's statement data management and imaging
capabilities with proven archive technology to allow customer service
representatives to view an exact replica of each customer statement. Exact View
is a client-server solution on an open platform architecture that works easily
with standard industry products. The database is compatible with a variety of
server platforms leveraging standard database software.
DIRECT ACCESS
Direct Access is a unique web-based program that enables our billing customers
to have real-time monitoring and reporting functions. Using standard internet
browsers and entry through secured access to our extranet, customers can monitor
their data from the time of completed transmission to the moment it leaves the
Company's facilities, thus providing the power to view every step of the process
remotely.
COMPUTER OUTPUT MICROFILM
For statement information that must be stored for long periods of time for
historical or legal purposes and referenced only occasionally, the Company
offers a computer output to microfilm product, usually in the form of
microfiche. Retrieval costs are considerably lower for this type of media than
for others.
FULFILLMENT AND TELEMARKETING
The Company offers a variety of telemarketing and fulfillment services including
i) Call Center Management to support the literature distribution needs of its
clients; ii) Pick & Pack Services offering dynamic package configuration and
inventory management; and iii) Replenishment Print Services offering
print-on-demand technology; and iv) Electronic fulfillment over the Internet.
PRODUCTION FACILITIES
The Company's primary production facilities are in Northern California, Kansas
City, Hartford, Boston, Denver, St. Louis, New York, and Toronto. These
facilities use both roll form and sheet fed production processes and can perform
variable and selective insertion and pre-sorted mailing.
The Company has patented processes and technologies, that provide a fully
integrated, computerized and automated production environment. The production
system (i) processes, logs, verifies and authenticates customer data, (ii)
creates automated production controls for a statement, including form bar codes,
weight and thickness parameters, unique statement tracking numbers, "due out"
dates, address
18
correction, carrier route/delivery point bar codes and postal processing
parameters, (iii) models production runs on-line before printing or electronic
transmission, and (iv) enables postal processing, sorting and discounting to be
performed on-line.
Full real-time automation enables the Company to monitor quality, control
remakes, predict and schedule production loading, verify customer data, forecast
production volumes and maintain production system history on-line. The system is
controlled by an on-line production control system that is based on advanced
client/server architecture and has high-speed data-transmission capabilities. A
local area network links the production equipment to the production control
system.
CUSTOMER CONCENTRATION
The Output Solutions Segment's five largest clients accounted for 26.5%, 29.6%
and 31.8% of the segment's revenues in 1998, 1997 and 1996, respectively. The
segment's largest customer, Ameritech Corporation, accounted for $41.4 million
or 10.0%, $39.3 million or 10.7%, and $41.1 million or 12.3% of total revenue in
1998, 1997, and 1996, respectively.
MARKETING / DISTRIBUTION
The Company believes that sales of separate statement processing services to
financial services, telecommunications, cellular, utility, and other service
providers offer both increased revenue opportunities as well as increased
visibility for the Company. The Company maintains a sales staff, including
account management and technical support teams and significant design resources,
to target these market segments. The Company has begun an international
statement processing marketing effort that seeks to exploit what the Company
believes is significant growth potential in that market. The Company has entered
into alliances with partners such as Xerox, Mellon Bank, LHS Group, Microsoft,
Intuit, CheckFree and CyberCash to jointly market its statement processing and
electronic presentment capabilities.
The Company's Output Solutions Segment distributes its products to the mutual
fund, banking, brokerage, insurance, healthcare, telecommunications,
transportation, utilities and other service industries. A team of client
administrators manages the needs of clients and a national sales force supports
efforts in the U.S. and Canada.
COMPETITION
The key competitive factors in the Output Solutions Segment are quality of
services, quality of customer support, ability to handle large volumes at month
and quarter ends and speed of production. The most significant competitors for
statement/output solutions services are in-house service providers, local
companies in the cities where the Company's printing operations are located and
other national competitors such as Moore Corporation Ltd. The Company believes
that it competes effectively with others in the market.
INTELLECTUAL PROPERTY
The Company holds 21 U.S. patents covering various aspects of its statement
processing services. In addition, the Company has applied for 7 additional U.S.
patents. The Company has no foreign patents. The Company believes that although
the patents it holds are valuable, they are not critical to the Company's
success, which depends principally upon its product quality, marketing and
service skills. However, despite patent protection, the Company may be
vulnerable to competitors who attempt to imitate the Company's systems or
processes and manufacturing techniques and processes. In addition, other
companies and inventors may receive patents that contain claims applicable to
the Company's system and processes.
19
INVESTMENTS AND OTHER SEGMENT
The Company's Investments and Other Segment is comprised of certain investments
in equity securities, financial interests and the Company's real estate and
hardware leasing subsidiaries and affiliates.
INVESTMENTS
The Company holds certain investments in equity securities with a market value
of approximately $1.0 billion at December 31, 1998, including approximately 8.6
million shares of Computer Sciences Corporation with a market value of $554.6
million and 6.0 million shares of State Street Corporation with a market value
of $420.8 million.
REAL ESTATE
The Company's real estate subsidiaries own approximately 193,000 square feet of
office space and 187,000 square feet of production facilities which are held
primarily for lease to the Company's other business segments. The real estate
subsidiaries also hold master leases in certain properties which are leased to
the Company's operating segments.
HARDWARE LEASING
The Company provides hardware leasing services to selected customer management
software clients that purchase stand-alone systems primarily in the U.S.
SOFTWARE DEVELOPMENT AND MAINTENANCE
The Company's research and development efforts are focused on introducing new
products and services as well as ongoing enhancement of its existing products
and services. Costs and expenses include approximately $165.5 million, $135.6
million and $107.2 million in 1998, 1997 and 1996, respectively, for software
development and maintenance and enhancements to the Company's proprietary
systems and software products. Capitalized development costs for systems to be
sold or licensed to third parties were approximately $2.5 million, $3.1 million
and $0.3 million in 1998, 1997 and 1996, respectively.
EMPLOYEES
As of December 31, 1998, the Company and its majority owned subsidiaries
employed approximately 8,600 employees, including approximately 3,800 in the
Financial Services Segment, 1,000 in the Customer Management Segment and 3,800
in the Output Solutions Segment. In addition, 50% owned unconsolidated
affiliates of the Company and its subsidiaries employed approximately 4,200
employees, including approximately 3,400 at BFDS. None of the Company's
employees are represented by a labor union or covered by a collective bargaining
agreement. The Company considers its employee relations to be good.
20
ITEM 2. PROPERTIES
The following table provides certain summary information with respect to the
principal properties owned or leased by the Company. The Company believes the
facilities, office space and other properties owned or leased are adequate for
its current operations.
OWNED/ SQUARE
LOCATION USE (1) LEASED (2) FEET
- --------------------------------------------------------------------------- -------------- ----------- ---------
FINANCIAL SERVICES SEGMENT (3)
Kansas City, MO............................................................ Data center Owned 163,000
Kansas City, MO............................................................ Office space Owned 132,000
Kansas City, MO............................................................ Production Owned 16,000
Kansas City, MO............................................................ Office space Leased 701,000
Boston, MA................................................................. Office space Leased 24,000
Canada..................................................................... Office space Leased 34,000
United Kingdom............................................................. Office space Leased 47,000
Australia.................................................................. Office space Leased 28,000
CUSTOMER MANAGEMENT SEGMENT (3)
Charlotte, NC.............................................................. Office space Leased 36,000
El Dorado Hills, CA........................................................ Office space Owned 48,000
Rancho Cordova, CA......................................................... Office space Leased 152,000
United Kingdom............................................................. Office space Leased 30,000
OUTPUT SOLUTIONS SEGMENT (3)
El Dorado Hills, CA........................................................ Office space Leased 29,000
El Dorado Hills, CA........................................................ Production Owned 366,000
Sacramento, CA............................................................. Production Leased 304,000
Kansas City, MO............................................................ Production Owned 306,000
Kansas City, MO............................................................ Office space Owned 13,000
Kansas City, MO............................................................ Production Leased 32,000
East Hartford, CT.......................................................... Production Leased 75,000
Braintree, MA.............................................................. Production Leased 81,000
Westwood, MA............................................................... Production Leased 128,000
New York, NY............................................................... Production Leased 30,000
St. Louis, MO.............................................................. Production Leased 40,000
Denver, CO................................................................. Production Leased 94,000
Mt. Prospect, IL........................................................... Production Leased 110,000
Wheeling, IL............................................................... Production Leased 26,000
Canada..................................................................... Production Owned 61,000
Canada..................................................................... Production Leased 66,000
INVESTMENTS AND OTHER SEGMENT
Kansas City, MO............................................................ Office space Owned 81,000
Kansas City, MO............................................................ Office space Leased 13,000
The Company also owns approximately 278 acres of undeveloped land adjacent to
its buildings in El Dorado Hills, CA and a 515,000 square foot underground
storage facility in the Kansas City, MO area that is primarily leased to third
parties.
(1) Property specified as being used for production in the above table includes
space used for manufacturing and warehouse space.
21
(2) Excluded from the table are a number of surface parking lots in the downtown
Kansas City, Missouri area. The table also excludes nine properties outside
the Kansas City, Missouri metropolitan area having an aggregate of
approximately 101,000 square feet of office or production space, which are
each less than 20,000 square feet. In addition to the property listed in the
table and discussed above, the Company, through its subsidiaries and joint
ventures, leases space in the Netherlands, Switzerland, Belgium, South
Africa, Hong Kong, Singapore, Thailand, New Zealand and Brazil. The property
listed in the table as owned by the Company is subject to mortgage
indebtedness in an aggregate amount of approximately $24.8 million as of
December 31, 1998.
(3) Includes approximately 517,000 square feet of property owned or leased by
the Company's real estate subsidiaries that are leased to other segments of
the Company, including approximately 285,000 sq. ft. in the Financial
Services Segment, 48,000 sq. ft. in the Customer Management Segment and
184,000 in the Output Solutions Segment.
The discussion under "Winchester Information Processing Services" in Item 1
hereto is hereby incorporated by reference in partial response to this Item 2.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are involved in various legal proceedings
arising in the normal course of their businesses. While the ultimate outcome of
these legal proceedings cannot be predicted with certainty, management believes,
after consultation with legal counsel, that the final outcome in such
proceedings, in the aggregate, would not have a material adverse effect on the
consolidated financial condition or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held a Special Meeting of Shareholders of DST Systems, Inc. on
December 21, 1998. Proxies for the meeting were solicited pursuant to Regulation
14A. Listed below are the matters voted on at the Company's Special Meeting.
These matters are fully described in the Company's Joint Proxy
Statement/Prospectus dated November 25, 1998. Beneficial owners of 43,496,806
shares, or 88.7%, of the shares of Common Stock outstanding on the record date
of November 6, 1998, were present in person or by proxy at the special meeting.
These shares were voted on the matters considered as follows. Based upon votes
required for approval, each of the matters passed.
1) Approval of the USCS Merger, including issuance of DST Common Stock pursuant
to the merger agreement between the Company and USCS International:
For........................... 43,337,888
Against....................... 108,665
Withheld...................... 50,253
----------
Total......................... 43,496,806
----------
----------
2) Amendment of DST Stock Option and Performance Award Plan to increase the
number of shares of DST Common Stock available for awards thereunder:
For........................... 30,669,269
Against....................... 12,771,878
Withheld...................... 55,659
----------
Total......................... 43,496,806
----------
----------
22
EXECUTIVE OFFICERS AND SIGNIFICANT EMPLOYEES OF THE COMPANY
Pursuant to General Instruction G(3) of Form 10-K and instruction 3 to paragraph
(b) of Item 401 of Regulation S-K, the following list is included as an
unnumbered Item in Part I of this Annual Report on Form 10-K in lieu of being
included in the Company's Definitive Proxy Statement in connection with its
annual meeting of stockholders scheduled for May 11, 1999.
All executive officers are elected by and serve at the discretion of the
Company's Board of Directors. Certain of the executive officers have employment
agreements with the Company. There are no arrangements or understandings between
the executive officers and any other person pursuant to which he or she was or
is to be selected as an officer, except with respect to the executive officers
who have entered into employment agreements, which agreements designate the
position or positions to be held by the executive officer. None of the executive
officers are related to one another.
THOMAS A. MCDONNELL, age 53, has served as director of the Company since 1971.
He has served as Chief Executive Officer of the Company since October 1984 and
as President of the Company since January 1973 (except for a 30 month period
from October 1984 to April 1987). He served as Treasurer of the Company from
February 1973 to September 1995 and as Vice Chairman of the Board from June 1984
to September 1995. He served as Executive Vice President of Kansas City Southern
Industries, Inc. ("KCSI") from February 1987 until October 1995 and as a
director of KCSI from 1983 until October 1995. He is a director of BHA Group,
Inc., Cerner Corporation, Computer Sciences Corporation, Euronet Services, Inc.,
and Informix Software, Inc.
THOMAS A. MCCULLOUGH, age 56, is Executive Vice President of the Company. He has
served as director of the Company since 1990 and as Executive Vice President
since April 1987. His responsibilities include full-service mutual fund
processing, remote-service mutual fund client servicing, information systems,
portfolio accounting, securities transfer and product sales and marketing.
JAMES C. CASTLE, PH.D., age 62, has served as director of the Company since
December 1998 and as Chairman, Chief Executive Officer and director of USCS
since 1992.
CHARLES W. SCHELLHORN, age 50, has served since March 1999 as Vice Chairman of
USCS. He had previously served since 1990 as President and since 1991 as
Chairman of Output Technologies, Inc., a wholly owned subsidiary of the Company.
JONATHAN J. BOEHM, age 38, joined the Company as a Group Vice President in
November 1997. He is responsible for the Company's full-service mutual fund
processing and corporate support. Prior to joining the Company, he had been an
officer of Kemper Service Company from October 1990 through November 1997.
ROBERT C. CANFIELD, age 60, has served as Senior Vice President, General Counsel
and Secretary of the Company since August 1995 and as Senior Vice President-Law
of the Company from March 1992 to August 1995.
KENNETH V. HAGER, age 48, has served as Vice President and Chief Financial
Officer of the Company since April 1988 and as Treasurer since August 1995. He
is responsible for the financial and internal audit functions of the Company. He
is a director of Digital Holdings, Inc.
C. RANDLES LINTECUM, age 54, has served as President of Output Technologies,
Inc. since March 1999. He has served since July 1995 as President of
International Billing Services, Inc., a wholly owned subsidary of USCS. He
served from February 1995 to July 1995 as Senior Vice President Marketing and
Distribution of USCS and from May 1993 to February 1995 as Vice President
Corporate Development of USCS.
23
JOHN W. MCBRIDE, age 57, joined the Company in 1985 and has served as Group Vice
President of the Company since 1993. He is responsible for the operations of the
Company's Winchester and Poindexter Data Centers.
MICHAEL F. MCGRAIL, age 51, has served since April 1995 as President of
CableData, Inc., a wholly owned subsidiary of USCS. Since December 1993, he has
been President and Managing Director of CableData International, Ltd., a wholly
owned subsidiary of CableData, Inc.
ROBERT L. TRITT, age 43, joined the Company in 1977 and has served as Group Vice
President of the Company since 1989. He is responsible for the Company's remote
mutual fund processing operations and for mutual fund product development.
MICHAEL A. WATERFORD, age 56, has served as Group Vice President of the Company
since 1986. He is responsible for certain of the Company's development projects
and Year 2000 readiness.
J. MICHAEL WINN, age 52, has served since June 1993 as Managing Director of DST
International Limited, a wholly owned subsidiary of the Company.
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's common stock trades under the symbol "DST" on the New York Stock
Exchange ("NYSE") and the Chicago Stock Exchange. As of March 17, 1999, there
were approximately 27,000 beneficial owners of the Company's common stock.
No cash dividends have been paid since the initial public offering of the
Company's common stock on October 31, 1995. The Company intends to retain its
earnings for use in its business and therefore does not anticipate paying any
cash dividends in the foreseeable future.
The information set forth in response to Item 201 of Regulation S-K in Part II
Item 8, Financial Statements, and Supplementary Data at Note 14, Quarterly
Financial Data (Unaudited) ("Note 14"), in this Form 10-K is incorporated by
reference in partial response to this Item 5. The prices set forth in Note 14 do
not include commissions and do not necessarily represent actual transactions.
The closing price of the Company's common stock on the NYSE on December 31, 1998
was $57.0625.
24
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected consolidated financial data of the
Company. This selected consolidated financial data has been derived from the
Company's consolidated financial statements which have been restated to reflect
the USCS Merger. The selected consolidated balance sheet data as of December 31,
1998 and 1997 and the selected consolidated income statement data for the years
ended December 31, 1998, 1997 and 1996 were derived from the Company's audited
consolidated financial statements and the related notes thereto which are
included in Item 8 of this Annual Report on Form 10-K. The selected consolidated
balance sheet data as of December 31, 1996, 1995 and 1994 and the selected
consolidated income statement data for the years ended December 31, 1995 and
1994 were derived from the separate audited financial statements of DST and USCS
as adjusted for the USCS Merger not included herein. This data should be read in
conjunction with and is qualified by reference to, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in Item 7 in
this Annual Report Form 10-K and the Company's audited consolidated financial
statements, including the notes thereto and the independent accountants report
thereon and the other financial information included in Item 8 in this Form
10-K.
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Revenues........................................ $ 1,096.1 $ 950.0 $ 844.0 $ 713.4 $ 590.5
Costs and expenses.............................. 834.7 719.6 653.0 571.6 473.0
Depreciation and amortization................... 108.8 103.5 99.1 87.7 68.7
Merger charges and other expenses (1) (2)....... 33.1 13.7
--------- --------- --------- --------- ---------
Income from operations.......................... 119.5 126.9 78.2 54.1 48.8
Interest expense................................ (8.6) (8.5) (10.5) (26.9) (18.3)
Other income, net............................... 7.4 5.8 4.5 4.9 3.5
Gains on sales of Continuum and IFTC (2)........ 223.4 43.6
Equity in earnings (losses) of unconsolidated
affiliates, net of income taxes............... (2.7) (1.3) (4.0) 6.4 22.2
--------- --------- --------- --------- ---------
Income before income taxes and minority
interests..................................... 115.6 122.9 291.6 82.1 56.2
Income taxes.................................... 44.3 42.9 113.3 49.5 18.9
--------- --------- --------- --------- ---------
Income before minority interests................ 71.3 80.0 178.3 32.6 37.3
Minority interests.............................. (0.3) 0.6 0.5 (1.1)
--------- --------- --------- --------- ---------
Net income (1) (2).............................. $ 71.6 $ 79.4 $ 177.8 $ 32.6 $ 38.4
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Basic earnings per share (3).................... $ 1.14 $ 1.25 $ 2.82 $ 0.71 $ 0.90
Diluted earnings per share (3).................. 1.11 1.23 2.78 0.70 0.89
Total assets.................................... $ 1,897.0 $ 1,548.5 $ 1,303.7 $ 912.8 $ 659.4
Long-term obligations........................... 49.7 97.4 81.5 103.6 213.4
Cash dividends per common share (3)............. $ $ $ $ $
- ------------------------
(1) The Company recognized $33.1 million in merger and integration costs in
1998. See Note 3 to the consolidated financial statements.
(2) In the third quarter 1996, The Continuum Company, Inc. merged with Computer
Sciences Corporation ("CSC") in a tax-free share exchange and as a result
became a wholly owned subsidiary of CSC. As a result of the CSC/Continuum
merger, the Company recognized a one-time gain. See Note 3 to the
consolidated financial statements.
(3) The Company's capital structure substantially changed as a result of public
offerings of the Company's common stock in the fourth quarter 1995 and
second quarter 1996. Earnings per share data
25
prior to the 1995 public offering is reflective of being a wholly owned
subsidiary of Kansas City Southern Industries, Inc. ("KCSI"). The Company
paid cash dividends of $150.0 million and $6.2 million to KCSI in 1995 and
1994, respectively, which have been excluded from this table. The
declaration and payment of dividends is at the discretion of the Board of
Directors which, prior to the 1995 public offering, was controlled by KCSI.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussions set forth in this Annual Report on Form 10-K contain statements
concerning potential future events. Such forward-looking statements are based
upon assumptions by the Company's management, as of the date of this Annual
Report, including assumptions about risks and uncertainties faced by the
Company. Readers can identify these forward-looking statements by their use of
such verbs as expects, anticipates, believes or similar verbs or conjugations of
such verbs. If any of management's assumptions are incorrect or should
unanticipated circumstances arise, the Company's actual results could materially
differ from those anticipated by such forward-looking statements. The
differences could be caused by a number of factors or combination of factors
including, but not limited to, those factors identified in the Company's amended
Current Report on Form 8-K dated March 25, 1999, which is hereby incorporated by
reference. This report has been filed with the United States Securities and
Exchange Commission ("SEC") in Washington, D.C. and can be obtained by
contacting the SEC's Public Reference Branch. Readers are strongly encouraged to
obtain and consider the factors listed in the March 25, 1999 Current Report and
any amendments or modifications thereof when evaluating any forward-looking
statements concerning the Company. The Company will not update any
forward-looking statements in this Annual Report to reflect future events or
developments.
INTRODUCTION
Originally established in 1969, DST is a leading global provider of
sophisticated information processing and computer software services and products
to the financial services industry (primarily mutual funds and investment
managers), communications industry and other service industries. In December
1998, USCS International, Inc. ("USCS") became a wholly owned subsidiary of the
Company through the issuance of approximately 13.8 million shares of common
stock ("USCS Merger"). The USCS Merger was accounted for under the pooling of
interests accounting method. The Company's business units have been aggregated
into three operating segments (Financial Services, Customer Management and
Output Solutions). In addition, certain investments in equity securities,
financial interests and real estate holdings have been aggregated into an
Investments and Other Segment.
The Financial Services Segment's revenues are generated from a variety of
sources. The Company's mutual fund, securities transfer and portfolio accounting
processing revenues are primarily dependent upon the number of accounts or
portfolios processed. The Company provides data processing services to Argus
Health Systems, Inc. ("Argus") and Computer Sciences Corporation Financial
Services Group ("CSC-FSG") to process their proprietary applications. Revenues
from Argus and CSC-FSG are primarily based upon data center capacity utilized,
which is significantly influenced by each company's volume of transactions. The
Company also licenses its work management software, certain investment
management and portfolio accounting software and securities exchange systems
and, outside the U.S., certain mutual fund shareowner accounting systems.
Revenues for licensed software products are primarily comprised of: (i) license
fees; (ii) consulting and development revenues based primarily on time and
materials billings; and (iii) annual maintenance fees. The license fee component
of these revenues is not material. The Financial Services Segment derives part
of its net income from its pro rata share in the earnings (losses) of certain
unconsolidated affiliates, primarily Boston Financial Data Services, Inc.
("BFDS"), Argus, European Financial Data Services Limited ("EFDS") and prior to
its merger with Computer Sciences Corporation ("CSC") discussed below, The
Continuum Company, Inc. ("Continuum").
26
The Customer Management Segment primarily derives its revenues from customer
management processing and computer software services and products based on the
number of end-users of the services offered by its clients, the number of bills
mailed and/or the number of images produced under multi-year bundled service and
usage agreements. Certain of the Company's customers, principally outside the
U.S., license the customer management software. Revenues for fixed fee license
agreements are recognized as the software is delivered and all customer
obligations have been met. Such fixed fee license amounts have not been
material.
The Output Solutions Segment's revenues for printing and mailing of customer
documents and archival depend on the number of statements mailed and/or the
number of images produced. Formatting and custom programming revenues are based
on time and materials billings or on the number of images produced. To attract
clients that want to take advantage of the Company's advanced output solutions
processing and functions in their own facilities, rather than on an outsourced
basis, the Company has licensed certain of its statement processing technology.
Revenues from licensed software products is not material.
The Investments and Other Segment's investment income (dividends and interest)
is recorded as other income. Income from financing leases is recognized as
revenue at a constant periodic rate of return on the net investment in the
lease. Rental income from Company owned and operated real estate is recorded as
revenue, but is eliminated in consolidation for the portion that relates to real
estate leased to the Company's other segments.
SIGNIFICANT EVENTS
USCS MERGER
Effective December 21, 1998, the Company acquired USCS, which was accounted for
as a pooling of interests. Accordingly, the Company's consolidated financial
statements for periods prior to December 21, 1998 have been restated to include
the financial position and results of operations of USCS. A summary of
historical results of DST and USCS are as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(DOLLARS IN MILLIONS)
Revenues
DST Systems, Inc................................................ $ 749.0 $ 650.7 $ 580.8
USCS International, Inc......................................... 347.1 299.3 263.2
--------- --------- ---------
Total revenues................................................ $ 1,096.1 $ 950.0 $ 844.0
--------- --------- ---------
--------- --------- ---------
Net income
DST Systems, Inc................................................ $ 73.9 $ 59.0 $ 167.2
USCS International, Inc......................................... 21.0 22.4 14.5
Conforming of accounting policies............................... (3.9) (2.0) (3.9)
Merger costs.................................................... (19.4)
--------- --------- ---------
Total net income.............................................. $ 71.6 $ 79.4 $ 177.8
--------- --------- ---------
--------- --------- ---------
In conjunction with the USCS Merger, certain conforming accounting adjustments
were recorded to conform the accounting policies of USCS relating primarily to
depreciation and amortization policies and the accounting for the costs of
software developed for internal USCS use. As a result of conforming accounting
policies, net income decreased $3.9 million, $2.0 million and $3.9 million for
each of the years ended December 31, 1998, 1997 and 1996, respectively.
Non-current assets decreased $33.3 million and $25.9 million at December 31,
1998 and 1997, respectively as a result of conforming
27
accounting policies. DST purchased 1.1 million shares of USCS common stock
during the fourth quarter of 1997 at a cost of $21.7 million. Prior to the USCS
Merger, there were no significant intercompany transactions between the Company
and USCS.
In the fourth quarter of 1998, the Company recorded $26.0 million ($19.4 million
net of taxes) of charges related to the USCS Merger.
In December 1998, DST's management approved plans which include initiatives to
integrate the operations of certain DST and USCS subsidiaries and consolidate
facilities. Total accrued integration costs of $16.9 million were recorded in
the fourth quarter of 1998, of which $0.7 million, $3.4 million and $12.8
million relate to the Financial Services, Customer Management and Output
Solutions Segments, respectively.
Accrued integration costs include $3.2 million for the severance cost of
involuntary separation benefits related to approximately 250 employees of which
approximately 50 employees have separated from the Company as of December 31,
1998. Employee separations will affect the majority of business functions and
job classifications across the Customer Management ($1.7 million) and Output
Solutions ($1.5 million) Segments, principally in North America.
The integration plans include $10.2 million related to lease abandonment costs,
elimination of certain non-strategic business lines and the closing of certain
production and administration centers associated with the Customer Management
($1.1 million) and Output Solutions ($9.1 million) Segments. For the locations
to be closed and the non-strategic business lines to be eliminated, the tangible
and intangible assets to be disposed of have been written down by $4.6 million
to fair value. The integration plans also include $2.7 million ($0.7, $0.2, and
$1.8 million for the Financial Services, Customer Management, and Output
Solutions Segments, respectively) related to purchased software and other
commited costs of software/communications systems that will be abandoned.
Additionally, $0.8 million ($0.4 million in each of the Customer Management and
Output Solutions Segments) of costs have been expensed related to terminating
certain contractual obligations which have no future benefit as a result of the
USCS Merger.
The cash and non-cash elements of the charge were approximately $9.5 million and
$7.4 million, respectively. Details of the merger charges are as follows:
UTILIZED
----------------------
BALANCE AT
ORIGINAL AMOUNT CASH NON-CASH DECEMBER 31, 1998
--------------- --------- ----------- -----------------
Employee severance benefits................... $ 3.2 $ 0.6 $ $ 2.6
Other......................................... 6.3 6.3
Write down of long-lived assets............... 7.4 7.4
----- --------- --- ---
$ 16.9 $ 0.6 $ 7.4 $ 8.9
----- --------- --- ---
----- --------- --- ---
Most of remaining employee severance benefits are expected to be paid in 1999.
The balance of the accrued costs is related primarily to facilities that will be
closed. Lease payments on closed facilities and abandoned equipment have terms
which end in 1999 through 2003. Location closures are planned to occur through
the year 2000 once arrangements have been made to process continuing business at
other facilities. Two of the locations have been closed as of December 31, 1998.
The costs of transitioning the continuing business have not been accrued.
DST expects that other integration costs will be incurred in the future which
cannot be accrued under current accounting rules and are dependent on management
decisions. Such costs could include, among other things, additional employee
costs, relocation and integration costs of moving to common internal systems.
Although precise estimates cannot be made, management does not believe such
costs will have
28
a materially adverse effect on the Company's consolidated results of operations,
liquidity or financial position.
Transaction costs for the USCS Merger of $9.1 million include investment banker
fees, legal fees and other costs paid in connection with the merger.
STOCK REPURCHASE PROGRAMS
In May 1996, the Board of Directors determined it was necessary for the Company
to have common stock available to provide to employees under its stock award
program and to provide to option holders who exercise options. The Board of
Directors authorized the purchase of up to 1.2 million shares during a
twenty-four month period in approximately equal monthly amounts. The Company
completed its purchase of the 1.2 million shares in March 1998 at a total cost
of approximately $42.7 million.
In December 1998, the Board of Directors approved a plan for DST to repurchase
600,000 shares of DST common stock at the rate of approximately 25,000 shares
per month in approximately equal monthly amounts beginning in February 1999,
subject to such variations as management considers appropriate, to provide
additional shares needed as a result of the USCS merger for use under various
DST option and benefit programs. Such purchases may be made in private or market
transactions and will be made in compliance with SEC regulations.
CREDIT AGREEMENTS
In December 1996, the Company entered into an amended and restated five-year
revolving credit facility of $105 million (increased to $125 million in February
1997) with a syndicate of U.S. and international banks. Borrowings under the
facility are available at rates based on the Eurodollar, Prime, Base CD, or
Federal Funds rates. A commitment fee of 0.085% per annum is required on the
total amount of the facility. An additional utilization fee of .050% is required
if the principal amount outstanding is greater than 50% of the total facility.
At December 31, 1998, no borrowings were outstanding under this facility.
EQUISERVE
In December 1998, Boston EquiServe LP ("Boston EquiServe") and First Chicago
Trust Company of New York completed a transaction creating EquiServe LP
("EquiServe"), the largest securities transfer agent in the U.S. Prior to the
transaction, Boston EquiServe was a limited partnership, 50% owned by Boston
Financial Data Services, Inc. ("BFDS") (a 50% owned joint venture of DST and
State Street Corporation) and 50% by BankBoston Corporation. DST is currently
developing a new securities transfer system ("Fairway") to be used exclusively
by EquiServe to process all of its accounts. DST has also agreed with EquiServe
to provide data processing services for EquiServe to use Fairway. Upon
acceptance of defined components of Fairway, DST will contribute Fairway and its
securities transfer processing business (approximately 2 million accounts) to
EquiServe for a 20% direct ownership interest in EquiServe (the "EquiServe
Contribution"). DST will also have a 10% indirect ownership interest in
EquiServe through BFDS after the EquiServe Contribution. DST believes that an
ownership in EquiServe provides the most effective participation in the
opportunities presented by the continued consolidation of the securities
transfer industry. The acceptance of the defined components of Fairway is
currently expected to occur in three stages beginning in the second quarter of
1999 and completing in the third quarter of 2000, at which time DST's
non-EquiServe stock transfer business will be transferred to EquiServe.
As Fairway is accepted and the transaction is completed, DST plans to account
for the EquiServe Contribution as a non-cash, non-taxable exchange. Accordingly,
no gain will be recognized from the EquiServe Contribution. The capitalized
costs associated with the Fairway development along with the net assets of the
securities transfer business contributed will become the basis of DST's
investment in
29
EquiServe. DST expensed costs of Fairway development of $8.7 million, $3.6
million and $2.2 million in 1998, 1997 and 1996, respectively. The Company
expects to account for the investment in EquiServe on the equity method.
CONTINUUM
On August 1, 1996, Continuum merged with CSC in a tax-free share exchange and as
a result became a wholly owned subsidiary of CSC. DST, which prior to the merger
owned approximately 23% of Continuum, received in the exchange CSC common stock
with a value of $295 million based upon the closing price of CSC common stock on
August 1, 1996. DST recognized a one-time gain after taxes and other expenses of
$127.6 million. In connection with the merger, DST elected to make a one-time
$13.7 million ESOP contribution to provide funding for certain Continuum
employee withdrawals from DST's ESOP. DST's shares of CSC represent an
approximate 5% interest in the combined company. As a result of the merger,
Continuum ceased to be an unconsolidated equity affiliate of DST and under
generally accepted accounting principles, no part of Continuum or CSC future
earnings since that time have been recognized by DST. DST recognized equity in
losses of Continuum of $4.9 million in 1996. DST's investment in CSC is
accounted for as available-for-sale securities. Although CSC does not currently
pay cash dividends, DST will recognize dividend income on any cash dividends
received from CSC.
DST currently provides data processing operations for CSC-FSG, formerly
Continuum, through DST's Winchester Data Center under a contract expiring in
September 1999. The merger has not affected the DST's existing agreements with
CSC-FSG for distribution of DST's AWD workflow management software to the
insurance and banking industries.
Although DST has limited registration rights with respect to the sale of the CSC
stock DST owns, any dispositions of such stock may be restricted by securities
laws. DST has no present intention to dispose of such stock.
In March 1996, Continuum, a then 29% owned unconsolidated affiliate of DST,
announced the completion of its merger with Hogan Systems, Inc. ("the Hogan
Merger"), a provider of software to banks and financial institutions, for shares
of Continuum stock. As a result of this merger, DST's common stock interest in
Continuum was reduced from approximately 29% to approximately 23%. As a result,
DST recorded in March 1996 its estimated $9.4 million after-tax share of a
non-recurring charge recorded by Continuum in connection with the Hogan Merger.
CUSTIMA ACQUISITION
In August 1998, USCS purchased 100% of the stock ("Custima Acquisition") of
United Kingdom based Custima International Holdings, plc ("Custima") for
approximately $15.4 million. The business acquired provides customer management
software for the utilities industry. The acquisition was accounted for as a
purchase, and accordingly, the Company's financial statements include Custima's
results of operations from the date of acquisition.
The purchase includes existing technology, in-process research and development
(IPR&D), trademarks and in-place workforce with an aggregate value of
approximately $18.1 million. The purchase price exceeded the fair market value
of net tangible assets acquired by $15.1 million; however, the purchase price
was less than the estimated fair value of all assets (tangible and intangible)
acquired. Accordingly, the non-current assets recorded in the transaction
(including IPR&D projects) were reduced on a pro-rata basis such that the total
amount of the assets recorded did not exceed the consideration paid.
The Company engaged a third party to perform an appraisal of the Custima
Acquisition (including the IPR&D projects acquired). The IPR&D projects included
improvements and increased functionality to the core billing product to adapt it
for competitive use within the U.S. and development of a new
30
Java-based product which will allow large utilities to benefit from an advanced
billing system while utilizing their existing legacy database.
The IPR&D projects were estimated to be approximately 60% complete as of the
date of acquisition and were assigned a total value of $7.1 million (using the
income method discounted at 30% which did not differ significantly from the
stage of completion method, reduced to $6.0 million as result of the total
amount of the assets acquired from Custima, exceeding the consideration paid).
Phased completion and delivery of the projects are expected through mid-year
2000. The estimated cost of completion for the projects is $7.5 million with
cash inflows expected to commence shortly after the respective completion dates.
As with any software development project, there are inherent development risks
and periodic review of the projects can result in changes to the development
plan and the Company's business plans for the software.
In accordance with applicable accounting principles, the assigned value of the
IPR&D ($6.0 million) was expensed at the date of acquisition. Also, a charge for
redundant facilities and workforce of $1.1 million was recorded in connection
with USCS's purchase and consolidation of Custima. Intangible assets (other than
IPR&D) are being amortized on a straight-line basis over periods ranging from 3
to 10 years. On a pro forma basis, the acquisition did not have a material
impact on the Company's historical results of operations or financial position.
DBS SYSTEMS CORPORATION ("DBS SYSTEMS")
In October 1997, the Company purchased the remaining 20% minority interest in
DBS Systems for $13.2 million in cash. The $11.6 million excess of the purchase
price over the net assets acquired has been assigned a useful life of 12 years.
The Company had previously acquired 20% and 60% of DBS Systems in December 1995
and May 1993, respectively. On a pro forma basis, the acquisition did not have a
material impact on the Company's historical results of operations or financial
position.
31
RESULTS OF OPERATIONS
The following table summarizes the Company's operating results (dollars in
millions, except per share amounts).
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
OPERATING RESULTS
REVENUES
Financial Services.............................................. $ 507.6 $ 425.0 $ 378.2
Customer Management............................................. 221.7 202.9 172.3
Output Solutions................................................ 414.7 366.4 334.2
Investments and Other........................................... 34.1 33.7 25.9
Eliminations.................................................... (82.0) (78.0) (66.6)
--------- --------- ---------
$ 1,096.1 $ 950.0 $ 844.0
--------- --------- ---------
--------- --------- ---------
% change from prior year........................................ 15.4% 12.6% 18.3%
INCOME FROM OPERATIONS BEFORE MERGER CHARGES AND OTHER EXPENSES
Financial Services.............................................. $ 85.4 $ 66.2 $ 47.1
Customer Management............................................. 22.3 28.3 15.8
Output Solutions................................................ 36.1 24.3 23.9
Investments and Other........................................... 8.8 8.1 5.1
--------- --------- ---------
152.6 126.9 91.9
MERGER CHARGES AND OTHER EXPENSES................................. 33.1 13.7
--------- --------- ---------
INCOME FROM OPERATIONS............................................ 119.5 126.9 78.2
Interest expense................................................ (8.6) (8.5) (10.5)
Other income, net............................................... 7.4 5.8 4.5
Gain on sale of Continuum....................................... 223.4
Equity in losses of unconsolidated affiliates, net of income
taxes......................................................... (2.7) (1.3) (4.0)
--------- --------- ---------
INCOME BEFORE INCOME TAXES AND MINORITY INTERESTS................. 115.6 122.9 291.6
Income taxes.................................................... 44.3 42.9 113.3
Minority interests.............................................. (0.3) 0.6 0.5
--------- --------- ---------
NET INCOME........................................................ $ 71.6 $ 79.4 $ 177.8
--------- --------- ---------
--------- --------- ---------
Basic earnings per share.......................................... $ 1.14 $ 1.25 $ 2.82
Diluted earnings per share........................................ $ 1.11 $ 1.23 $ 2.78
CONSOLIDATED REVENUES
Consolidated revenues increased $146.1 million or 15.4% in 1998 and $106.0
million or 12.6% in 1997. Revenue growth in 1998 was primarily a result of an
$82.6 million, or 19.4%, increase in Financial Services Segment revenues. This
increase in 1998 Financial Services Segment revenues resulted from increased
U.S. revenues of $52.1 million or 15.4%, primarily from an increase in mutual
fund shareowner accounts processed of 10.7% to 49.8 million at December 31,
1998, and an increase in international revenues of $30.5 million or 35.1% from
increased investment accounting software licenses and services and growth in
Canadian mutual fund processing revenues. These same trends contributed to the
1997 Financial Services Segment revenue growth of $46.8 million or 12.4% as U.S.
mutual fund shareowner accounts processed increased 9.5% to 45.0 million at
December 31, 1997.
Customer Management Segment revenues increased $18.8 million or 9.3% in 1998 and
$30.6 million or 17.8% in 1997. Exclusive of Tele-Communications, Inc. ("TCI")
(discontinued customer), revenues
32
increased $31.6 million or 20.5% in 1998 and $33.9 million or 28.2% in 1997.
Growth in non-TCI customer management revenues resulted primarily from increases
in the number of subscribers of existing and new clients in the U.S. and
international markets, increases in prices allowed by existing contracts, and
migration of clients to higher priced services. In addition, the August 1998
acquisition of Custima added $3.9 million to 1998 revenues.
Output Solutions Segment revenues increased $48.3 million or 13.2% in 1998 and
$32.2 million or 9.6% in 1997. The growth is a result of an increase in volume
of statements and images produced from the growth in existing customers in the
Financial Services and Customer Management Segments and the acquisition of new
customers, primarily in telecommunications and other high-volume markets.
Investments and Other Segment revenues increased $0.4 million or 1.2% in 1998
and $7.8 million or 30.1% in 1997. Segment revenues are primarily rental income
for facilities leased to the Company's operating segments. The increase in 1997
results from the leasing of additional facilities.
INCOME FROM OPERATIONS BEFORE MERGER CHARGES AND OTHER EXPENSES
Consolidated income from operations before merger charges and other expenses,
increased $25.7 million or 20.2% in 1998 and $35.0 million or 38.1% in 1997. The
operating margin before merger charges and other expenses, was 13.9%, 13.4% and
10.9% in 1998, 1997 and 1996, respectively. The growth in 1998 was primarily a
result of a $19.2 million or 29.0% increase in the Financial Services Segment,
which resulted in an operating margin, before merger charges and other expenses,
of 16.8% in 1998 compared to 15.6% in 1997. The increase in 1998 Financial
Services Segment operating margin resulted from increased U.S. revenue and a
significant improvement in international operations. The improvement in 1997
Financial Services operating margin resulted from increased U.S. revenues.
In 1998, Customer Management Segment income from operations before merger
charges and other expenses decreased $6.0 million or 21.2% in 1998, primarily
attributable to costs incurred in transitioning new customers onto the Company's
products and services while transitioning TCI off and the consolidation of
Custima's operations. In 1997, Customer Management Segment income from
operations before merger charges and other expense, increased $12.5 million or
79.1% from increased revenues, productivity improvements as well as cost
containment efforts, and an increase in change order development revenues.
Output Solutions Segment income from operations before merger charges and other
expenses increased $11.8 million or 48.6% in 1998 and $0.4 million or 1.7% in
1997. Output Solutions Segment operating margin was 8.7%, 6.6% and 7.2% in 1998,
1997 and 1996, respectively. The decline in the 1997 operating margin percentage
is a result of increased costs associated with facility expansion,
implementation of new manufacturing and management information systems,
improvement and expansion of certain bill processing lines and new customer
conversions. The improvement in the 1998 operating margin percentage results
from processing efficiencies and increased volumes.
Investments and Other Segment income from operations before merger charges and
other expenses, was $8.8 million, $8.1 million, and $5.1 million in 1998, 1997
and 1996, respectively. The 1998 and 1997 operating margin was favorably
impacted from an increase in rental income as compared to 1996.
MERGER CHARGES AND OTHER EXPENSES
The 1998 results include recognition of $26.0 million of merger charges related
to the USCS Merger and $7.1 million of merger charges related to the Custima
Acquisition. In 1996, in connection with the Continuum Merger, the Company
accrued a one-time $13.7 million ESOP contribution which provided funding for
certain Continuum employee withdrawals from the ESOP.
33
INTEREST EXPENSE
Interest expense was $8.6 million in 1998 as compared to $8.5 million in 1997.
Average debt balances and interest rates for 1998 and 1997 were essentially the
same. Interest expense for 1997 decreased by $2.0 million, or 19.0% compared to
1996. Proceeds of the second quarter public stock offering were utilized to pay
down existing debt and resulted in decreased interest expense on a comparative
basis.
OTHER INCOME, NET
Other income consists mainly of dividends received on investments held by the
Company (principally shares of State Street stock) and amortization of deferred
non-operating gains. The 1998, 1997 and 1996 amounts include $1.9 million, $1.5
million and $0.4 million, respectively, of gains on the sale of marketable
securities.
GAIN ON THE SALE OF CONTINUUM
The 1996 amount represents the Company's gain on the Continuum Merger.
EQUITY IN LOSSES OF UNCONSOLIDATED AFFILIATES
Equity in losses of unconsolidated affiliates increased $1.4 million in 1998 as
a result of lower earnings at Argus and non-recurring real estate debt financing
costs. Argus' 1998 earnings declined as a result of a significant client not
renewing its processing contract which expired in the first quarter of 1998.
Equity in losses of unconsolidated affiliates of $1.3 million were recorded in
1997 as compared to $0.9 million of equity in earnings in 1996 (excluding equity
in losses of Continuum from 1996 results) as a result of increased losses at
EFDS, partially offset by improved earnings at BFDS and Argus.
DST recorded losses from EFDS of $11.1 million, $11.8 million and $6.0 million
in 1998, 1997 and 1996, respectively. The losses at EFDS were the result of the
continued development of the new FAST2000 software and conversion activity
associated with converting existing clients from the old system to FAST2000.
EFDS' 1998 and 1997 costs were also impacted by business growth as accounts
serviced increased 40% to 1.4 million accounts in 1998 and 150% to 1.0 million
accounts in 1997.
INCOME TAXES
The Company's effective tax rate was 38.4%, 34.9% and 38.8% for the years ended
December 31, 1998, 1997 and 1996, respectively. Excluding the impact of the
previously discussed 1998 merger charges and all 1996 Continuum related equity
in earnings, gains and charges, the Company's effective tax rate would have been
34.5%, 34.9% and 36.4% for 1998, 1997 and 1996, respectively. The primary
difference between the Company's effective tax rate and the combined federal and
state statutory rates is the result of deferred taxes being provided for
unremitted earnings of U.S. unconsolidated affiliates net of the dividends
received deduction provided under current tax law, increased tax benefits
associated with 1998 and 1997 international operations, and the benefits
associated with new 1998 Missouri income apportionment rules designed to attract
and retain mutual fund service companies.
NET INCOME
The Company's net income (and earnings per share) for 1998, 1997 and 1996 was
$71.6 million ($1.14 basic earnings per share and $1.11 diluted earnings per
share), $79.4 million ($1.25 basic earnings per share and $1.23 diluted earnings
per share), and $177.8 million ($2.82 basic earnings per share and $2.78 diluted
earnings per share), respectively. Excluding the impact of the previously
discussed 1998 merger charges and all 1996 Continuum related equity in earnings,
gains and charges, the Company's net income and earnings per share for 1998,
1997, and 1996 would have been $97.7 million ($1.56 basic earnings per share and
$1.52 diluted earnings per share), $79.4 million ($1.25 basic earnings per share
34
and $1.23 diluted earnings per share), and $54.7 million ($0.87 basic earnings
per share and $0.85 diluted earnings per share), respectively.
YEAR TO YEAR BUSINESS SEGMENT COMPARISONS
FINANCIAL SERVICES SEGMENT
REVENUES
Financial Services Segment revenues for 1998 increased 19.4% over 1997 to $507.6
million. U.S. Financial Services revenues increased 15.4% to $390.1 million in
1998. U.S. mutual fund processing revenues for 1998 increased 16.0% over the
prior year as shareowner accounts serviced increased 10.7% from 45.0 million at
December 31, 1997 to 49.8 million at December 31, 1998. During the fourth
quarter of 1998 new clients with 1.7 million accounts were added, while 1.7
million accounts derived from a broker-dealer were converted to the
broker-dealer's system. The Company also recognized a $3.9 million contract
termination fee in the fourth quarter 1998 from GT Global which terminated its
services with the Company as a result of its acquisition by the AIM Management
Group and a one-time $2.6 million contract termination fee from Zurich Kemper
Investments in the first quarter 1998 as a result of its merged operations with
Scudder. U.S. AWD product revenues for 1998 increased 17.0% over the prior year
primarily due to an increase in the number of AWD workstations licensed.
Financial Services Segment revenues from international operations for 1998
increased 35.1% to $117.5 million. The revenue increase resulted primarily from
increased investment accounting software licenses and services and growth in
Canadian mutual fund shareowner processing revenues. In addition, 1998 revenues
of $3.1 million were recorded by DST Catalyst, Inc. as compared to $1.2 million
during 1997. DST Catalyst was acquired in August 1997.
Segment revenues for the year ended December 31, 1997 increased 12.4% over 1996
to $425.0 million. U.S. revenues increased 9.7% to $338.0 million in 1997. U.S.
mutual fund processing revenues for 1997 increased 11.5% over the prior year as
shareowner accounts serviced increased 9.5% from 41.1 million at December 31,
1996 to 45.0 million at December 31, 1997. Accounts serviced at December 31,
1997 include approximately 900,000 accounts which were converted to TA2000
during the fourth quarter 1997. U.S. AWD product revenues for 1997 increased
10.5% over the prior year primarily due to an increase in the number of AWD
workstations licensed.
Segment revenues from international operations for 1997 increased 24.3% to $87.0
million, driven primarily by increases in investment accounting and AWD license
and service revenues. In addition, 1997 revenues of $1.2 million were recorded
by DST Catalyst, Inc. which was acquired in August 1997.
COSTS AND EXPENSES
Segment costs and expenses for 1998 and 1997 increased 19.3% to $360.5 million
and 10.9% to $302.3 million over the comparable prior year periods. Personnel
costs for 1998 and 1997 increased 24.0% and 13.6% over the comparable prior year
periods as a result of increased staff levels to support volume growth,
development costs for the Company's new securities transfer system (Fairway) and
increased wages for data processing professionals. In addition, the
renegotiation of certain third party software agreements, effective March 31,
1998, resulted in certain amounts being recorded as costs and expenses instead
of as depreciation expense.
The Financial Services Segment has experienced increases in costs necessary to
hire and retain computer programmers and other systems professionals. While
these cost increases have not materially affected the Company's overall cost
structure to date, the Company believes that the costs associated with computer
programmers and other systems professionals may continue to increase at least
through the Year 2000 at rates above general inflation.
35
DEPRECIATION AND AMORTIZATION
Segment depreciation and amortization for 1998 increased 9.2% or $5.2 million.
The increase is primarily attributable to increased capital additions during
1998 and the fourth quarter of 1997, a one-time write-off of intangible assets
totaling $3.2 million in the first quarter 1998 and a $1.4 million accelerated
write-off of personal computers scheduled for replacement in the fourth quarter
1998, partially offset by the renegotiation of certain third party software
agreements, effective March 31, 1998, resulted in certain amounts being recorded
as costs and expenses instead of as depreciation expense. Segment depreciation
and amortization for 1997 decreased 3.3% or $1.9 million. The containment of
depreciation and amortization expenses in 1997 was primarily the result of lower
capital expenditures in 1997 and 1996 compared to prior years, decreases in the
unit costs of electronic data processing equipment and the Company's use of
accelerated depreciation methods.
INCOME FROM OPERATIONS BEFORE MERGER CHARGES AND OTHER EXPENSES
The Segment's income from operations before merger charges and other expenses
for 1998 and 1997, increased 29.0% to $85.4 million and 40.6% to $66.2 million
over the comparable prior year periods. The Segment's operating margins,
excluding merger charges, were 16.8%, 15.6% and 12.5% in 1998, 1997 and 1996.
The increases in Financial Services Segment operating margins are a result of
increased U.S. revenue and a significant improvement in international
operations.
CUSTOMER MANAGEMENT SEGMENT
REVENUES
Customer Management Segment revenues for 1998 increased 9.3% to $221.7 million
from $202.9 million in 1997. Equipment sales and services revenue increased to
$25.0 million in 1998 from $18.8 in 1997. Customer Management Segment revenues
for 1997 increased by 17.7% to $202.9 million from $172.3 million in 1996. The
growth in Customer Management Segment software and services revenues, exclusive
of revenue from TCI, came primarily from increases in the number of subscribers
of existing and new clients in the U.S. and international markets, increases in
prices allowed by existing contracts, and migration of clients to higher-priced
services. In addition, the August 1998 acquisition of Custima added $3.9 million
to 1998 revenues.
During 1998, TCI continued to remove subscribers from the Company's systems.
Revenues and percent of total Customer Management Segment revenues from TCI,
respectively, totaled $35.9 million and 16.2% in 1998, $48.7 million and 24.0%
in 1997, and $52.0 and 30.2% in 1996. Exclusive of revenues from TCI, the 1998
and 1997 revenue increases were 20.5% and 28.2%, respectively, as compared to
the prior year. TCI subscribers serviced by the Company totaled 2.4 million,
10.9 million and 11.4 million at December 31, 1998, 1997 and 1996, respectively.
The Company expects the TCI subscriber count to decrease to 1.0 million by June
1999.
COSTS AND EXPENSES
Segment costs and expenses for 1998 and 1997 increased 14.2% to $187.8 million
and 11.4% to $164.5 million over the comparable prior year periods. Personnel
costs for 1998 and 1997 increased 19.6% and 18.9%, respectively, over the
comparable prior year periods as a result of increased staff levels to support
volume growth and research and development costs relating primarily to ongoing
product development.
The Company has experienced increases in costs necessary to hire and retain
computer programmers and other systems professionals. While these cost increases
have not materially affected the Company's
36
overall cost structure to date, the Company believes that the costs associated
with computer programmers and other systems professionals may continue to
increase at least through the Year 2000 at rates above general inflation.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization for 1998 and 1997 increased 14.9% to $11.6 million
and 13.5% to $10.1 million over the comparable prior year periods. The increases
in 1998 and 1997 are primarily attributable to increased goodwill amortization
relating to the Company's purchase of the remaining 20% minority interest in DBS
Systems in October 1997.
INCOME FROM OPERATIONS BEFORE MERGER CHARGES AND OTHER EXPENSES
The Segment's income from operations before merger charges and other expenses
for 1998 decreased $6.0 million as compared to 1997. The 1998 decrease is
attributable to costs associated with transitioning new customers on to the
Company's products and services while transitioning TCI off, increased goodwill
amortization relating to the Company's purchase of the remaining 20% minority
interest in DBS Systems in October 1997 and the 1998 consolidation of Custima's
operations. The Segment's income from operations before merger charges and other
expenses for 1997 increased $12.5 million as compared to 1996. The 1997 increase
is primarily attributable to increased subscriber and change order revenue in
1997. The Segment's operating margin before merger charges and other expenses
was 10.1%, 14.0% and 9.2% in 1998, 1997 and 1996, respectively.
OUTPUT SOLUTIONS SEGMENT
REVENUES
Output Solutions Segment revenues for 1998 increased 13.2% to $414.7 million as
compared to 1997. Output Solutions Segment revenues for 1997 increased by 9.6%
to $366.4 million from $334.2 million in 1996. The growth in segment revenue was
derived from an increase in the volume of statements and images produced because
of the growth of existing customers in the Financial Services and Customer
Management Segments and the acquisition of new customers, primarily in
telecommunications and other high-volume markets.
COSTS AND EXPENSES
Segment costs and expenses for 1998 and 1997 increased 12.2% to $350.9 million
and 10.4% to $312.8 million over the comparable prior year periods. Personnel
costs for 1998 and 1997 increased 11.9% and 13.2% over the comparable prior year
periods as a result of increased staff levels to support volume growth and
research and development costs relating primarily to ongoing product
development. In addition, costs of $5.1 million, $7.2 million and $4.7 million
to develop and implement a new manufacturing system were included in 1998, 1997
and 1996, respectively.
The Company has experienced increases in costs necessary to hire and retain
computer programmers and other systems professionals. While these cost increases
have not materially affected the Company's overall cost structure to date, the
Company believes that the costs associated with computer programmers and other
systems professionals may continue to increase at least through the Year 2000 at
rates above general inflation.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization for 1998 decreased 5.5% to $27.7 million as
compared to 1997. Depreciation and amortization for 1997 increased 8.5% to $29.3
million from $27.0 million in 1996. The containment of depreciation and
amortization expenses in 1998 is primarily the result of lower capital
37
expenditures in 1997 and 1998 compared to prior years, decreases in the unit
costs of electronic data processing equipment and the Company's use of
accelerated depreciation methods. The increase in depreciation and amortization
in 1997 as compared to 1996 is attributable to facility expansion and the
improvement and expansion of certain bill processing lines.
INCOME FROM OPERATIONS BEFORE MERGER CHARGES AND OTHER EXPENSES
The Segment's income from operations before merger charges and other expenses
for 1998 increased $11.8 million or 48.6% primarily attributable to realizing
processing efficiencies and economies of scale. In 1997, the Output Solutions
Segment's income from operations before merger charges and other expense,
increased $0.4 million or 1.6% as compared to 1996. The increase in income from
operations was significantly lower than the increase in revenues due to costs
associated with facility and processing line improvements and expansion, costs
to develop and implement a new manufacturing system, and new customer
conversions. The Segment's operating margins, excluding merger charges, were
8.7%, 6.6% and 7.2% in 1998, 1997 and 1996.
INVESTMENTS AND OTHER SEGMENT
REVENUES
Investments and Other Segment revenues totaled $34.1 million, $33.7 million and
$25.9 million in 1998, 1997 and 1996, respectively. Real estate revenues of
$27.8 million, $28.9 million and $22.6 million in 1998, 1997 and 1996 were
primarily derived from the lease of facilities to the Company's other business
segments. Revenues of $6.3 million, $4.8 million and $3.2 million in 1998, 1997
and 1996 were derived from the Segment's hardware leasing activities.
COSTS AND EXPENSES
Investments and Other Segment costs and expenses decreased in 1998 and increased
in 1997 primarily as a result of changes in real estate related costs.
DEPRECIATION AND AMORTIZATION
Investments and Other Segment depreciation and amortization increased $0.2
million in 1998 as a result of increased depreciation related to additional real
estate leasing activities and an increase in depreciation related to equipment
leased to customers. Depreciation and amortization increased by $2.8 million in
1997 as a result of an increase in depreciation related to equipment leased to
customers partially offset by a decrease in deprecation related to real estate
leasing activities.
INCOME FROM OPERATIONS BEFORE MERGER CHARGES AND OTHER EXPENSES
The segment's income from operations before merger charges and other expenses
totaled $8.8 million, $8.1 million and $5.1 million in 1998, 1997, and 1996. The
increase in 1997 and 1998 income from operations as compared to 1996 is
primarily related to increased revenues from real estate and hardware leasing
activities.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash flow from operating activities totaled $274.8 million, $148.7
million and $136.8 million in 1998, 1997 and 1996, respectively. Operating cash
flows in 1998 were impacted by net income of $71.6 million and the impact of
depreciation and amortization of $108.8 million, other non-cash charges and
accruals totaling $29.7 million (primarily the USCS Merger charges and the
Custima Acquisition merger charges) and $65.9 million of increases in other
liabilities (primarily customer deposits and deferred revenues). The Company
utilized its 1998 operating cash flow to reinvest
38
in its existing business, fund investments and advances to unconsolidated
affiliates, repay debt and fund treasury stock purchases.
Operating costs include software development and maintenance costs relating to
internal use proprietary systems and non-capitalizable costs for systems to be
sold or licensed to third parties of approximately $165.5 million, $135.6
million and $107.2 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Capitalized development costs for systems to be sold or licensed
to third parties were approximately $2.5 million, $3.1 million and $0.3 million
for the years ended December 31, 1998, 1997 and 1996, respectively.
Accounts receivable increased in 1998 by approximately $13.0 million or 4.8%
primarily because of the increase in revenue. The Company collects from its
clients and remits to the U.S. Postal Service a significant amount of postage. A
significant number of contracts allow the Company to pre-bill and/or require
deposits from its clients to mitigate the effect on cash flow.
The Company continues to make significant investments in capital equipment and
facilities. During the years ended December 31, 1998, 1997 and 1996, the Company
expended approximately $132.7 million, $82.6 million and $100.9 million,
respectively, in capital expenditures for equipment and facilities which
includes amounts directly paid by third-party lenders. Capital expenditures for
1998 include $17.4 million for assets placed in service in 1997 but not paid for
until 1998. Future capital expenditures are expected to be funded primarily by
cash flows from operating activities, secured term notes or bank lines of credit
as required.
The Company expended approximately $48.0 million, $16.1 million and $23.3
million primarily for investments and advances to unconsolidated affiliates
during 1998, 1997 and 1996, respectively. In addition, the Company expended
$14.2 million, $16.8 million and $3.2 million during 1998, 1997 and 1996,
respectively, for acquisitions previously described, net of cash acquired. The
Company received proceeds of $12.4 million in 1997 from the sale of equity
investments including $9.6 million from the sale of the Company's equity
investment in First of Michigan Capital Corporation.
The Company used its positive operating cash flow to reduce its debt. Total
long-term debt, including the current portion, was $61.8 million as of December
31, 1998 compared to $115.2 million at December 31, 1997. The Company maintains
$100 million in bank lines of credit for working capital requirements and
general corporate purposes, of which $50 million matures May 1999, $20 million
matures December 1999 and $30 million matures December 2000. The Company also
maintains a $125 million line of credit with a syndicate of U.S. and
international banks which is available through December 2001. Borrowings under
these facilities totaled $23.0 million at December 31, 1998.
In May 1996, the Board of Directors determined it was necessary for the Company
to have common stock available to provide to employees under its stock award
program and to provide to option holders who exercise options. The Board of
Directors authorized the purchase of up to 1.2 million shares during a
twenty-four month period in approximately equal monthly amounts subject to such
variations as management deemed appropriate. The Company expended $10.0 million,
$20.3 million, and $12.5 million in 1998, 1997 and 1996, respectively to
complete the purchases under this plan.
In December 1998, the Board of Directors approved a plan to repurchase 600,000
shares of common stock at a rate of approximately 25,000 shares per month
beginning in February 1999 to provide additional shares for use under various
DST option and benefit programs needed as a result of the USCS Merger. Such
purchases may be made in private or market transactions and will be made in
compliance with SEC regulations.
In the fourth quarter 1997, DST expended $21.7 million to purchase 1.1 million
shares of USCS common stock. These shares were retired in conjunction with the
USCS Merger.
39
USCS, prior to the USCS Merger, expended approximately $6.2 million in 1998 and
$10.2 million in 1997 for the repurchase of common stock in order to meet
obligations under stock option plans, employee stock purchase plans and 401(k)
retirement plans. Substantially all these shares were reissued under the plans,
prior to the consummation of the USCS Merger.
The Company believes that its existing cash balances and other current assets,
together with cash provided by operating activities and, as necessary, the
Company's bank and revolving credit facilities, will suffice to meet the
Company's operating and debt service requirements and other current liabilities
for at least the next 12 months. Further, the Company believes that its longer
term liquidity and capital requirements will also be met through cash provided
by operating activities and bank credit facilities, as well as the Company's
$125 million revolving credit facility described above.
OTHER
YEAR 2000
Many computer programs use only two digits to identify a year in a date field
within the program (e.g., "98" or "02"). If not corrected, computer applications
making calculations and comparisons in different centuries may cause inaccurate
results, or fail by or at the Year 2000. These Year 2000-related issues are of
particular importance to the Company. The Company depends upon its computer and
other systems and the computer and other systems of third parties to conduct and
manage the Company's business. Additionally, the Company's products and services
depend upon using accurate dates in order to function properly. These Year
2000-related issues may also adversely affect the operations and financial
performance of one or more of the Company's customers or suppliers. As a result,
the failure of the Company's computer and other systems, products or services,
or the computer systems and other systems upon which the Company depends, or of
the Company's customers or suppliers to be Year 2000 ready could have a material
adverse effect on the Company.
The Company has completed its review and evaluation of its mission critical U.S.
shareowner accounting and U.S. portfolio accounting related products, services
and internal systems and achieved material Year 2000 readiness in such products,
services and systems as of December 31, 1998. The Company anticipates readiness
for its other mission critical products, services and systems and products by
September 30, 1999. The Company will continue testing its systems with clients
and other third parties for Year 2000 related issues as needed throughout 1999,
as well as assisting clients with interrelated hardware and software upgrades,
subject to the cooperation of such third parties. The Company licenses certain
of its software products to third parties. The Company expects that customers
which elect to upgrade to current versions and customers with current
maintenance contracts will be provided with Year 2000 ready software by June 30,
1999. In certain cases, the Company will be required under applicable
maintenance contracts to provide Year 2000 ready software free of charge. The
Company believes that the cost of such upgrades will be immaterial.
The Company believes it will not experience any material Year 2000 problems from
most of its major vendors and suppliers; however, the Company is unable to
determine whether certain suppliers, principally the Company's utilities
providers, will likely be Year 2000 ready in time. As part of addressing its
Year 2000 issues, the Company is developing contingency plans. The Company has
had for several years formal contingency plans, including an uninterruptable
power supply with permanent generator backup, for its Winchester and Poindexter
Data Centers in the event of a natural disaster. The contingency plans are being
revised to address, to the extent possible, failures that could be caused by
Year 2000 issues. The Company expects to formalize contingency plans for its
U.S. shareowner accounting and U.S. portfolio accounting business units, which
would incorporate Year 2000 related contingencies, by March 31, 1999 and to
complete testing of the contingency plans by June 30, 1999. The Company expects
to formalize contingency plans for its other mission critical products, services
and systems by June 30, 1999 and to test the contingency plans by September 30,
1999. There can be no assurances
40
that an acceptable contingency plan can be developed for certain suppliers, such
as utilities, or that any such plan would successfully protect the Company from
any Year 2000 exposure. The costs to address the Year 2000 related issues to
date have not been material, and the Company does not anticipate such costs to
become material in the future.
Although the Company is not aware of any material operational or financial Year
2000-related issues not being addressed, the Company cannot assure that its
computer systems, products, services or other systems or the computers and other
systems of others upon which the Company depends will be Year 2000 ready on
schedule, that the costs of its Year 2000 program will not become material or
that the Company's alternative plans will be adequate. The Company is currently
unable to anticipate accurately the magnitude, if any, of the Year 2000-related
issues arising from the Company's customers or suppliers. If any such risks
(either with respect to the Company or its customers or suppliers) materialize,
the Company could experience material adverse consequences to its business.
INTERNAL USE SOFTWARE
Effective January 1, 1999, the Company adopted, as required, Statement of
Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." Prior to the adoption of SOP 98-1, the Company
expensed the costs of internally developed proprietary software as it was
incurred. SOP 98-1, effective for fiscal periods beginning after December 15,
1998, requires that certain costs for the development of internal use software
should be capitalized, including the costs of coding, software configuration,
upgrades and enhancements. Based on internal software development plans, the
Company estimates that $14.0 million to $20.0 million of costs related to the
development of internal use software could be capitalized for the year ending
December 31, 1999, net of related amortization. These costs, which have been
previously expensed, will be amortized under the Company's current policy on a
straight-line basis, depending on the nature of the project, generally over a
three to five year period beginning on the date such software is placed in
service. The estimated range of capitalizable development costs for internal use
software reflects the Company's current views. There may be differences between
these estimates and actual development costs, and those differences may be
material.
SEASONALITY
Generally, the Company does not have significant seasonal fluctuations in its
business operations. Processing and output solutions volumes for mutual fund
customers are usually highest during the quarter ended March 31 due primarily to
processing year-end transactions and printing and mailing of year-end statements
and tax forms during January. The Company has historically added operating
equipment in the last half of the year in preparation for processing year-end
transactions which has the effect of increasing costs for the second half of the
year. Revenues and operating results from individual license sales depend
heavily on the timing and size of the contract.
COMPREHENSIVE INCOME
The Company's comprehensive income totaled $232.8 million, $181.9 million and
$252.0 million in 1998, 1997 and 1996, respectively. Comprehensive income
consists of net income of $71.6 million, $79.4 million and $177.8 million and
other comprehensive income of $161.2 million, $102.5 million and $74.2 million
in 1998, 1997 and 1996, respectively. Other comprehensive income consists of
unrealized gains (losses) on available-for-sale securities and foreign currency
translation adjustments. The Company had net unrealized gains on
available-for-sale securities of $161.2 million, $104.1 million and $72.6
million in 1998, 1997 and 1996, respectively. The Company's net unrealized gains
on available-for-sale securities results primarily from market appreciation of
the Company's investments in approximately 8.6 million shares of CSC common
stock and 6.0 million shares of State Street common stock. At December 31, 1998,
these two investments had an aggregate pre-tax unrealized gain of
41
$581.8 million. The amounts of foreign currency translation adjustments included
in other comprehensive income are immaterial.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the operations of its businesses, the Company's financial results can be
affected by changes in interest rates, currency exchange rates and equity
pricing. Changes in interest rates and exchange rates have not materially
impacted the consolidated financial position, results of operations or cash
flows of the Company. Changes in equity values of the Company's investments have
had a material effect on the Company's comprehensive income and financial
position.
INTEREST RATE RISK
At December 31, 1998, the Company had $61.8 million of long-term debt, of which
$26.2 million was subject to variable interest rates (Federal Funds rates, LIBOR
rates, Prime rates). The Company estimates that a 10% increase in interest rates
would not be material to the Company's consolidated pretax earnings for 1999 or
to the fair value of its debt.
FOREIGN CURRENCY EXCHANGE RATE RISK
The operation of the Company's subsidiaries in international markets results in
exposure to movements in currency exchange rates. The principal currencies
involved are the Canadian dollar, the Australian dollar and the British pound.
As currency exchange rates change, translation of the financial results of
international operations into U.S. dollars does not now materially affect, and
has not historically materially affected, the consolidated financial results of
the Company.
The Company's international subsidiaries use the local currency as the
functional currency. The Company translates all assets and liabilities at
year-end exchange rates and income and expense accounts at average rates during
the year. While it is generally not the Company's practice to enter into
derivative contracts, from time to time the Company and its subsidiaries do
utilize forward foreign currency exchange contracts to minimize the impact of
currency movements.
EQUITY PRICE RISK
The Company's investments in available-for-sale equity securities are subject to
price risk. The fair value of such investments, as of December 31, 1998 was
approximately $1.0 billion. The potential change in the fair value of these
investments, assuming a 10% change in prices would be approximately $100.0
million on a pretax basis. As discussed under "Comprehensive Income" in Item 7
above, net unrealized gains on the Company's investments in available-for-sale
securities have had a material effect on the Company's comprehensive income and
financial position.
42
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF MANAGEMENT
To the Stockholders of DST Systems, Inc.
The accompanying consolidated financial statements of DST Systems, Inc. and its
subsidiaries were prepared by management in conformity with generally accepted
accounting principles. In preparing the financial statements, management has
made judgments and estimates based on currently available information. Other
financial information included in this annual report is consistent with that in
the consolidated financial statements.
The Company maintains a system of internal accounting controls designed to
provide reasonable assurance that its assets are safeguarded and that its
financial records are reliable. Management monitors the system for compliance,
and the Company's internal auditors measure its effectiveness and recommend
possible improvements thereto.
Independent accountants provide an objective assessment of the degree to which
management meets its responsibility for fairness of financial reporting. They
regularly evaluate the system of internal accounting controls and perform such
tests and other procedures as they deem necessary to express an opinion on the
fairness of the consolidated financial statements.
The Board of Directors pursues its oversight role in the area of financial
reporting and internal accounting controls through its Audit Committee which is
composed solely of directors who are not officers or employees of the Company.
This committee meets regularly with the independent accountants, management and
internal auditors to discuss the scope and results of their work and their
comments on the adequacy of internal accounting controls and the quality of
external financial reporting.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors
of DST Systems, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of changes in stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
DST Systems, Inc. and its subsidiaries at December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998 in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Kansas City, Missouri
February 25, 1999
43
DST SYSTEMS, INC.
CONSOLIDATED BALANCE SHEET
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31,
--------------------
1998 1997
--------- ---------
ASSETS
Current assets
Cash and cash equivalents.............................................. $ 28.1 $ 18.6
Accounts receivable (includes related party receivables of $9.9 and
$9.5)................................................................ 282.4 268.4
Inventories............................................................ 16.3 15.9
Deferred income taxes.................................................. 21.3 7.6
Other assets........................................................... 27.7 34.8
--------- ---------
375.8 345.3
Investments.............................................................. 1,130.5 815.8
Properties............................................................... 328.4 323.3
Intangibles and other assets............................................. 62.3 64.1
--------- ---------
Total assets......................................................... $ 1,897.0 $ 1,548.5
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Debt due within one year............................................... $ 12.1 $ 17.8
Accounts payable....................................................... 85.3 80.9
Accrued compensation and benefits...................................... 53.4 49.6
Deferred revenues and gains............................................ 41.1 27.2
Other liabilities...................................................... 76.7 36.5
--------- ---------
268.6 212.0
Long-term debt........................................................... 49.7 97.4
Deferred income taxes.................................................... 343.2 236.3
Other liabilities........................................................ 68.5 70.5
--------- ---------
730.0 616.2
--------- ---------
Commitments and contingencies (Note 12)..................................
--------- ---------
Minority interests....................................................... 0.8 1.4
--------- ---------
Stockholders' equity
Preferred stock, $0.01 par, 10,000,000 shares authorized and
unissued.............................................................
Common stock, $0.01 par, 125,000,000 shares authorized, 63,816,639 and
63,843,101 shares issued............................................. 0.6 0.6
Additional paid-in capital............................................. 462.3 466.1
Retained earnings...................................................... 378.1 306.5
Treasury stock, at cost................................................ (34.1) (40.4)
Accumulated other comprehensive income................................. 359.3 198.1
--------- ---------
Total stockholders' equity........................................... 1,166.2 930.9
--------- ---------
Total liabilities and stockholders' equity......................... $ 1,897.0 $ 1,548.5
--------- ---------
--------- ---------
The accompanying notes are an integral part of these financial statements.
44
DST SYSTEMS, INC.
CONSOLIDATED STATEMENT OF INCOME
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Revenues (includes related parties revenues of $105.0, $90.2 and
$89.6).......................................................... $ 1,096.1 $ 950.0 $ 844.0
Costs and expenses................................................ 834.7 719.6 653.0
Depreciation and amortization..................................... 108.8 103.5 99.1
Merger charges and other expenses................................. 33.1 13.7
--------- --------- ---------
Income from operations............................................ 119.5 126.9 78.2
Interest expense.................................................. (8.6) (8.5) (10.5)
Other income, net................................................. 7.4 5.8 4.5
Gain on sale of Continuum......................................... 223.4
Equity in losses of unconsolidated affiliates, net of income
taxes........................................................... (2.7) (1.3) (4.0)
--------- --------- ---------
Income before income taxes and minority interests................. 115.6 122.9 291.6
Income taxes...................................................... 44.3 42.9 113.3
--------- --------- ---------
Income before minority interests.................................. 71.3 80.0 178.3
Minority interests................................................ (0.3) 0.6 0.5
--------- --------- ---------
Net income........................................................ $ 71.6 $ 79.4 $ 177.8
--------- --------- ---------
--------- --------- ---------
Average common shares outstanding................................. 62.7 63.6 63.0
Dilutive shares outstanding....................................... 64.3 64.7 64.0
Basic earnings per share.......................................... $ 1.14 $ 1.25 $ 2.82
Diluted earnings per share........................................ $ 1.11 $ 1.23 $ 2.78
The accompanying notes are an integral part of these financial statements.
45
DST SYSTEMS, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN MILLIONS)
COMMON STOCK ACCUMULATED
---------------------- ADDITIONAL OTHER TOTAL
NUMBER PAR PAID-IN RETAINED TREASURY COMPREHENSIVE STOCKHOLDERS'
OF SHARES VALUE CAPITAL EARNINGS STOCK INCOME EQUITY
----------- --------- ----------- ----------- ----------- ------------- -----------
BALANCE, DECEMBER 31, 1995....... 61.8 $ 0.6 $ 409.6 $ 70.9 $ $ 21.4 $ 502.5
Comprehensive income:
Net income..................... 177.8
Other comprehensive income..... 74.2
Comprehensive income......... 252.0
Issuance of common stock......... 2.5 54.1 0.1 54.2
Repurchase of common stock....... (0.4) (12.5) (12.5)
----- --------- ----------- ----------- ----------- ------ -----------
BALANCE, DECEMBER 31, 1996....... 63.9 0.6 463.7 248.7 (12.4) 95.6 796.2
Comprehensive income:
Net income..................... 79.4
Other comprehensive income..... 102.5
Comprehensive income......... 181.9
Issuance of common stock......... 0.3 2.4 2.4 4.8
Repurchase of common stock....... (1.6) (21.6) (30.4) (52.0)
----- --------- ----------- ----------- ----------- ------ -----------
BALANCE, DECEMBER 31, 1997....... 62.6 0.6 466.1 306.5 (40.4) 198.1 930.9
Comprehensive income:
Net income..................... 71.6
Other comprehensive income..... 161.2
Comprehensive income......... 232.8
Issuance of common stock......... 0.7 (2.9) 21.6 18.7
Repurchase of common stock....... (0.4) (0.9) (15.3) (16.2)
----- --------- ----------- ----------- ----------- ------ -----------
BALANCE, DECEMBER 31, 1998....... 62.9 $ 0.6 $ 462.3 $ 378.1 $ (34.1) $ 359.3 $ 1,166.2
----- --------- ----------- ----------- ----------- ------ -----------
----- --------- ----------- ----------- ----------- ------ -----------
The accompanying notes are an integral part of these financial statements.
46
DST SYSTEMS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(DOLLARS IN MILLIONS)
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
CASH FLOWS--OPERATING ACTIVITIES:
Net income........................................................ $ 71.6 $ 79.4 $ 177.8
--------- --------- ---------
Depreciation and amortization..................................... 108.8 103.5 99.1
Noncash portion of merger charges................................. 13.5
Equity in losses of unconsolidated affiliates..................... 2.7 1.3 4.0
Cash dividends received from unconsolidated affiliates............ 9.9 8.0
Gain on sale of Continuum......................................... (223.4)
Deferred taxes.................................................... (10.0) (3.1) 80.4
Changes in accounts receivable.................................... (13.0) (40.3) (30.5)
Changes in inventories and other current assets................... 6.6 (12.3) (1.6)
Changes in accounts payable and accrued liabilities............... 82.0 11.8 16.4
Other, net........................................................ 2.7 8.4 6.6
--------- --------- ---------
Total adjustments to net income................................... 203.2 69.3 (41.0)
--------- --------- ---------
Net........................................................... 274.8 148.7 136.8
--------- --------- ---------
CASH FLOWS--INVESTING ACTIVITIES:
Investments and advances to unconsolidated affiliates............. (48.0) (16.1) (23.3)
Capital expenditures.............................................. (132.7) (82.6) (100.9)
Net investment in leases.......................................... (11.9) (8.0) (7.4)
Principal collections on leases................................... 6.4 8.6 10.4
Payment for purchases of subsidiaries, net of cash acquired....... (14.2) (16.8) (3.2)
Other, net........................................................ 9.3 14.8 3.9
--------- --------- ---------
Net........................................................... (191.1) (100.1) (120.5)
--------- --------- ---------
CASH FLOWS--FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net....................... 7.9 2.4 53.7
Proceeds from issuance of long-term debt.......................... 7.4 2.8
Principal payments on long-term debt.............................. (23.4) (19.4) (45.6)
Net increase (decrease) in short-term notes payable............... (1.5) 2.6 (12.0)
Net increase (decrease) in revolving credit facilities............ (36.0) 25.5 3.6
Common stock repurchased.......................................... (16.2) (52.2) (12.5)
Other, net........................................................ (12.4) (5.6) (9.3)
--------- --------- ---------
Net........................................................... (74.2) (46.7) (19.3)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents.............. 9.5 1.9 (3.0)
Cash and cash equivalents, beginning of year...................... 18.6 16.7 19.7
--------- --------- ---------
Cash and cash equivalents, end of year............................ $ 28.1 $ 18.6 $ 16.7
--------- --------- ---------
--------- --------- ---------
The accompanying notes are an integral part of these financial statements.
47
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
DST Systems, Inc. (the "Company" or "DST") provides sophisticated information
processing and computer software services and products to the financial services
industry (primarily mutual funds and investment managers), communications
industry and other service industries. In December 1998, the Company completed
its merger ("USCS Merger") with USCS International, Inc. ("USCS") through the
issuance of approximately 13.8 million shares of common stock. The USCS Merger
was accounted for under the pooling of interests accounting method. Accordingly,
the DST financial results have been restated to combine the historical results
of operations of DST and USCS, adjusted for conformity of accounting policies
relating primarily to USCS' depreciation and amortization policies and
accounting for the costs of software developed for internal USCS use.
The Company has several operating business units that offer sophisticated
information processing and software services and products. These operating
business units have been aggregated into three operating segments (Financial
Services, Customer Management and Output Solutions). In addition, certain
investments in equity securities, financial interests and real estate holdings
have been aggregated into an Investments and Other Segment. A summary of each of
the Company's segments follows:
FINANCIAL SERVICES
The Financial Services Segment provides sophisticated information processing and
computer software services and products primarily to mutual funds, investment
managers, insurance companies, banks and other financial services organizations.
The Company's software systems include shareowner accounting and recordkeeping
systems offered to the U.S. mutual fund industry; a shareowner accounting and
recordkeeping system offered to non-U.S. mutual funds and unit trusts; a
securities transfer system offered primarily to corporate trustees and
securities transfer agents; a variety of portfolio accounting and investment
management systems offered to U.S. and international fund accountants and
investment managers; an image-based work management system offered primarily to
mutual funds, insurance companies and other financial services organizations;
and securities exchange and broker order systems offered to brokers and
companies involved in the exchange of equity, bond and derivative securities
primarily outside the U.S.
The Financial Services Segment distributes its services and products on a direct
basis and through subsidiaries and joint venture affiliates in the U.S., Canada,
United Kingdom, Europe, Australia, South Africa and Asia-Pacific, and to a
lesser degree distributes such services and products through various strategic
alliances.
CUSTOMER MANAGEMENT
The Customer Management Segment provides sophisticated customer management
processing and computer software services and products to cable television,
direct broadcast satellite (DBS), wireless and wire-line telephony and
multi-service providers. The Company's software systems enable its clients to
manage mission-critical customer relationship functions, including new account
set-up, order processing, customer support, customer billing, management
reporting and marketing analysis.
The Customer Management Segment distributes its services and products on a
direct basis and through subsidiaries in North America, the United Kingdom and
parts of Europe and with international alliance partners in other regions of the
world. As a result of the acquisition of Custima, the Segment is also expanding
into the utilities industry.
48
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
OUTPUT SOLUTIONS
The Output Solutions Segment provides complete statement processing services and
solutions, including electronic presentment, which include generation of
customized statements that are produced in sophisticated automated facilities
designed to minimize turnaround time and mailing costs. This Segment provides
statement processing services and solutions in North America to customers of the
Company's Financial Services and Customer Management business segments, and to
telecommunications, utilities and other high volume industries which require
high quality, accurate and timely statement processing.
INVESTMENTS AND OTHER
The Investments and Other Segment holds certain investments in securities,
financial interests, the Company's real estate subsidiaries and the Company's
hardware leasing subsidiary. The Company holds certain investments in equity
securities with a market value of approximately $1.0 billion at December 31,
1998, including approximately 8.6 million shares of Computer Sciences
Corporation ("CSC") with a market value of $554.6 million and 6.0 million shares
of State Street Corporation ("State Street") with a market value of $420.8
million. Additionally, the Company owns and operates real estate in North
America which is held primarily for lease to the Company's other business
segments.
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include all majority-owned subsidiaries of
DST. All significant intercompany balances and transactions have been
eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles 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.
REVENUE RECOGNITION
Computer processing and services revenues are recognized upon completion of the
services provided. Revenues under bundled service agreements are recognized over
the life of the agreement based on usage and as the bundled services are
provided. Software license fees, maintenance fees and other ancillary fees are
recognized as services are provided or delivered and all customer obligations
have been met. The Company generally does not have customer obligations that
extend past one year. Revenue from equipment sales and sales-type leases is
recognized as equipment is shipped. Income from financing leases is recognized
as revenue at a constant periodic rate of return on the net investment in the
lease. Revenue from rentals and operating leases is recognized monthly as the
rent accrues. Billing for services in advance of performance is recorded as
deferred revenue. Allowances for billing adjustments are determined as revenues
are recognized and are recorded as reductions in revenues. Doubtful account
expense for the Company is immaterial.
The Company has entered into various agreements with related parties,
principally unconsolidated affiliates, to utilize the Company's data processing
facilities and its computer software systems. The
49
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Company believes that the terms of its contracts with related parties are fair
to the Company and are no less favorable to the Company than those obtained from
unaffiliated parties.
COSTS AND EXPENSES
Costs and expenses include all costs, excluding depreciation and amortization,
incurred by the Company to produce revenues. The Company believes that the
nature of its business as well as its organizational structure, in which
virtually all officers and associates have operational responsibilities, does
not allow for a meaningful segregation of selling, general and administrative
costs. These costs, which the Company believes to be immaterial, are also
included in costs and expenses. Substantially all depreciation and amortization
are directly associated with the production of revenues.
SOFTWARE DEVELOPMENT AND MAINTENANCE
Purchased software is recorded at cost and is amortized over the estimated
economic lives of three to ten years. Costs of internally developed proprietary
software, used for producing revenues and to support the Company's operations,
are expensed as incurred. Effective January 1, 1999, the Company adopted, as
required, Statement of Position (SOP) 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" issued by the
Accounting Standards Executive Committee of the American Institute of Certified
Public Accountants. SOP 98-1, effective for periods beginning after December 15,
1998, requires that certain costs for the development of internal use software
including coding and software configuration costs, and costs of upgrades and
enhancements be capitalized. Based on internal software development plans, the
Company estimates that $14.0 to $20.0 million (unaudited) of costs related to
the development of internal use software could be capitalized for the year
ending December 31, 1999, net of related amortization. These costs, which have
been previously expensed, will be amortized under the Company's current policy
on a straight-line basis, depending on the nature of the project, generally over
a three to five year period beginning on the date such software is place in
service. The estimated range of capitalizable development costs for internal use
software reflects the Company's current views. There may be differences between
these estimates and actual development costs, and those differences may be
material.
Research and development costs for software that will be sold or licensed to
third parties are expensed as incurred and consist primarily of software
development costs incurred prior to the achievement of technological
feasibility. The Company capitalizes software development costs for software
that will be sold or licensed to third parties after the products reach
technological feasibility and it has been determined that the software will
result in probable future economic benefits and management has committed to
funding the project. These capitalized development costs are amortized on a
product-by-product basis using the greater of the amount computed by taking the
ratio of current year's net revenue to current year's net revenue plus estimated
future net revenues or the amount computed by the straight-line method over the
estimated useful life of the product, generally three to five years. The Company
evaluates the net realizable value of capitalized software development costs on
a product-by-product basis in accordance with SFAS ("Statement of Financial
Accounting Standards") No. 86. The cost of custom development that is required
and funded by a specific client is charged to costs and expenses as incurred.
A portion of the Company's development costs is funded by customers through
various programs, including product support and shared-cost arrangements.
Amounts received under the arrangements reduce the amount of development costs
either expensed or capitalized, depending on the terms of the agreement and the
nature of the software being developed.
50
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Operating costs include software development and maintenance costs relating to
internal proprietary systems and non-capitalizable costs for systems to be sold
or licensed to third parties of approximately $165.5 million, $135.6 million and
$107.2 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Capitalized development costs for systems to be sold or licensed
to third parties was approximately $2.5 million, $3.1 million and $0.3 million
for the years ended December 31, 1998, 1997 and 1996, respectively. Amortization
expense related to capitalized development costs totaled $0.4 million for the
year ended December 31, 1998, while no amortization expense was recognized in
1997 or 1996 since the related software had not been placed in service.
CASH EQUIVALENTS
Short-term liquid investments with a maturity of three months or less are
considered cash equivalents. Due to the short-term nature of these investments,
carrying value approximates market value.
INVENTORIES
Inventories are valued at the lower of cost or market. Cost is determined on the
specific identification or first-in, first-out basis. Inventories are comprised
primarily of paper and envelope stocks.
INVESTMENTS IN SECURITIES
The equity method of accounting is used for all entities in which the Company or
its subsidiaries have at least 20% but not more than 50% voting interest or
significant influence; the cost method of accounting is used for investments of
less than 20% voting interest. Investments classified as available-for-sale
securities are reported at fair value with unrealized gains and losses excluded
from earnings and recorded net of deferred taxes directly to stockholders'
equity as accumulated other comprehensive income.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost with major additions and
improvements capitalized. Cost includes the amount of interest cost associated
with significant capital additions. Depreciation of buildings is recorded using
the straight-line method over 15 to 30 years. Equipment and furniture are
depreciated using straight-line and accelerated methods over the estimated
useful lives, principally 3 to 10 years. Leasehold improvements are depreciated
using the straight-line method over the lesser of the term of the lease or life
of the improvements. The Company reviews, on a quarterly basis, its property and
equipment for possible impairment. In management's opinion, no such impairment
exists at December 31, 1998. In conjunction with the USCS Merger, the Company
incurred certain integration costs related to lease abandonment charges and the
closing of certain production and administration centers as discussed in Note 3.
INTANGIBLES
Goodwill resulting from the cost of investments in excess of the underlying fair
value of identifiable net assets acquired is amortized over periods ranging from
3 to 20 years. On a quarterly basis, the Company reviews the recoverability of
goodwill. The measurement of possible impairment is based primarily on the
ability to recover the balance of the goodwill from expected future operating
cash flows on an undiscounted basis. These analyses are performed on an
individual investment basis with the primary focus of the analyses being the
expected future cash flows from significant products of each of the investments.
In management's opinion, no such impairment exists at December 31, 1998.
51
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
INCOME TAXES
Deferred income tax effects of transactions reported in different periods for
financial reporting and income tax return purposes are recorded by the liability
method. This method gives consideration to the future tax consequences of
deferred income or expense items and immediately recognizes changes in income
tax laws upon enactment. The income statement effect is generally derived from
changes in deferred income taxes on the balance sheet.
Prior to 1993, the Company generally did not provide deferred income taxes for
unremitted earnings of certain investees accounted for under the equity method
because those earnings have been and will continue to be reinvested. Beginning
in 1993, pursuant to the provisions of SFAS No. 109 (Note 8), the Company began
providing deferred taxes for unremitted earnings of U.S. unconsolidated
affiliates net of the 80% dividends received deduction provided for under
current tax law. Through December 31, 1998, the cumulative amount of such
unremitted earnings was $37.8 million. These amounts would become taxable to the
Company if distributed by the affiliates as dividends, in which case the Company
would be entitled to the dividends received deduction for 80% of the dividends;
alternatively, these earnings could be realized by the sale of the affiliates'
stock, which would give rise to tax at federal capital gains rates and state
ordinary income tax rates, to the extent the stock sale proceeds exceeded the
Company's tax basis. Deferred taxes provided on unremitted earnings through
December 31, 1998 and 1997 were $2.5 million and $2.3 million, respectively.
Determination of the amount of the unrecognized deferred tax liability related
to investments in international subsidiaries, including but not limited to
unremitted earnings and cumulative translation adjustments, is not practicable.
CUSTOMER DEPOSITS
The Company requires postage deposits from certain of its clients based on
long-term contractual arrangements. The Company does not anticipate repaying in
the next year amounts classified as non-current.
FOREIGN CURRENCY TRANSLATION
The Company's international subsidiaries use the local currency as the
functional currency. The Company translates all assets and liabilities at year
end exchange rates and income and expense accounts at average rates during the
year. Translation adjustments are recorded in stockholders' equity and were not
material at December 31, 1998 and 1997. While it is generally not the Company's
practice to enter into derivative contracts, from time to time the Company and
its subsidiaries do utilize forward foreign currency exchange contracts to
minimize the impact of currency movements.
EARNINGS PER SHARE
Basic earnings per share is determined by dividing net income by the weighted
average number of common shares outstanding during the year. The dilutive effect
of all potential common shares outstanding during the year has been included in
diluted earnings per share.
STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation in accordance with Accounting
Principles Board Opinion No. 25 and has presented the required SFAS No. 123 pro
forma disclosures in Note 9.
52
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
COMPREHENSIVE INCOME
In 1998, the Company adopted SFAS No. 130, Reporting Comprehensive Income. This
statement establishes rules for the reporting of comprehensive income and its
components. The Company's comprehensive income consists of net income,
unrealized gains (losses) on available-for-sale securities, net of deferred
income taxes, and foreign currency translation adjustments and is presented in
the Consolidated Statement of Stockholders' Equity. The adoption of SFAS No. 130
had no impact on total stockholders' equity or net income. Prior year's
financial statements have been prepared in accordance with the SFAS No. 130
requirements.
SEGMENT INFORMATION
The Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise
and Related Information, in 1998 which changes the way the Company reports
information about its operating segments. The information for 1997 and 1996 has
been prepared in accordance with SFAS 131 requirements in order to conform to
the 1998 presentation.
3. ACQUISITIONS AND DISPOSITIONS
USCS MERGER
Effective December 21, 1998, the Company acquired USCS, which was accounted for
as a pooling of interests. Accordingly, the Company's consolidated financial
statements for periods prior to December 21, 1998 have been restated to include
the financial position and results of operations of USCS. A summary of
historical results of DST and USCS are as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Revenues:
DST Systems, Inc................................................ $ 749.0 $ 650.7 $ 580.8
USCS International, Inc......................................... 347.1 299.3 263.2
--------- --------- ---------
Total revenues.................................................... $ 1,096.1 $ 950.0 $ 844.0
--------- --------- ---------
--------- --------- ---------
Net income
DST Systems, Inc................................................ $ 73.9 $ 59.0 $ 167.2
USCS International, Inc......................................... 21.0 22.4 14.5
Conforming of accounting policies............................... (3.9) (2.0) (3.9)
Merger costs.................................................... (19.4)
--------- --------- ---------
Total net income.................................................. $ 71.6 $ 79.4 $ 177.8
--------- --------- ---------
--------- --------- ---------
In conjunction with the USCS Merger, certain conforming accounting adjustments
were recorded to conform the accounting policies relating primarily to USCS'
depreciation and amortization policies and the accounting for the costs of
software developed for internal USCS use. As a result of conforming accounting
policies, net income decreased $3.9 million, $2.0 million and $3.9 million for
each of the years ended December 31, 1998, 1997 and 1996, respectively.
Non-current assets decreased $33.3 million and $25.9 million at December 31,
1998 and 1997, respectively, as a result of conforming accounting policies. DST
purchased 1.1 million shares of USCS common stock during the fourth quarter of
1997 at a cost of $21.7 million. Prior to the USCS Merger, there were no
significant intercompany transactions between the Company and USCS.
53
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In December 1998, DST's management approved plans which include initiatives to
integrate the operations of certain DST and USCS subsidiaries and consolidate
facilities. Total accrued integration costs of $16.9 million were recorded in
the fourth quarter of 1998, of which $0.7 million, $3.4 million and $12.8
million relate to the Financial Services, Customer Management and Output
Solutions Segments, respectively.
Accrued integration costs include $3.2 million for the severance cost of
involuntary separation benefits related to approximately 250 employees of which
approximately 50 employees have separated from the Company as of December 31,
1998. Employee separations will affect the majority of business functions and
job classifications across the Customer Management ($1.7 million) and Output
Solutions ($1.5 million) Segments, principally in North America.
The integration plans include $10.2 million related to lease abandonment costs,
elimination of certain non-strategic business lines and the closing of certain
production and administration centers associated with the Customer Management
($1.1 million) and Output Solutions ($9.1 million) Segments. For the locations
to be closed and the non-strategic business lines to be eliminated, the tangible
and intangible assets to be disposed of have been written down by $4.6 million
to fair value. The integration plans also include $2.7 million ($0.7, $0.2, and
$1.8 million for the Financial Services, Customer Management, and Output
Solutions Segments, respectively) related to purchased software/communications
systems that will be abandoned. Additionally, $0.8 million ($0.4 million in each
of the Customer Management and Output Solutions Segments) of costs have been
expensed related to terminating certain obligations which have no future benefit
as a result of the USCS Merger.
The cash and non-cash elements of the charge were approximately $9.5 million and
$7.4 million, respectively. Details of the merger charge are as follows (in
millions):
UTILIZED BALANCE AT
ORIGINAL -------------------------- DECEMBER 31,
AMOUNT CASH NON-CASH 1998
----------- ----- ------------- ---------------
Employee severance benefits........................................... $ 3.2 $ 0.6 $ $ 2.6
Other................................................................. 6.3 6.3
Write down of long-lived assets....................................... 7.4 7.4
----- --- --- ---
Total merger charges.................................................. $ 16.9 $ 0.6 $ 7.4 $ 8.9
----- --- --- ---
----- --- --- ---
Most of the remaining employee severance benefits are expected to be paid in
1999. The balance of the accrued costs relates primarily to facilities that will
be closed. Lease payments on closed facilities and abandoned equipment have
terms which end in 1999 through 2003. Location closures are planned to occur
through the year 2000 once arrangements have been made to process continuing
business at other facilities. Two of the locations have been closed as of
December 31, 1998. The costs of transitioning the continuing business have not
been accrued.
DST expects that other integration costs will be incurred in the future which
cannot be accrued under current accounting rules and are dependent on management
decisions. Such costs could include, among other things additional employee
costs, relocation and integration costs of moving to common internal systems.
Although precise estimates cannot be made, mangement does not believe such costs
will have a materially adverse effect on the Company's consolidated results of
operations, liquidity or financial position.
Transaction costs for the USCS Merger of $9.1 million include investment banker
fees, legal fees and other costs paid in connection with the merger.
54
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
EQUISERVE
In December 1998, Boston EquiServe LP ("Boston EquiServe") and First Chicago
Trust Company of New York completed a transaction creating EquiServe LP
("EquiServe"), the largest securities transfer agent in the U.S. Prior to the
transaction, Boston EquiServe was a limited partnership, 50% owned by Boston
Financial Data Services, Inc. ("BFDS") (a 50% owned joint venture of the Company
and State Street Corporation) and 50% by BankBoston Corporation. DST is
currently developing a new securities transfer system ("Fairway") to be used by
EquiServe to process all of its accounts. The Company has also agreed with
EquiServe to provide the data processing services for EquiServe to use Fairway.
Upon acceptance of defined components of Fairway, DST will contribute Fairway
and its securities transfer processing business (approximately 2 million
accounts) to EquiServe for a 20% direct ownership interest in EquiServe (the
"EquiServe Contribution"). DST will also have a 10% indirect ownership interest
in EquiServe through BFDS, after the EquiServe Contribution. The Company
believes that an ownership in EquiServe provides the most effective
participation in the opportunities presented by the continued consolidation of
the securities transfer industry. The acceptance of the defined components of
Fairway is currently expected to occur in three stages beginning in the second
quarter of 1999 and completing in the third quarter of 2000, at which time the
Company's non-EquiServe securities transfer business will be transferred to
EquiServe. The Company expects to account for the investment in EquiServe on the
equity method.
As Fairway is accepted and the transaction is completed, the Company plans to
account for the EquiServe Contribution as a non-cash, non-taxable, like-kind
exchange of similar productive assets. Accordingly, no gain will be recognized
from the EquiServe Contribution. The capitalized costs associated with the
Fairway development along with the net assets of the securities transfer
business contributed will become the basis of the Company's investment in
EquiServe. The Company expensed costs of Fairway development of $8.7 million,
$3.6 million and $2.2 million in 1998, 1997 and 1996, respectively. The Company
expects to account for the investment in EquiServe on the equity method.
CUSTIMA
In August 1998, USCS purchased 100% of the stock ("Custima Acquisition") of
United Kingdom based Custima International Holdings, plc ("Custima") for
approximately $15.4 million. The business acquired provides customer management
software for the utilities industry. The acquisition was accounted for as a
purchase, and accordingly, the Company's financial statements include Custima's
results of operations from the date of acquisition.
The purchase includes existing technology, in-process research and development
(IPR&D), trademarks and in-place workforce with an aggregate value of
approximately $18.1 million. The purchase price exceeded the fair market value
of net tangible assets acquired by $15.1 million, however, the purchase price
was less than the estimated fair value of all assets (tangible and intangible)
acquired. Accordingly, the non-current assets recorded in the transaction
(including IPR&D projects) were reduced on a pro-rata basis such that the total
amount of the assets recorded did not exceed the consideration paid.
The Company engaged a third party to perform an appraisal of the Custima
Acquisition (including the IPR&D projects acquired). The IPR&D projects included
improvements and increased functionality to the core billing product to adapt it
for competitive use within the U.S. and development of a new Java-based product
which will allow large utilities to benefit from an advanced billing system
while utilizing their existing legacy database.
The IPR&D projects were estimated to be approximately 60% complete as of the
date of acquisition and were assigned a total value at $7.1 million (using the
income method discounted at 30% which did
55
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
not differ significantly from the stage of completion method, reduced to $6.0
million as a result of the total amount of the assets acquired from Custima
exceeding the consideration paid). Phased completion and delivery of the
projects are expected through mid-year 2000. The estimated cost of completion
for the projects is $7.5 million with cash inflows expected to commence shortly
after the respective completion dates. As with any software development project,
there are inherent development risks and periodic review of the projects can
result in changes to the development plan and the Company's business plans for
the software.
In accordance with applicable accounting principles, the assigned value of the
IPR&D ($6.0 million) was expensed at the date of acquisition. Also, a charge for
redundant facilities and workforce of $1.1 million was recorded in connection
with USCS's purchase and consolidation of Custima. Intangible assets (other than
IPR&D) are being amortized on a straight-line basis over periods ranging from 3
to 10 years. On a pro forma basis, the acquisition did not have a material
impact on the Company's historical results of operations or financial position.
DBS SYSTEMS CORPORATION ("DBS SYSTEMS")
In October 1997, the Company purchased the remaining 20% minority interest in
DBS Systems for $13.2 million in cash. The excess of the purchase price over the
net assets acquired of $11.6 million has been assigned a useful life of 12
years. The Company had previously acquired 20% and 60% of DBS Systems in
December 1995 and May 1993, respectively. On a pro forma basis, the acquisition
did not have a material impact on the Company's historical results of operations
or financial position.
DST CATALYST, INC. ("DST CATALYST")
In August 1997, the Company formed DST Catalyst by purchasing an 81% interest in
the international information technology subsidiary of the Chicago Stock
Exchange. DST Catalyst provides software and services to support automated
securities exchange activities and broker order interfaces primarily outside the
U.S. On a pro forma basis, the acquisition did not have a material impact on the
Company's historical results of operations or financial position.
FIRST OF MICHIGAN CAPITAL CORPORATION ("FIRST OF MICHIGAN")
In July 1997, the Company sold its interest in First of Michigan for $9.6
million. The transaction, on an after-tax basis, did not have a material effect
on the Company's financial position or results of operations.
THE CONTINUUM COMPANY, INC. ("CONTINUUM")
On August 1, 1996, Continuum merged with Computer Sciences Corporation ("CSC")
in a tax-free share exchange accounted for as a pooling-of-interests. DST, which
prior to the merger owned approximately 23% of Continuum, received in the
exchange shares of CSC common stock with a value of $295 million based upon the
closing price of CSC common stock on August 1, 1996. DST recognized a one-time
gain after taxes and other expenses of $127.6 million. In connection with the
merger, the Company elected to make a one-time $13.7 million Employee Stock
Ownership Program ("ESOP") contribution to provide funding for certain Continuum
employee withdrawals from DST's ESOP. DST's shares of CSC represent an
approximate 5% interest in the combined company. As a result of the merger,
Continuum ceased to be an unconsolidated equity affiliate of DST and under
generally accepted accounting principles, no part of Continuum or CSC earnings
since that time have been
56
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
recognized by DST. DST recognized equity in losses of Continuum of $4.9 million
in 1996. The Company's investment in CSC is accounted for as available-for-sale
securities. Although CSC does not currently pay cash dividends, DST will
recognize dividend income on any cash dividends received from CSC.
In March 1996, Continuum, a then 29% owned unconsolidated affiliate of the
Company, announced the completion of its merger with Hogan Systems, Inc., (the
"Hogan Merger") a provider of software to banks and financial institutions, for
shares of Continuum stock. As a result of this transaction, the Company's common
stock interest in Continuum was reduced from approximately 29% to approximately
23%. The Company recorded in March 1996 its estimated $9.4 million after-tax
share of a non-recurring charge recorded by Continuum in connection with the
Hogan Merger.
4. PROPERTIES
Properties and related accumulated depreciation are as follows (in millions):
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Land........................................................ $ 20.1 $ 21.8
Buildings................................................... 128.2 122.1
Data processing equipment................................... 296.9 275.1
Data processing software.................................... 112.8 102.8
Software development costs.................................. 7.9 5.4
Furniture, fixtures and other equipment..................... 209.6 187.9
Leasehold improvements...................................... 35.9 44.0
Capitalized leases.......................................... 4.5 4.7
Construction-in-progress.................................... 28.6 21.8
--------- ---------
844.5 785.6
Less accumulated depreciation and amortization.............. 516.1 462.3
--------- ---------
Net properties.............................................. $ 328.4 $ 323.3
--------- ---------
--------- ---------
Depreciation expense for the years ended December 31, 1998, 1997 and 1996, was
$94.9 million, $94.8 million and $91.1 million, respectively. Cost includes the
amount of interest cost associated with significant capital additions.
Capitalized interest was $0.1 million, $0.1 million and $1.1 million for the
years ended December 31, 1998, 1997 and 1996, respectively.
57
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INVESTMENTS
Investments are as follows (in millions):
CARRYING VALUE
1998 DECEMBER 31,
OWNERSHIP --------------------
PERCENTAGE 1998 1997
------------- --------- ---------
Available-for-sale securities:
Computer Sciences Corporation................................................. 5% $ 554.6 $ 360.4
State Street Corporation...................................................... 4% 420.8 347.5
Euronet Services, Inc......................................................... 11% 4.5 9.2
Other available-for-sale securities........................................... 38.7 8.2
--------- ---------
1,018.6 725.3
--------- ---------
Unconsolidated affiliates:
Boston Financial Data Services, Inc........................................... 50% 39.4 32.3
European Financial Data Services Ltd.......................................... 50% 5.5 6.2
Argus Health Systems, Inc..................................................... 50% 3.8 10.6
Other unconsolidated affiliates............................................... 25.6 14.9
--------- ---------
74.3 64.0
--------- ---------
Other:
Net investment in leases...................................................... 16.3 10.6
Other......................................................................... 21.3 15.9
--------- ---------
37.6 26.5
--------- ---------
Total investments......................................................... $ 1,130.5 $ 815.8
--------- ---------
--------- ---------
Computer Sciences Corporation ("CSC") is a provider of outsourcing, system
integration, information technology, management consulting and other
professional services to industry and government. The Company's investment in
CSC is a result of the merger of CSC with The Continuum Company, Inc. on August
1, 1996, as described in Note 3. Continuum is an international software systems
and services provider specializing in the development and installation of
advanced computing software for life and property and casualty insurance,
annuities and other financial services products. The aggregate market value of
the Company's investment in CSC's common stock presented above was based on the
closing price on the New York Stock Exchange.
State Street Corporation ("State Street") is a leading provider of securities
custody and recordkeeping services to the mutual fund industry. State Street
also provides corporate banking services to New England middle market companies,
as well as specialized lending and international banking services. The aggregate
market value of the Company's investment in State Street's common stock
presented above was based on the closing price on the New York Stock Exchange.
The Company received $3.0 million, $2.5 million and $2.2 million in dividends
from State Street in 1998, 1997 and 1996, respectively, which have been recorded
in other income.
Euronet Services, Inc. operates an independent, non-bank owned automatic teller
machine network as a service provider to banks and other financial institutions
in certain Central European countries. Euronet consummated an initial public
offering of its common stock in March 1997. The aggregate market value of the
Company's investment in Euronet's common stock presented above was based on the
closing price on the New York Stock Exchange.
58
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company's investments in available-for-sale securities had an aggregate
market value of $1,018.6 million and $725.3 million and aggregate cost basis of
$427.9 million and $399.1 million at December 31, 1998 and 1997, respectively.
Proceeds of $7.0 million and gross realized gains of $1.9 million were recorded
in 1998 from the sale of available-for-sale securities. Gross unrealized holding
gains totaled $591.2 million and $326.2 million at December 31, 1998 and 1997,
respectively. Gross unrealized holding losses totaled $0.5 million December 31,
1998. There were no gross holding losses at December 31, 1997.
Boston Financial Data Services, Inc. ("BFDS") is a corporate joint venture of
the Company and State Street Corporation, the parent of State Street Bank and
Trust Company. BFDS performs shareowner accounting services for mutual fund
companies using the Company's proprietary application system for mutual fund
shareowner recordkeeping, TA2000, and retirement plan recordkeeping services
using TRAC2000. BFDS also performs remittance and proxy processing,
teleservicing and class action administration services.
European Financial Data Services Limited ("EFDS") is a United Kingdom joint
venture of DST and State Street. EFDS provides full and remote processing for
United Kingdom unit trusts and related products. EFDS is also implementing a new
unit trust accounting system for the United Kingdom market.
Argus Health Systems, Inc. ("Argus") is a corporate joint venture of the Company
and a privately held life insurance holding company. Argus provides pharmacy
benefit plan processing services to the health care industry. Argus utilizes the
Company's data processing facility for its claims processing services. The
Company received a $9.5 million cash dividend from Argus in 1998 and a $9.5
million dividend from Argus in 1996, of which $8.0 million was cash.
Equity in earnings (losses) of unconsolidated affiliates, net of income taxes
provided by the unconsolidated affiliates and related goodwill amortization is
as follows (in millions):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Boston Financial Data Services, Inc................................... $ 7.2 $ 6.2 $ 5.4
European Financial Data Services Limited.............................. (11.1) (11.8) (6.0)
Argus Health Systems, Inc............................................. 2.7 4.5 1.7
Other................................................................. (1.1) (0.2) (0.3)
The Continuum Company, Inc. (1)....................................... (4.9)
--------- --------- ---------
$ (2.3) $ (1.3) $ (4.1)
--------- --------- ---------
--------- --------- ---------
- ------------------------
(1) Through the period ended June 30, 1996.
59
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Certain condensed financial information of the unconsolidated affiliates follows
(in millions):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Revenues............................................ $ 410.9 $ 336.1 $ 614.7
Costs and expenses.................................. 418.8 337.6 633.4
Net loss (1)........................................ (7.9) (1.5) (18.7)
Current assets...................................... 104.9 99.9
Noncurrent assets................................... 203.7 195.5
Current liabilities................................. 51.8 41.5
Noncurrent liabilities.............................. 208.0 174.7
Partners' and stockholders' equity.................. 48.8 79.2
- ------------------------
(1) Includes Continuum through the period ended June 30, 1996.
Net investment in leases of $16.3 million and $10.6 million at December 31, 1998
and 1997, respectively, reflects the gross lease receivable from sales-type
leases and the estimated residual value of the leased equipment less unearned
income.
The Company has committed to make additional investments approximating $2.5
million related to certain private equity partnerships.
6. INTANGIBLES AND OTHER ASSETS
Intangibles and other assets include the following items (in millions):
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Intangibles.................................................. $ 103.3 $ 94.4
Less accumulated amortization................................ 43.9 32.8
--------- ---------
Net........................................................ 59.4 61.6
Other assets................................................. 2.9 2.5
--------- ---------
Total...................................................... $ 62.3 $ 64.1
--------- ---------
--------- ---------
Intangibles exclude goodwill of $4.5 million and $4.6 million at December 31,
1998 and 1997, respectively, related to unconsolidated affiliates which is
classified as part of the investments in the unconsolidated affiliates.
Amortization expense, including amortization related to goodwill recorded in
investments, totaled $13.8 million, $8.7 million and $9.0 million for the years
ended December 31, 1998, 1997 and 1996, respectively.
60
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. LONG-TERM DEBT
The Company is obligated under notes and other indebtedness as follows (in
millions):
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Secured notes payable....................................... $ 10.5 $ 16.0
Mortgage notes.............................................. 24.8 34.0
Revolving credit facilities................................. 23.0 59.1
Other....................................................... 3.5 6.1
--------- ---------
61.8 115.2
Less debt due within one year............................... (12.1) (17.8)
--------- ---------
Long-term debt.............................................. $ 49.7 $ 97.4
--------- ---------
--------- ---------
The secured notes payable primarily represent notes, which are secured by data
processing and production equipment and minimum rental receivables. These notes
are generally payable over 12 to 24 month periods with interest rates from 3.90%
to 9.72% at December 31, 1998.
The mortgage notes represent real estate borrowings due in installments with the
balance due at the end of the term. Interest rates are based on floating prime
or are fixed and range from 8.39% to 10.0% at December 31, 1998.
In December 1996, the Company entered into an amended and restated five-year
revolving credit facility of $105 million (increased to $125 million in February
1997) with a syndicate of U.S. and international banks. Borrowings under the
facility are available at rates based on the Eurodollar, Prime, Base CD, or
Federal Funds rates. A commitment fee of 0.085% per annum is required on the
total amount of the facility. An additional utilization fee of .050% is required
if the principal amount outstanding is greater than 50% of the total facility.
Among other provisions, the agreement limits subsidiary indebtedness and sales
of assets and requires the Company to maintain certain coverage and leverage
ratios. No borrowings were outstanding at December 31, 1998, and borrowings of
$30.0 million were outstanding at December 31, 1997.
The Company and its subsidiaries maintain additional lines of credit totaling
$100 million for working capital requirements and general corporate purposes of
which $50 million matures May 1999, $20 million matures December 1999 and $30
million matures December 2000. Borrowings under the facilities are available at
rates tied to the Eurodollar, federal funds rates or LIBOR rates. Commitment
fees of 0.105% to 0.25% per annum are required on the unused portions.
Borrowings of $23.0 million and $29.1 million were outstanding under these
additional lines of credit at December 31, 1998 and 1997, respectively.
61
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Future principal payments of indebtedness at December 31, 1998 are as follows
(in millions):
1999................................................................. $ 12.1
2000................................................................. 7.1
2001................................................................. 1.9
2002................................................................. 25.1
2003................................................................. 2.2
Thereafter........................................................... 13.4
---------
Total................................................................ $ 61.8
---------
---------
Based upon the borrowing rates currently available to the Company and its
subsidiaries for indebtedness with similar terms and average maturities, the
carrying value of long-term debt is considered to approximate fair value at
December 31, 1998 and 1997.
8. INCOME TAXES
As a result of the USCS Merger, USCS will be included with the Company and its
consolidated U.S. subsidiaries in filing a consolidated federal income tax
return beginning December 21, 1998. Prior to the USCS Merger, USCS and its
consolidated U.S. subsidiaries filed a separate consolidated federal income tax
return.
Deferred tax assets and liabilities are determined based on the differences
between the financial statement and tax bases of assets and liabilities as
measured by the enacted tax rates which will be in effect when these differences
reverse. Deferred tax expense (benefit) is generally the result of changes in
the assets or liabilities for deferred taxes.
The following summarizes pretax income (loss) (in millions):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
U.S................................................. $ 108.9 $ 133.0 $ 299.8
International....................................... 6.7 (10.1) (8.2)
--------- --------- ---------
Total............................................... $ 115.6 $ 122.9 $ 291.6
--------- --------- ---------
--------- --------- ---------
62
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Income tax expense consists of the following components (in millions):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Current:
Federal............................................. $ 43.3 $ 37.0 $ 28.5
State and local..................................... 5.0 6.0 3.9
International....................................... 6.0 3.0 0.5
--------- --------- ---------
Total current..................................... 54.3 46.0 32.9
--------- --------- ---------
Deferred:
Federal............................................. (5.0) (1.2) 67.3
State and local..................................... (2.8) (0.7) 13.3
International....................................... (2.2) (1.2) (0.2)
--------- --------- ---------
Total deferred.................................... (10.0) (3.1) 80.4
--------- --------- ---------
Total income tax expense.............................. $ 44.3 $ 42.9 $ 113.3
--------- --------- ---------
--------- --------- ---------
Differences between the Company's effective income tax rate and the U.S. federal
income tax statutory rate are as follows (in millions):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Income tax expense using the statutory rate in
effect.............................................. $ 40.5 $ 43.0 $ 102.1
Tax effect of:
State and local income taxes, net................... 1.4 3.4 11.2
International income taxes, net..................... (0.6) 1.1 1.1
Earnings of U.S. unconsolidated affiliates.......... (2.8) (3.1) (1.3)
Transaction costs for USCS Merger................... 3.2
Acquired in-process research and development
costs............................................. 2.1
Other............................................... 0.5 (1.5) 0.2
--------- --------- ---------
Total income tax expense.............................. $ 44.3 $ 42.9 $ 113.3
--------- --------- ---------
--------- --------- ---------
Effective tax rate.................................... 38.4% 34.9% 38.8%
Statutory federal tax rate............................ 35.0% 35.0% 35.0%
63
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The federal and state deferred tax assets (liabilities) recorded on the
Consolidated Balance Sheet are as follows (in millions):
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Liabilities:
Investments in available for sale securities............ $ (359.8) $ (256.5)
Unconsolidated affiliates and investments............... (2.1) (2.8)
Other, net.............................................. (9.4) (5.1)
--------- ---------
Gross deferred tax liabilities.......................... (371.3) (264.4)
--------- ---------
Assets:
Book accruals not currently deductible for tax.......... 17.2 13.7
Depreciation and amortization........................... 16.0 10.6
Deferred compensation and other employee benefits....... 11.9 7.8
International operating loss carryforwards.............. 2.5 2.7
Other, net.............................................. 1.8 0.9
--------- ---------
Gross deferred tax assets............................... 49.4 35.7
--------- ---------
Net deferred tax liability................................ $ (321.9) $ (228.7)
--------- ---------
--------- ---------
9. STOCKHOLDERS' EQUITY
STOCK BASED COMPENSATION
In September 1995, the Company established the Stock Option and Performance
Award Plan, which now provides for the availability of 9,000,000 shares of the
Company's common stock for the grant of awards to officers, directors and other
designated employees. The awards may take the form of an option, stock
appreciation right, limited right, performance share or unit, dividend
equivalent, or any other right, interest or option relating to shares of common
stock granted under the plan. The option prices must be at least equal to the
fair market value of the underlying shares on the date of grant. Options become
exercisable and expire as determined by the Compensation Committee of the Board
of Directors at or subsequent to the date of grant.
USCS, prior to its merger with DST, issued stock options under five stock option
plans to directors, officers and key employees of USCS. Under the 1988, 1990,
1993 and 1996 USCS Stock Option Plans, options were granted at prices and with
terms and conditions established by USCS' Board of Directors at the date of
grant. Options under these plans vest over periods of up to sixty months and
expire ten years after the date of grant. Under the USCS Director's Stock Option
Plan, options were granted at fair market value and vested annually over three
years and expire five years after the date of grant. Upon completion of the USCS
Merger, each outstanding option to purchase USCS common stock issued pursuant to
USCS' stock option plans was assumed by DST. Each such option now constitutes an
option to acquire, on the same terms and conditions as were applicable under
such assumed option, that number of shares of DST Common Stock equal to the
product of the merger exchange ratio of 0.62 and the number of shares of USCS
Common Stock subject to such option rounded down to the nearest whole share. The
exercise price per share of DST common stock is equal to the exercise price per
share of such option before the USCS Merger divided by the merger exchange ratio
of 0.62, rounded up to the nearest whole cent. Pursuant to certain change in
control provisions in the USCS
64
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Option Plans, approximately 50% of the unvested portions of the options
accelerated and became exercisable at the completion of the USCS Merger.
Compensation expense recognized in accordance with APB 25 was not material in
1998, 1997 and 1996.
Summary stock option activity is presented in the table below (shares in
millions):
1998 1997 1996
------------------------ ------------------------ ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
----------- ----------- ----------- ----------- ----------- -----------
Outstanding at January 1.................... 4.6 $ 23.01 3.7 $ 18.50 3.4 $ 15.90
Granted..................................... 1.3 47.69 1.3 31.95 0.8 22.38
Exercised................................... (0.4) 16.34 (0.3) 7.52 (0.3) 3.39
Canceled.................................... (0.2) 31.30 (0.1) 20.67 (0.2) 15.88
--- --- ---
Outstanding at December 31.................. 5.3 $ 29.28 4.6 $ 23.01 3.7 $ 18.50
--- --- ---
--- --- ---
Exercisable at December 31.................. 3.5 $ 23.45 1.7 $ 18.87 1.2 $ 17.05
Summary information concerning outstanding and exercisable stock options as of
December 31, 1998 follows (in millions, except per share amounts):
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
----------------------------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE PRICE EXERCISABLE PRICE
- ------------------------------ ----------- ---------------- -------- ----------- --------
$0.34 -- $11.91............... 0.2 6.0 $ 7.35 0.2 $ 7.30
20.17 -- 21.51................ 2.5 6.9 20.83 2.1 20.87
26.21 -- 41.74................ 1.6 8.3 31.01 1.2 31.19
47.79 -- 62.34................ 1.0 9.3 53.73
-- -- -------- -- --------
$0.34 -- $62.34............... 5.3 7.7 $29.28 3.5 $23.45
Had compensation cost been determined consistent with Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation," the
Company's net income would have been reduced to the following pro forma amounts:
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Net income (millions): As reported $ 71.6 $ 79.4 $ 177.8
Pro forma 58.0 71.3 172.9
Basic earnings per share: As reported 1.14 1.25 2.82
Pro forma 0.92 1.12 2.75
Diluted earnings per share: As reported 1.11 1.23 2.78
Pro forma 0.90 1.10 2.70
Pro forma net income for 1998 was significantly impacted by the acceleration of
vesting of certain USCS stock options at the time of the USCS Merger pursuant to
certain change in control provisions in the USCS Stock Option Plans.
65
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The weighted average fair value of options granted was $17.31, $13.06 and $11.83
for 1998, 1997 and 1996, respectively. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option pricing model with
the following weighted average assumptions used for grants in 1998, 1997 and
1996, respectively: expected option terms of 5.3, 5.7 and 7.1 years, volatility
of 28.4%, 30.7% and 41.6%, dividend yield of 0% and risk-free interest rates of
5.4%, 6.2% and 5.8%.
Prior to the USCS Merger, shares were issued under the USCS Employee Stock
Purchase Plan. Common stock purchases under the Plan totaled approximately
32,000 shares and 12,000 shares in 1998 and 1997, respectively. The weighted
average fair value of the employee purchase rights and compensation expense was
immaterial.
EARNINGS PER SHARE
The computation of basic and diluted earnings per share is as follows (in
millions, except per share amounts):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Net income............................................ $ 71.6 $ 79.4 $ 177.8
--------- --------- ---------
--------- --------- ---------
Average common shares outstanding..................... 62.7 63.6 63.0
Incremental shares from assumed conversions of stock
options............................................. 1.6 1.1 1.0
--------- --------- ---------
Dilutive potential common shares...................... 64.3 64.7 64.0
--------- --------- ---------
--------- --------- ---------
Basic earnings per share.............................. $ 1.14 $ 1.25 $ 2.82
Diluted earnings per share............................ $ 1.11 $ 1.23 $ 2.78
STOCK ISSUANCE AND REPURCHASES
Net proceeds of $54.1 million were received in 1996 from the initial public
offering of USCS common stock.
In December 1998, the Board of Directors approved a plan for DST to repurchase
600,000 shares of DST common stock at the rate of approximately 25,000 shares
per month in approximately equal monthly amounts beginning in February 1999, to
provide additional shares needed as a result of the USCS Merger for use under
various DST option and benefit programs. Such purchases may be made in private
or market transactions and will be made in compliance with SEC regulations.
In the fourth quarter 1997, DST expended $21.7 million to purchase 1.1 million
shares of USCS common stock. These shares were retired in conjunction with the
USCS Merger.
In May 1996, the Board of Directors determined it was necessary for the Company
to have common stock available to provide to employees under its stock award
program and to provide to option holders who exercise options. The Board of
Directors authorized the purchase of up to 1.2 million shares during a
twenty-four month period in approximately equal monthly amounts. The Company
expended $10.0 million, $20.3 million, and $12.5 million in 1998, 1997 and 1996,
respectively to complete the purchases under this plan.
USCS, prior to the USCS Merger, expended approximately $6.2 million in 1998 and
$10.2 million in 1997 for the repurchase of common stock in order to meet
obligations under stock option plans,
66
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
employee stock purchase plans and 401(k) retirement plans. Substantially all
these shares were reissued prior to the USCS Merger.
The Company had 0.9 million and 1.3 million shares held in treasury at December
31, 1998 and 1997, respectively.
COMPREHENSIVE INCOME
Components of other comprehensive income consist of the following (in millions):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Unrealized gains on investments:
Unrealized holding gains arising during the
period.......................................... $ 266.4 $ 170.9 $ 119.1
Less reclassification adjustment for gains
included in net income.......................... (1.9)
Foreign currency translation adjustments............ (1.6) 1.6
Deferred income taxes............................... (103.3) (66.8) (46.5)
--------- --------- ---------
Other comprehensive income.......................... $ 161.2 $ 102.5 $ 74.2
--------- --------- ---------
--------- --------- ---------
Components of the related tax provision of other comprehensive income consists
of the following (in millions):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Unrealized gains on investments:
Unrealized holding gains arising during the
period............................................ $ 104.0 $ 66.8 $ 46.5
Less reclassification adjustment for gains included
in net income..................................... (0.7)
--------- --------- ---------
Deferred income taxes................................. $ 103.3 $ 66.8 $ 46.5
--------- --------- ---------
--------- --------- ---------
RIGHTS PLAN
The Company is party to a Stockholder's Rights Agreement (the "Rights Plan")
dated as of October 6, 1995, and amended as of July 9, 1998. Each share of the
Company's common stock held of record on October 18, 1995 (when Kansas City
Southern Industries, Inc. ("KCSI") was then the sole stockholder of the Company)
and all shares of common stock issued in and subsequent to the Offerings have
received one Right. Each Right entitles its holder to purchase 1/1000th share of
preferred stock of the Company, or in some circumstances, other securities of
the Company. In certain circumstances, the Rights entitle their holders to
purchase shares in a surviving entity or its affiliates resulting from
transactions in which the Company is not the surviving entity or disposes of
more than 50% of the Company's assets or earnings power.
The Rights, which are automatically attached to common stock, are not
exercisable or transferable separately from shares of common stock until ten
days following the earlier of an announcement that a person or group (an
"Acquiring Person"), has acquired, or obtained the right to acquire, beneficial
ownership of 15% or more of the outstanding shares of the Company's common
stock, or ten days following the commencement or announcement of any person's
intention to make a tender offer or
67
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
exchange offer that would result in ownership of 15% or more of the outstanding
common stock, unless the Board of Directors sets a later date in either event.
The Rights attached to the stock of an Acquiring Person become void. KCSI, its
subsidiary, FAM Holdings, Inc. ("FAM"), and certain entities affiliated with FAM
are in certain circumstances excluded from the definition of an "Acquiring
Person" under the Rights Plan.
The Rights Plan is intended to encourage a potential acquiring person to
negotiate directly with the Board of Directors, but may have certain
anti-takeover effects. The Rights Plan could significantly dilute the interests
in the Company of an acquiring person. The Rights Plan may therefore have the
effect of delaying, deterring or preventing a change in control of the Company.
10. BENEFITS PLANS
The Company sponsors defined contribution 401(k) and profit sharing plans that
cover substantially all domestic employees following the completion of an
eligibility period. These plans provide for employer contributions based
primarily upon employee participation and are made at the discretion of the
Board of Directors. The total expense under these plans was $9.7 million, $9.2
million and $7.9 million in 1998, 1997 and 1996, respectively. The Company
funded $6.5 million of the 1997 obligation in 1998 with shares held in treasury
at the fair market value on the date of contribution.
Prior to 1998, DST participated in a multi-employer ESOP. In January 1998, the
Company formed The DST Systems, Inc. Employee Stock Ownership Plan ("DST ESOP")
and transferred all balances from DST's portion of the multi-employer ESOP to
the DST ESOP. This plan provide for employer contributions based primarily upon
employee participation and are made at the discretion of the Board of Directors.
The total expense under this plan was $1.0 million, $2.0 million and $13.7
million in 1998, 1997 and 1996, respectively.
USCS had two defined contribution stock ownership plans ("USCS ESOP") covering
substantially all employees who were employed by USCS as of February 18, 1993.
There were no contributions to the plans in 1998, 1997 and 1996. Under the
plans, USCS was obligated, at the employee's option, to repurchase vested shares
at the current fair market value upon termination or retirement. Substantially
all share repurchases in 1996 and prior years resulted from the repurchase of
shares from former employees. USCS' repurchase obligations under the plans
lapsed effective with the initial public offering of USCS common stock. The USCS
ESOP was terminated effective January 1, 1997. An initial distribution from the
ESOP trust occurred in August 1997, with a total of approximately 321,000 shares
and cash of $579,000 distributed to the participants. In December 1997, the
remaining approximately 1.8 million shares and cash of $97,000 were distributed.
The Company has active and nonactive non-qualified deferred compensation plans
for senior management, certain highly compensated employees and directors. The
active plans permit participants to defer a portion of their compensation and
may provide additional life insurance benefits until termination of their
employment, at which time payment of amounts deferred is made in a lump sum or
annual installments. Deferred amounts accrue interest at a rate determined by
the Board of Directors or are credited with deemed gains or losses of the
underlying investments. Amounts deferred under the plans totaled approximately
$22.5 million and $16.3 million at December 31, 1998 and 1997, respectively.
68
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental disclosure of cash flow information for the years ended December
31, (in millions):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Interest paid during the year.......................... $ 11.4 $ 6.2 $ 13.0
Income taxes paid during the year...................... 40.7 43.6 30.8
In 1998, the Company received a $9.5 million dividend from Argus. The Company
also received a $9.5 million dividend from Argus in December 1996, $8.0 million
of which was received in cash and $1.5 million of which was received in the form
of a note receivable from a related party.
The Company purchased mainframe computer equipment and other capital additions
in the amount of $30.2 million and $4.8 million in 1997 and 1996, respectively,
through secured notes payable or vendor financed installment notes which
required no direct outlay of cash. No such purchases occurred in 1998.
The renegotiation of certain third party software agreements, effective March
31, 1998, resulted in certain amounts being recorded as costs and expenses
instead of as depreciation expense.
12. COMMITMENTS AND CONTINGENCIES
The Company has future obligations under certain software license agreements and
operating leases. The operating leases, which include facilities, data
processing and other equipment have lease terms ranging from 1 to 25 years not
including options to extend the leases for various lengths of time. Rental
expense from operating leases was $40.9 million, $43.2 million and $40.4 million
for the years ended December 31, 1998, 1997 and 1996, respectively. Future
minimum rentals for the non-cancelable term of all operating leases and
obligations under software license agreements are as follows (in millions):
SOFTWARE
NON-CANCELABLE LICENSE
LEASES AGREEMENTS TOTAL
--------------- ------------- ---------
1999................................................... $ 29.7 $ 8.7 $ 38.4
2000................................................... 23.2 10.2 33.4
2001................................................... 16.1 7.7 23.8
2002................................................... 9.7 7.1 16.8
2003................................................... 6.0 0.2 6.2
Thereafter............................................. 38.4 0.4 38.8
------ ----- ---------
Total.................................................. $ 123.1 $ 34.3 $ 157.4
------ ----- ---------
------ ----- ---------
Certain leases have clauses that call for the annual rents to be increased
during the term of the lease. Such lease payments are expensed on a
straight-line basis.
The Company leases certain facilities from unconsolidated real estate affiliates
and incurred occupancy expenses of $6.8 million, $6.6 million and $4.7 million
for the years ended December 31, 1998, 1997 and 1996, respectively.
The Company has also entered into agreements with co-participants in certain
joint venture subsidiaries whereby upon defined circumstances constituting a
change in control of either party to the venture, the other party has the right
to acquire, at a specified price, the entire interest in the joint venture.
69
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company has entered into agreements with certain officers whereby upon
defined circumstances constituting a change in control of the Company, certain
benefit entitlements are automatically funded and such officers are entitled to
specific cash payments upon termination of employment.
The Company has also established trusts to provide for the funding of corporate
commitments and entitlements of Company officers, directors, employees and
others in the event of a change in control of the Company. Assets held in such
trusts at December 31, 1998 were not significant.
The Company and its subsidiaries are involved in various legal proceedings
arising in the normal course of their businesses. While the ultimate outcome of
these legal proceedings cannot be predicted with certainty, it is the opinion of
management, after consultation with legal counsel, that the final outcome in
such proceedings, in the aggregate, would not have a material adverse effect on
the consolidated financial condition or results of operations of the Company.
70
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. SEGMENT AND GEOGRAPHIC INFORMATION
The Company has four segments as defined in Note 1. The Company evaluates the
performance of its segments based on income before taxes, non-recurring items
and interest expense. Intersegment revenues are reflected at rates prescribed by
the Company and may not be reflective of market rates. Summarized financial
information concerning the segments is shown in the following tables (in
millions):
YEAR ENDED DECEMBER 31, 1998
------------------------------------------------------------------------------
FINANCIAL CUSTOMER OUTPUT INVESTMENTS/ CONSOLIDATED
SERVICES MANAGEMENT SOLUTIONS OTHER ELIMINATIONS TOTAL
----------- ----------- ----------- ------------- ----------- -----------
External revenues................... $ 506.4 $ 221.7 $ 357.0 $ 11.0 $ $ 1,096.1
Intersegment revenues............... 1.2 57.7 23.1 (82.0)
----------- ----------- ----------- ----- ----------- -----------
Total revenues...................... 507.6 221.7 414.7 34.1 (82.0) 1,096.1
Cost and expenses................... 360.5 187.8 350.9 17.5 (82.0) 834.7
Depreciation and amortization....... 61.7 11.6 27.7 7.8 108.8
Merger charges...................... 33.1 33.1
----------- ----------- ----------- ----- ----------- -----------
Income from operations.............. 85.4 22.3 36.1 8.8 (33.1) 119.5
Other income (loss), net............ 1.5 (0.6) 0.5 5.4 0.6 7.4
Equity in losses of unconsolidated
affiliates........................ (1.4) (1.3) (2.7)
----------- ----------- ----------- ----- ----------- -----------
Earnings before interest and income
taxes............................. $ 85.5 $ 21.7 $ 36.6 $ 12.9 $ (32.5) $ 124.2
----------- ----------- ----------- ----- ----------- -----------
----------- ----------- ----------- ----- ----------- -----------
YEAR ENDED DECEMBER 31, 1997
------------------------------------------------------------------------------
FINANCIAL CUSTOMER OUTPUT INVESTMENTS/ CONSOLIDATED
SERVICES MANAGEMENT SOLUTIONS OTHER ELIMINATIONS TOTAL
----------- ----------- ----------- ------------- ----------- -----------
External revenues................... $ 424.3 $ 202.9 $ 310.9 $ 11.9 $ $ 950.0
Intersegment revenues............... 0.7 55.5 21.8 (78.0)
----------- ----------- ----------- ----- ----------- -----------
Total revenues...................... 425.0 202.9 366.4 33.7 (78.0) 950.0
Cost and expenses................... 302.3 164.5 312.8 18.0 (78.0) 719.6
Depreciation and amortization....... 56.5 10.1 29.3 7.6 103.5
----------- ----------- ----------- ----- ----------- -----------
Income from operations.............. 66.2 28.3 24.3 8.1 126.9
Other income (loss), net............ 0.8 (0.6) 0.7 4.7 0.2 5.8
Equity in losses of unconsolidated
affiliates........................ (0.9) (0.4) (1.3)
----------- ----------- ----------- ----- ----------- -----------
Earnings before interest and income
taxes............................. $ 66.1 $ 27.7 $ 25.0 $ 12.4 $ 0.2 $ 131.4
----------- ----------- ----------- ----- ----------- -----------
----------- ----------- ----------- ----- ----------- -----------
71
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1996
------------------------------------------------------------------------------
FINANCIAL CUSTOMER OUTPUT INVESTMENTS/ CONSOLIDATED
SERVICES MANAGEMENT SOLUTIONS OTHER ELIMINATIONS TOTAL
----------- ----------- ----------- ------------- ----------- -----------
External revenues................... $ 378.2 $ 172.3 $ 284.0 $ 9.5 $ $ 844.0
Intersegment revenues............... 50.2 16.4 (66.6)
----------- ----------- ----------- ----- ----------- -----------
Total revenues...................... 378.2 172.3 334.2 25.9 (66.6) 844.0
Cost and expenses................... 272.7 147.6 283.3 16.0 (66.6) 653.0
Depreciation and amortization....... 58.4 8.9 27.0 4.8 99.1
Other expense....................... 13.7 13.7
----------- ----------- ----------- ----- ----------- -----------
Income from operations.............. 47.1 15.8 23.9 5.1 (13.7) 78.2
Other income (loss), net............ 1.4 0.2 (2.0) 3.7 1.2 4.5
Gain on sales of Continuum.......... 223.4 223.4
Equity in losses of unconsolidated
affiliates........................ (3.2) (0.8) (4.0)
----------- ----------- ----------- ----- ----------- -----------
Earnings before interest and income
taxes............................. $ 268.7 $ 16.0 $ 21.9 $ 8.0 $ (12.5) $ 302.1
----------- ----------- ----------- ----- ----------- -----------
----------- ----------- ----------- ----- ----------- -----------
Earnings before interest and income taxes in the segment reporting information
above less interest expense of $8.6 million, $8.5 million and $10.5 million for
the year ended December 31, 1998, 1997 and 1996, respectively, is equal to the
Company's income before income taxes and minority interests on a consolidated
basis for the corresponding year.
The Financial Services Segment derives its revenues from two primary products
and services. Revenues from shareowner accounting products and services totaled
$384.0 million, $326.8 million and $285.9 million in 1998, 1997 and 1996,
respectively. Revenues from portfolio/investment management accounting products
and services totaled $101.0 million, $77.1 million and $69.8 million in 1998,
1997, and 1996, respectively.
72
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Information concerning principal geographic areas is as follows (in millions):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Revenues:
U.S............................................. $ 942.1 $ 832.4 $ 748.4
U.K............................................. 55.9 56.5 45.9
Canada.......................................... 31.4 26.4 24.3
Australia....................................... 13.9 13.1 15.3
Germany......................................... 8.6 1.3 0.3
Netherlands..................................... 8.3 4.6 0.8
Switzerland..................................... 6.1 0.5 0.2
South Africa.................................... 6.1 5.5 5.5
Others.......................................... 23.7 9.7 3.3
--------- --------- ---------
$ 1,096.1 $ 950.0 $ 844.0
--------- --------- ---------
--------- --------- ---------
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Long-lived assets:
U.S............................................... $ 347.4 $ 342.1
U.K............................................... 17.0 18.0
Canada............................................ 12.5 12.8
Others............................................ 13.8 14.6
--------- ---------
$ 390.7 $ 387.5
--------- ---------
--------- ---------
73
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables of quarterly financial data for the years ended December
31, 1998 and 1997 have been restated to combine the historical results of
operations of DST and USCS adjusted for conformity of accounting principles.
(dollars in millions, except per share amounts):
YEAR ENDED DECEMBER 31, 1998
-------------------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
QUARTER QUARTER QUARTER QUARTER 1998
----------- ----------- ----------- ----------- ---------
Revenues................................................ $ 266.0 $ 269.8 $ 268.8 $ 291.5 $ 1,096.1
Cost and expenses....................................... 198.4 207.6 207.0 221.7 834.7
Depreciation and amortization........................... 27.2 24.6 26.2 30.8 108.8
Merger charges.......................................... 7.1 26.0 33.1
----------- ----------- ----------- ----------- ---------
Income from operations.................................. 40.4 37.6 28.5 13.0 119.5
Interest expense........................................ (2.6) (2.3) (2.0) (1.7) (8.6)
Other income, net....................................... 1.0 1.3 3.7 1.4 7.4
Equity in earnings (losses) of unconsolidated
affiliates, net of taxes.............................. (0.4) 0.1 (1.2) (1.2) (2.7)
----------- ----------- ----------- ----------- ---------
Income before income taxes and minority interests....... 38.4 36.7 29.0 11.5 115.6
Income taxes............................................ 14.3 13.6 11.3 5.1 44.3
----------- ----------- ----------- ----------- ---------
Income before minority interests........................ 24.1 23.1 17.7 6.4 71.3
Minority interests...................................... (0.2) (0.1) (0.3)
----------- ----------- ----------- ----------- ---------
Net income.............................................. $ 24.1 $ 23.3 $ 17.7 $ 6.5 $ 71.6
----------- ----------- ----------- ----------- ---------
----------- ----------- ----------- ----------- ---------
Basic average shares outstanding........................ 62.6 62.8 62.8 62.8 62.7
Basic earnings per share................................ $ 0.38 $ 0.37 $ 0.28 $ 0.10 $ 1.14(1)
Diluted average shares outstanding...................... 64.0 64.2 64.5 64.5 64.3
Diluted earnings per share.............................. $ 0.38 $ 0.36 $ 0.27 $ 0.10 $ 1.11
Common stock price ranges: High......................... $ 53.00 $ 56.81 $ 69.94 $ 59.75 $ 69.94
Low.......................... $ 40.25 $ 50.13 $ 47.88 $ 35.81 $ 35.81
- ------------------------
(1) Earnings per share are computed independently for each of the quarters
presented. As such, the accumulation of 1998 quarterly earnings per share
may not equal the total computed for the year.
74
DST SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1997
-------------------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
QUARTER QUARTER QUARTER QUARTER 1997
----------- ----------- ----------- ----------- ---------
Revenues.................................................. $ 229.7 $ 228.1 $ 232.9 $ 259.3 $ 950.0
Cost and expenses......................................... 172.9 173.1 176.7 196.9 719.6
Depreciation and amortization............................. 25.1 25.1 26.6 26.7 103.5
----------- ----------- ----------- ----------- ---------
Income from operations.................................... 31.7 29.9 29.6 35.7 126.9
Interest expense.......................................... (2.5) (2.2) (1.9) (1.9) (8.5)
Other income, net......................................... 1.1 1.3 2.3 1.1 5.8
Equity in earnings (losses) of unconsolidated affiliates,
net of taxes............................................ 1.0 0.8 (0.4) (2.7) (1.3)
----------- ----------- ----------- ----------- ---------
Income before income taxes and minority interests......... 31.3 29.8 29.6 32.2 122.9
Income taxes.............................................. 11.4 10.4 10.6 10.5 42.9
----------- ----------- ----------- ----------- ---------
Income before minority interests.......................... 19.9 19.4 19.0 21.7 80.0
Minority interests........................................ 0.1 0.3 0.3 (0.1) 0.6
----------- ----------- ----------- ----------- ---------
Net income................................................ $ 19.8 $ 19.1 $ 18.7 $ 21.8 $ 79.4
----------- ----------- ----------- ----------- ---------
----------- ----------- ----------- ----------- ---------
Basic average shares outstanding.......................... 63.8 63.7 63.7 63.0 63.6
Basic earnings per share.................................. $ 0.31 $ 0.30 $ 0.30 $ 0.35 $ 1.25(1)
Diluted average shares outstanding........................ 64.8 64.8 65.0 64.2 64.7
Diluted earnings per share................................ $ 0.31 $ 0.29 $ 0.29 $ 0.34 $ 1.23
Common stock price ranges: High........................... $ 35.63 $ 33.31 $ 37.81 $ 44.56 $ 44.56
Low............................ $ 28.50 $ 24.25 $ 32.19 $ 34.56 $ 24.25
- ------------------------
(1) Earnings per share are computed independently for each of the quarters
presented. As such, the accumulation of 1997 quarterly earnings per share
may not equal the total computed for the year.
75
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The Company has incorporated by reference certain information in response or
partial response to the Items under this Part III of this Annual Report on Form
10-K pursuant to General Instruction G(3) of this Form 10-K and Rule 12b-23
under the Exchange Act. The Company's definitive proxy statement in connection
with its annual meeting of stockholders scheduled for May 11, 1999 (the
"Definitive Proxy Statement") will be filed with the Securities and Exchange
Commission no later than 120 days after December 31, 1998.
(A) DIRECTORS OF THE COMPANY
The information set forth in response to Item 401 of Regulation S-K under the
headings "Proposal-Election of Two Directors" and "The Board of Directors" in
the Company's Definitive Proxy Statement is hereby incorporated herein by
reference in partial response to this Item 10.
(B) EXECUTIVE OFFICERS OF THE COMPANY
The information set forth in response to Item 401 of Regulation S-K under the
heading "Executive Officers of the Company" in Part I of this Form 10-K is
incorporated herein by reference in partial response to this Item 10. The
information set forth in response to Item 405 of Regulation S-K under the
heading "Other Matters-Section 16(a) Beneficial Ownership Reporting Compliance"
in the Company's Definitive Proxy Statement is hereby incorporated herein by
reference in partial response to this Item 10.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth in response to Item 402 of Regulation S-K under "The
Board of Directors-- Compensation of Directors" and under "Executive
Compensation" in the Company's Definitive Proxy Statement (other than The
Compensation Committee Report on Executive Compensation and the Stock
Performance Graph) is hereby incorporated herein by reference in response to
this Item 11.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth in response to Item 403 of Regulation S-K under the
heading "Principal Stockholders and Stockholdings of Management" in the
Company's Definitive Proxy Statement is hereby incorporated herein by reference
in response to this Item 12.
The Company has no knowledge of any arrangement the operation of which may at a
subsequent date result in a change of control of the Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth in response to Item 404 of Regulation S-K under the
heading "Compensation Committee Interlocks and Insider Participation" in the
Company's Proxy Statement is incorporated herein by reference in response to
this Item 13.
76
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) List of Documents filed as part of this Report
(1) Consolidated Financial Statements
The consolidated financial statements and related notes, together with
the report of PricewaterhouseCoopers LLP dated February 25, 1999 appear in
Part II Item 8 Financial Statements and Supplementary Data of this Form
10-K.
(2) Consolidated Financial Statement Schedules
All schedules have been omitted because they are not applicable,
insignificant or the required information is shown in the consolidated
financial statements or notes thereto.
(3) List of Exhibits
(a) Exhibits
The Company has incorporated by reference herein certain exhibits as specified
below pursuant to Rule 12b-32 under the Exchange Act.
2. Plan of acquisition, reorganization, arrangement, liquidation or succession
2 The Company's Agreement and Plan of Merger, dated September 2, 1998 by and among
DST Systems, Inc., DST Acquisitions, Inc. and USCS International, Inc, which is
attached as Exhibit 2 to the Company's Registration Statement on Form S-4 dated
November 20, 1998, (Commission file no. 333-67611) ("S-4"), is hereby incorporated
by reference as Exhibit 2.
3. Articles of Incorporation and by-laws
3.1 The Company's Amended Delaware Certificate of Incorporation, as restated, which is
attached as Exhibit 3.1 to the Company's Registration Statement dated September 1,
1995, as amended August 31, 1995 (Commission file no. 33-96526) (the "IPO
Registration Statement"), is hereby incorporated by reference as Exhibit 3.1.
3.2 The Company's Amended and Restated By-laws as adopted August 28, 1995, which are
attached as Exhibit 3.2 to the Company's IPO Registration Statement, are hereby
incorporated by reference as Exhibit 3.2.
4. Instruments defining the rights of security holders, including indentures
4.1 The Registration Rights Agreement dated October 24, 1995, between the Company and
Kansas City Southern Industries, Inc. ("KCSI"), which is attached as Exhibit 4.1 to
the Company's IPO Registration Statement, is hereby incorporated by reference as
Exhibit 4.1.
4.2 The Certificate of Designations dated October 16, 1995, establishing the Series A
Preferred Stock of the Company, which is attached as Exhibit 4.3 to the Company's
IPO Registration Statement, is hereby incorporated by reference as Exhibit 4.2.
4.3 The Summary of the preferred stock purchase rights set forth in Form 8-A dated
November 15, 1995 (Commission file no. 1-14036), and the related Rights Agreement
dated as of October 6, 1995, between the Company and State Street Bank and Trust
Company, as rights agent, which is attached as Exhibit 4.4 to the Company's IPO
Registration Statement, are hereby incorporated by reference as Exhibit 4.3.
77
4.3.1 The First Amendment dated as of July 9, 1998 to the Rights Agreement dated as of
October 6, 1995 between the Registrant and State Street Bank and Trust Company
attached as Exhibit 99 to Amendment No.1, dated July 30, 1998, to the Company's
Registration Statement on Form 8-A for its Preferred Share Purchase Rights
(Commission file no. 1-14036) is hereby incorporated by reference as Exhibit 4.3.1.
4.4 The Registration Rights Agreement dated October 31, 1995, between the Company and
UMB Bank, N.A. as trustee of The Employee Stock Ownership Plan of DST Systems, Inc.
("UMB") which is attached as Exhibit 4.4 to the Company's Annual Report for the
year ended December 31, 1995 (Commission file no. 1-14036), is hereby incorporated
by reference as Exhibit 4.4.
4.5 The Stock Exchange Agreement dated October 26, 1995, between KCSI and UMB, which is
attached as Exhibit 4.6 to the Company's IPO Registration Statement, is hereby
incorporated by reference as Exhibit 4.5.
4.6 The description set forth under the heading "Dividend Policy" in the Company's IPO
Registration Statement of the Common Stock on Form 8-A (Commission file no.
1-14036) is hereby incorporated by reference as Exhibit 4.6.
4.7 The description of the Company's common stock, par value $0.01 per share, set forth
in the Company's Registration Statement on Form 8-A dated January 21, 1998,
(Commission file no. 1-14036), is hereby incorporated by reference as Exhibit 4.7.
4.8 Paragraphs fourth, fifth, sixth, seventh, tenth, eleventh, and twelfth of Exhibit
3.1 are hereby incorporated by reference as Exhibit 4.8.
4.9 Article I, Sections 1, 2, 3, and 11 of Article II, Article V, Article VIII, Article
IX of Exhibit 3.2 are hereby incorporated by reference as Exhibit 4.9.
4.10 The Affiliate Agreement with James C. Castle dated October 28, 1998, is attached as
Exhibit 4.10 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998 (Commission file no. 1-14036).
4.11 The Affiliate Agreement with George L. Argyros, Sr. dated September 3, 1998, is
attached as Exhibit 4.11 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998 (Commission file no. 1-14036).
4.12 The Stockholder Agreement with Kansas City Southern Industries, Inc. dated
September 2, 1998 is attached as Exhibit 4.12 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1998 (Commission file no. 1-14036).
4.12.1 The First Amendment to the Stockholder Agreement with Kansas City Southern
Industries, Inc. dated October 29, 1998, which is attached as Exhibit 4.2.1 to the
Company's S-4, is hereby incorporated by reference as Exhibit 4.12.1.
4.13 The Stockholder Agreement with George L. Argyros, Sr. dated September 2, 1998, is
attached as Exhibit 4.13 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998 (Commission file no. 1-14036).
4.14 The Stockholder Agreement with James C. Castle dated September 2, 1998, is attached
as Exhibit 4.14 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998 (Commission file no. 1-14036).
4.15 The Registration Rights Agreement with George L. Argyros, Sr., James C. Castle and
certain other individuals dated December 21, 1998 is attached as Exhibit 4.15 to
the Company's Annual Report on Form 10-K for the year ended December 31, 1998
(Commission file no. 1-14036).
78
4.16 The Five-Year Competitive Advance and Revolving Credit Facility Agreement ("Chase
Agreement") among the Company, the lenders named therein, The Chase Manhattan Bank,
N.A. as Documentation, Syndication, and Administrative Agent dated December 30,
1996, which is attached as Exhibit 10.17 to the Company's Annual Report on Form
10-K for the year ended December 31, 1996 (Commission file no. 1-14036), is hereby
incorporated by reference as Exhibit 4.16.
4.16.1 The Amendment to the Chase Agreement dated November 19, 1998, is attached as
Exhibit 4.16.1 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998 (Commission file no. 1-14036).
The Company agrees to furnish to the Commission a copy of any long-term debt
agreements that do not exceed 10 percent of the total assets of the Company upon
request.
9. VOTING TRUST AGREEMENT
Not applicable.
10. MATERIAL CONTRACTS
10.1 The Tax Disaffiliation Agreement between the Company and KCSI dated October 23,
1995, which is attached as Exhibit 10.4 to the Company's IPO Registration
Statement, is hereby incorporated by reference as Exhibit 10.1
10.2 The Stock Purchase, Sale of Assets, Assignment and Assumption Agreement dated
August 30, 1995, among the Company, DST Realty, Inc., Tolmak, Inc., Mulberry
Western Company and KCSI, which is attached as Exhibit 10.5 to the Company's IPO
Registration Statement, is hereby incorporated by reference as Exhibit 10.2.
10.3 The Agreement between State Street Boston Financial Corporation and Data-Sys-Tance
dated June 1, 1974 ("State Street Agreement"), which is attached as Exhibit 10.14
to the Company's IPO Registration Statement, is hereby incorporated by reference as
Exhibit 10.3.
10.3.1 The Amendment to the State Street Agreement between the Company and State Street,
dated October 1, 1987, which is attached as Exhibit 10.14.1 to the Company's IPO
Registration Statement, is hereby incorporated by reference as Exhibit 10.3.1.
10.3.2 The Amendment to the State Street Agreement between the Company and State Street,
dated February 6, 1992, is attached as Exhibit 10.3.2 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1998 (Commission file no.
1-14036). Portions of this agreement are subject to confidential treatment.
10.4 The Data Processing Services Agreement between the Company and The Continuum
Company, Inc. dated October 1, 1993, which is attached as Exhibit 10.15 to the
Company's IPO Registration Statement, is hereby incorporated by reference as
Exhibit 10.4.
10.5 The Agreement among the Company, Financial Holding Corporation, KCSI and Argus
Health Systems, Inc. dated June 30, 1989, which is attached as Exhibit 10.16 to the
Company's IPO Registration Statement, is hereby incorporated by reference as
Exhibit 10.5.
10.6 The Stock Transfer Restriction and Option Agreement between the Company, Argus
Health Systems, Inc. and Financial Holding Corporation dated June 30, 1989, which
is attached as Exhibit 10.16.1 to the Company's IPO Registration Statement, is
hereby incorporated by reference as Exhibit 10.6.
79
10.7 The Contribution Agreement between DST Systems, Inc. and Boston EquiServe Limited
Partnership dated November 30, 1998, is attached as Exhibit 10.7 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1998 (Commission file
no. 1-14036).
10.8 The Fairway System Software Development Agreement dated November 30, 1998, is
attached as Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998 (Commission file no. 1-14036).
10.9 The Company's Executive Plan effective as of October 31, 1995, attached as Exhibit
10.2 to the Company's Annual Report on Form 10-K for the year ended December 31,
1995 (Commission file no. 1-14036), is hereby incorporated by reference as Exhibit
10.9.
10.10 The Company's Incentive Compensation Plan, dated February 27, 1997, is attached as
Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998 (Commission file no. 1-14036).
10.11 The Company's Deferred Compensation Plan, dated May 12, 1998, is attached as
Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998 (Commission file no. 1-14036).
10.12 The Company's Directors' Deferred Fee Plan effective September 1, 1995, which is
attached as Exhibit 10.19 to the Company's Registration Statement, is hereby
incorporated by reference as Exhibit 10.12.
10.13 The 1999 USCS Executive Bonus Plan, is attached as Exhibit 10.13 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1998 (Commission file
no. 1- 14036). Portions of this agreement are subject to confidential treatment.
10.14 The USCS International, Inc. Deferred Compensation Plan, which is attached as
Exhibit 10.7 to USCS International, Inc.'s Annual Report on Form 10-K for the year
ended December 31, 1997 (Commission file no. 000-28268), is hereby incorporated by
reference as Exhibit 10.14.
10.15 The USCS International, Inc. Bonus Deferral Plan, which is attached as Exhibit 4.1
to USCS International, Inc.'s Registration Statement on Form S-8 dated August 29,
1997 (Commission file no. 333-34801), is hereby incorporated by reference as
Exhibit 10.15.
10.16 The Trust Agreement between the Company as settlor and United Missouri Bank of
Kansas City, N.A. as Trustee dated December 31, 1987, which is attached as Exhibit
10.20 to the Company's IPO Registration Statement, is hereby incorporated by
reference as Exhibit 10.16.
10.16.1 The Eighth Amendment to the Trust Agreement between the Company as settlor and
United Missouri Bank of Kansas City, N.A. as Trustee dated December 31, 1998, is
attached as Exhibit 10.16.1 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1998 (Commission file no. 1-14036).
10.17 Trust Agreement by and between the Company as settlor and United Missouri Bank of
Kansas City, N.A., Trustee dated June 30, 1989, for the benefit of James Horan,
which is attached as Exhibit 10.20.1 to the Company's IPO Registration Statement,
is hereby incorporated by reference as Exhibit 10.17.
10.17.1 The Amendment to the Trust Agreement by and between the Company as settlor and
United Missouri Bank of Kansas City, N.A., Trustee dated December 31, 1998, for the
benefit of James Horan, is attached as Exhibit 10.17.1 to the Company's Annual
Report of Form 10-K for the year ended December 31, 1998 (Commission file no.
1-14036).
80
10.18 The Employment Agreement between the Company and Thomas A. McDonnell dated January
1, 1999, is attached as Exhibit 10.18 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998 (Commission file no. 1-14036).
10.19 The Employment Agreement between the Company, KCSI and Thomas A. McCullough dated
April 1, 1992, as amended October 9, 1995, which is attached as Exhibit 10.9 to the
Company's IPO Registration Statement, is hereby incorporated by reference as
Exhibit 10.19.
10.20 The Employment Agreement between the Company, KCSI and James P. Horan dated April
1, 1992 as amended October 9, 1995, which is attached as Exhibit 10.10 to the
Company's IPO Registration Statement, is hereby incorporated by reference as
Exhibit 10.20.
10.21 The Employment Agreement between the Company, KCSI and Robert C. Canfield, dated
April 1, 1992, as amended October 9, 1995, which is attached as Exhibit 10.11 to
the Company's Registration Statement, is hereby incorporated by reference as
Exhibit 10.21.
10.22 The Employment Agreement between the Company, KCSI and Charles W. Schellhorn, dated
April 1, 1992, as amended October 9, 1995, which is attached as Exhibit 10.12 to
the Company's Annual Report on Form 10-K for the year ended December 31, 1996
(Commission file no. 1- 14036), is hereby incorporated by reference as Exhibit
10.22.
10.23 The Employment Agreement between USCS and James C. Castle dated August 10, 1992,
which is attached to USCS' Registration Statement on Form S-1, Registration No.
333-03842, is hereby incorporated by reference as Exhibit 10.23.
10.24 The USCS International, Inc. 1996 Directors' Stock Option Plan (the "Directors'
Plan") dated as of April 18, 1996, which is attached as Exhibit 10.5 to USCS
International, Inc.'s Registration Statement on Form S-1 (Commission File No.
333-3842) dated May 29, 1996, is hereby incorporated by reference as Exhibit
10.24.*
10.24.1 The First Amendment to the Directors' Plan dated February 22, 1998, which is
attached as Exhibit 4.6.2 to the Company's Registration Statement on Form S-8 dated
March 2, 1999 (Commission File No. 333-73241), is hereby incorporated by reference
as Exhibit 10.24.1.*
10.25 The USCS International, Inc. 1988 Incentive Stock Option Plan ("the 1988 USCS
Plan") dated July 1, 1988, as amended and restated as of March 5, 1997, which is
attached as Exhibit 4.6.1 to the Company's Registration Statement on Form S-8 dated
December 21, 1998 (Commission File No. 333-69393), is hereby incorporated by
reference as Exhibit 10.25.*
10.25.1 The Amendment dated January 22, 1998, to the 1988 USCS Plan, which is attached as
Exhibit 4.6.2 to the Company's Registration Statement on Form S-8 dated December
21, 1998 (Commission File No. 333-69393), is hereby incorporated by reference as
Exhibit 10.25.1.*
10.26 The USCS International, Inc. 1990 Stock Option Plan ("the 1990 USCS Plan") dated
December 31, 1990, as amended and restated as of March 5, 1997, which is attached
as Exhibit 4.7.1 to the Company's Registration Statement on Form S-8 dated December
21, 1998 (Commission File No. 333-69393), is hereby incorporated by reference as
Exhibit 10.26.*
10.26.1 The Amendment dated January 22, 1998, to the 1990 USCS Plan, which is attached as
Exhibit 4.7.2 to the Company's Registration Statement on Form S-8 dated December
21, 1998 (Commission File No. 333-69393), is hereby incorporated by reference as
Exhibit 10.26.1.*
10.27 The USCS International, Inc. 1993 Incentive Stock Option Plan ("the 1993 USCS
Plan") dated May 18, 1993, as amended and restated as of March 5, 1997, which is
attached as Exhibit 4.8.1 to the Company's Registration Statement on Form S-8 dated
December 21, 1998 (Commission File No. 333-69393), is hereby incorporated by
reference as Exhibit 10.27.*
81
10.27.1 The Amendment dated January 22, 1998, to the 1993 USCS Plan, which is attached as
Exhibit 4.8.2 to the Company's Registration Statement on Form S-8 dated December
21, 1998 (Commission File No. 333-69393), is hereby incorporated by reference as
Exhibit 10.27.1.*
10.28 The USCS International, Inc. 1989 Stock Option Plan ("the 1996 USCS Plan") dated
April 12, 1996, which is attached as Exhibit 4.9.1 to the Company's Registration
Statement on Form S-8 dated December 21, 1998 (Commission File No. 333-69393), is
hereby incorporated by reference as Exhibit 10.28*.
10.28.1 The Amendment dated July 25, 1996, to the 1996 USCS Plan, which is attached as
Exhibit 4.9.2 to the Company's Registration Statement on Form S-8 dated December
21, 1998 (Commission File No. 333-69393), is hereby incorporated by reference as
Exhibit 10.28.1.*
10.28.2 The Amendment dated January 23, 1997, to the 1996 USCS Plan, including the
footnote, which is attached as Exhibit 4.9.3 to the Company's Registration
Statement on Form S-8 dated December 21, 1998 (Commission File No. 333-69393), is
hereby incorporated by reference as Exhibit 10.28.2.
10.28.3 The Amendment dated January 22, 1998, to the 1996 USCS Plan, including the
footnote, which is attached as Exhibit 4.9.4 to the Company's Registration
Statement on Form S-8 dated December 21, 1998 (Commission File No. 333-69393), is
hereby incorporated by reference as Exhibit 10.28.3.
10.29 The Company's 1995 Stock Option and Performance Award Plan, effective September 1,
1995, which is attached as Exhibit 10.3 to the Company's registration statement on
Form S-1 dated September 1, 1995 (Commission file no. 33-96526), is hereby
incorporated by reference as Exhibit 10.29.
10.29.1 The First Amendment to the DST Systems, Inc. 1995 Stock Option and Performance
Award Plan, approved May 13, 1997, attached as Exhibit 10.3.1 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1997 (Commission file
no. 1-14036), is hereby incorporated by reference as Exhibit 10.29.1.
10.29.2 The Second Amendment to the DST Systems, Inc. 1995 Stock Option and Performance
Award Plan approved December 21, 1998, set forth under "Proposal 2 for DST
Stockholders-- Amendment of the DST Plan--DST Plan Proposal; Recommendation of the
DST Board" in the S-4, is hereby incorporated by reference as Exhibit 10.29.2.
- ------------------------
* The agreements and the amendments thereto are included as exhibits only to
the extent that they are incorporated into the option agreements assumed by
the Company with its acquisition of USCS.
11. STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
Not applicable.
12. STATEMENTS RE COMPUTATION OF RATIOS
Not applicable.
13. ANNUAL REPORT TO SECURITY HOLDERS, FORM 10-Q OR QUARTERLY REPORT TO SECURITY
HOLDERS
Not applicable.
82
16. LETTER RE CHANGE IN CERTIFYING ACCOUNTANT
Not applicable.
18. LETTER RE CHANGE IN ACCOUNTING PRINCIPLES
Not applicable.
21. SUBSIDIARIES OF THE COMPANY
The list of the Company's significant subsidiaries, which is attached as Exhibit
21.1 to the Company's Annual Report on Form 10-K for the year ended December 31,
1998, (Commission file no. 1-14036).
22. PUBLISHED REPORT REGARDING MATTERS SUBMITTED TO VOTE OF SECURITY HOLDERS
Not applicable.
23. CONSENTS OF EXPERTS AND COUNSEL
The consent dated March 26, 1999 of PricewaterhouseCoopers LLP to the
incorporation by reference of their report included in this Annual Report on
Form 10-K is attached hereto as Exhibit 23.1.
24. POWER OF ATTORNEY
Not applicable.
27. FINANCIAL DATA SCHEDULE
A Financial Data Schedule prepared in accordance with Item 601 (c) of Regulation
S-K is attached hereto as Exhibit 27.1.
99. ADDITIONAL EXHIBITS
Not applicable.
(B) REPORTS ON FORM 8-K DURING THE LAST CALENDAR QUARTER
The Company filed a Form 8-K dated October 22, 1998, under Item 5 of such form,
reporting the announcement of financial results for the quarter ended
September 30, 1998.
The Company filed a Form 8-K dated December 21, 1998, under Item 5 of such form,
reporting the announcement of the merger of USCS International, Inc. with a
wholly-owned subsidiary of the Company.
The Company filed a Form 8-K dated December 21, 1998, under Item 2 and 7 of such
form, reporting the merger of USCS International, Inc. with a wholly-owned
subsidiary of the Company, including financial information and exhibits
associated with the merger.
83
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
DST SYSTEMS, INC.
By: /s/ Thomas A. McDonnell
-----------------------------------------
Thomas A. McDonnell
PRESIDENT AND CHIEF EXECUTIVE OFFICER,
DIRECTOR
Dated: February 25, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Company and in
capacities indicated on February 25, 1999.
/s/ Thomas A. McDonnell
/s/ A. Edward Allinson ---------------------------
- ------------------------------ THOMAS A. MCDONNELL
A. EDWARD ALLINSON PRESIDENT AND CHIEF
DIRECTOR EXECUTIVE OFFICER,
DIRECTOR
/s/ Thomas A. McCullough
/s/ George L. Argyros, Sr. ---------------------------
- ------------------------------ THOMAS A. MCCULLOUGH
GEORGE L. ARGYROS, SR. EXECUTIVE VICE PRESIDENT,
DIRECTOR DIRECTOR
/s/ Michael G. Fitt /s/ James C. Castle
- ------------------------------ ---------------------------
MICHAEL G. FITT JAMES C. CASTLE
DIRECTOR DIRECTOR
/s/ Kenneth V. Hager
---------------------------
/s/ William C. Nelson KENNETH V. HAGER
- ------------------------------ VICE PRESIDENT, CHIEF
WILLIAM C. NELSON FINANCIAL OFFICER AND
DIRECTOR TREASURER (PRINCIPAL
FINANCIAL OFFICER)
/s/ John J. Faucett
/s/ M. Jeannine Standjord ---------------------------
- ------------------------------ JOHN J. FAUCETT
M. JEANNINE STANDJORD CONTROLLER (PRINCIPAL
DIRECTOR ACCOUNTING OFFICER)
84
DST SYSTEMS, INC.,
1998 FORM 10-K ANNUAL REPORT
INDEX TO EXHIBITS
The following Exhibits are attached hereto.* See Part IV of this Annual Report
on Form 10-K for a complete list of exhibits.
EXHIBIT NUMBER DOCUMENT
- --------------- -------------------------------------------------------------------------------------------------
4.10 Affiliate Agreement with James C. Castle
4.11 Affiliate Agreement with George L. Argyros, Sr.
4.12 Stockholder Agreement with Kansas City Southern Industries, Inc.
4.13 Stockholder Agreement with George L. Argyros, Sr.
4.14 Stockholder Agreement with James C. Castle
4.15 Registration Rights Agreement with George L. Argyros, Sr. and James C. Castle
4.16.1 Amendment to Chase Agreement
10.7 Contribution Agreement
10.8 Fairway System Software Development Agreement
10.10 Incentive Compensation Plan
10.11 Deferred Compensation Plan
10.13 1999 USCS Executive Bonus Plan
10.16.1 Eighth Amendment to the Trust Agreement
10.17.1 Amendment to the Trust Agreement
10.18 Employment Agreement with Thomas A. McDonnell
21.1 Subsidiaries of the Company
23.1 Consent of Independent Accountants
27.1 Financial Data Schedule
- ------------------------
* The above exhibits are not included in this Form 10-K, but are on file with
the Securities and Exchange Commission
85