Back to GetFilings.com
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
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
------------------------
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
- ----------------------------------------------- -----------------------------------------------
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
- ------------------------------------------------------------------------------ ---------------------------------------
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
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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,
----------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
(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
--------- --------- ---------
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
--------- --------- ---------
--------- --------- ---------
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
- ------------------------
(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
7
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 ("Cust