UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
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 of (I.R.S. Employer
incorporation or organization) Identification No.)
333 West 11th Street, Kansas City, Missouri 64105
(Address of principal executive offices) (Zip Code)
(816) 435-1000
(Company's telephone number, including area code)
No Changes
(Former name, former address and former fiscal year,
if changed since last report)
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 [ ]
Number of shares outstanding of the Company's common stock as of
September 30, 1999:
Common Stock $.01 par value - 63,407,725
<PAGE>
DST Systems, Inc.
Form 10-Q
September 30, 1999
Table of Contents
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Introductory Comments 3
Condensed Consolidated Balance Sheet -
September 30, 1999 and December 31, 1998 4
Condensed Consolidated Statement of Income -
Three and Nine Months Ended September 30, 1999 and 1998 5
Condensed Consolidated Statement of Cash Flows -
Nine Months Ended September 30, 1999 and 1998 6
Notes to Condensed Consolidated Financial Statements 7-12
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13-23
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 27
SIGNATURES 27
The Company's service marks and trademarks include without limitation
CUSTIMA(TM), DST(R), TRAC-2000(R), Automated Work Distributor(TM), AWD(R),
FAST2000(TM) referred to in this Report.
2
DST Systems, Inc.
Form 10-Q
September 30, 1999
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Introductory Comments
The Condensed Consolidated Financial Statements of DST Systems, Inc. ("DST" or
the "Company") included herein have been prepared by the Company, without audit,
pursuant to the rules and regulations of the United States Securities and
Exchange Commission. Certain information and note disclosures normally included
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures are adequate to
enable a reasonable understanding of the information presented. These Condensed
Consolidated Financial Statements should be read in conjunction with the audited
financial statements and the notes thereto for the year ended December 31, 1998.
Additionally, the Condensed Consolidated Financial Statements should be read in
conjunction with Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations included in this Form 10-Q.
The results of operations for the three and nine months ended September 30,
1999, are not necessarily indicative of the results to be expected for the full
year 1999.
3
<TABLE>
<CAPTION>
DST Systems, Inc.
Condensed Consolidated Balance Sheet
(dollars in millions, except per share amounts)
(unaudited)
September 30, December 31,
1999 1998
--------------- ---------------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 95.6 $ 28.1
Accounts receivable 291.1 282.4
Other current assets 66.2 65.3
--------------- ---------------
452.9 375.8
Investments 1,173.2 1,130.5
Properties 329.6 328.4
Intangibles and other assets 52.2 62.3
--------------- ---------------
Total assets $ 2,007.9 $ 1,897.0
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Debt due within one year $ 15.8 $ 12.1
Accounts payable 77.5 85.3
Accrued compensation and benefits 53.8 53.4
Deferred revenues and gains 32.4 41.1
Other liabilities 85.8 76.7
--------------- ---------------
265.3 268.6
Long-term debt 47.6 49.7
Deferred income taxes 350.1 343.2
Other liabilities 69.0 68.5
--------------- ---------------
732.0 730.0
--------------- ---------------
Commitments and contingencies
--------------- ---------------
Minority interest 0.5 0.8
--------------- ---------------
Stockholders' equity
Common stock, $0.01 par; 125,000,000 shares authorized,
63,816,639 shares issued 0.6 0.6
Additional paid-in capital 449.8 462.3
Retained earnings 479.0 378.1
Treasury stock (408,914 and 945,114 shares,
respectively), at cost (21.1) (34.1)
Accumulated other comprehensive income 367.1 359.3
--------------- ---------------
Total stockholders' equity 1,275.4 1,166.2
--------------- ---------------
Total liabilities and stockholders' equity $ 2,007.9 $ 1,897.0
=============== ===============
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<TABLE>
<CAPTION>
DST Systems, Inc.
Condensed Consolidated Statement of Income
(in millions, except per share amounts)
(unaudited)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
1999 1998 1999 1998
-------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues $ 298.7 $ 268.8 $ 891.1 $ 804.6
Costs and expenses 221.6 207.0 657.4 613.0
Depreciation and amortization 28.8 26.2 84.1 78.0
Acquisition related charges 7.1 7.1
-------------- --------------- --------------- ---------------
Income from operations 48.3 28.5 149.6 106.5
Interest expense (1.2) (2.0) (3.9) (6.9)
Other income, net 4.2 3.7 5.0 6.0
Equity in earnings (losses) of unconsolidated
affiliates, net of income taxes 1.5 (1.2) 6.3 (1.5)
-------------- --------------- --------------- ---------------
Income before income taxes and minority interests 52.8 29.0 157.0 104.1
Income taxes 19.0 11.3 56.4 39.2
-------------- --------------- --------------- ---------------
Income before minority interest 33.8 17.7 100.6 64.9
Minority interest (0.1) (0.3) (0.2)
-------------- --------------- --------------- ---------------
Net income $ 33.9 $ 17.7 $ 100.9 $ 65.1
============== =============== =============== ===============
Average common shares outstanding 63.4 62.8 63.2 62.7
Diluted shares outstanding 65.1 64.5 64.8 64.2
Basic earnings per share $ 0.53 $ 0.28 $ 1.60 $ 1.04
Diluted earnings per share $ 0.52 $ 0.27 $ 1.56 $ 1.01
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<TABLE>
<CAPTION>
DST Systems, Inc.
Condensed Consolidated Statement of Cash Flows
(in millions)
(unaudited)
For the Nine Months
Ended September 30,
1999 1998
---------------- ----------------
<S> <C> <C>
Cash flows -- operating activities:
Net income $ 100.9 $ 65.1
---------------- ----------------
Depreciation and amortization 84.1 77.7
Noncash portion of acquisition related charges 6.0
Equity in (earnings) losses of unconsolidated affiliates (6.3) 1.5
Cash dividends received from unconsolidated affiliates 0.2 8.4
Deferred taxes (2.9) (4.9)
Changes in accounts receivable (8.7) (4.5)
Changes in other current assets 4.4 5.1
Changes in accounts payable and accrued liabilities 4.4 26.9
Other, net (3.0) 9.3
---------------- ----------------
Total adjustments to net income 72.2 125.5
---------------- ----------------
Net 173.1 190.6
---------------- ----------------
Cash flows -- investing activities:
Proceeds from sale of investments 14.8 2.7
Investments and advances to unconsolidated affiliates (31.1) (29.3)
Capital expenditures (98.4) (85.5)
Payment for purchase of subsidiary, net of cash acquired (14.0)
Other, net 10.5 (0.9)
---------------- ----------------
Net (104.2) (127.0)
---------------- ----------------
Cash flows -- financing activities:
Proceeds from issuance of long-term debt 11.5 7.4
Proceeds from exercise of stock options 20.6 3.0
Principal payments on long-term debt (11.0) (13.9)
Net increase (decrease) in revolving credit
facilities and notes payable 1.1 (3.0)
Common stock repurchased (22.4) (12.6)
Other, net (1.2) (11.1)
---------------- ----------------
Net (1.4) (30.2)
---------------- ----------------
Net increase in cash and cash equivalents 67.5 33.4
Cash and cash equivalents at beginning of period 28.1 18.6
---------------- ----------------
Cash and cash equivalents at end of period $ 95.6 $ 52.0
================ ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
1. Summary of Accounting Policies
The Condensed Consolidated Financial Statements of DST Systems, Inc. ("DST" or
the "Company") included herein have been prepared by the Company, without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations, although
the Company believes that the disclosures are adequate to enable a reasonable
understanding of the information presented. These Condensed Consolidated
Financial Statements should be read in conjunction with the audited financial
statements and the notes thereto for the year ended December 31, 1998.
Additionally, the Condensed Consolidated Financial Statements should be read in
conjunction with Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations included in this Form 10-Q.
Effective December 21, 1998, the Company acquired USCS International, Inc.
("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.
In the opinion of management, the accompanying unaudited condensed consolidated
financial statements contain all adjustments (consisting of normal interim
closing procedures) necessary to present fairly the financial position of the
Company and its subsidiaries at September 30, 1999 and December 31, 1998, and
the results of operations for the three and nine months ended September 30, 1999
and 1998, and cash flows for the nine months ended September 30, 1999 and 1998.
The results of operations for the three and nine months ended September 30,
1999, are not necessarily indicative of the results to be expected for the full
year 1999.
Software development and maintenance. Effective January 1, 1999, DST adopted, as
required, Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, which requires that certain
costs incurred for the development of internal use software be capitalized.
Prior to the adoption of SOP 98-1, the Company expensed the costs of internally
developed proprietary software as incurred. For the three and nine months ended
September 30, 1999, the Company capitalized $6.2 million and $18.1 million,
respectively, of costs related to the development of internal use software
consisting of $5.8 million and $16.1 million, respectively, for the Financial
Services Segment for the three and nine months ended September 30, 1999, and
$0.4 million and $2.0 million, respectively, for the Output Solutions Segment
for the three and nine months ended September 30, 1999. If internal use software
development costs had been expensed rather than capitalized, consolidated net
income for the three and nine months ended September 30, 1999 would have been
$29.9 million ($0.47 per basic share, $0.46 per diluted share) and $89.3 million
($1.41 per basic share, $1.38 per diluted share), respectively.
2. USCS Merger Integration Costs
In December 1998, DST's management approved plans which include initiatives to
integrate the operations of certain DST and USCS subsidiaries and consolidate
certain facilities. Total accrued integration costs of $16.9 million were
recorded in the fourth quarter of 1998, of which $0.7 million, $12.8 million and
$3.4 million related to the Financial Services, Output Solutions, and Customer
Management Segments, respectively. $8.0 million of these costs were utilized
during 1998.
7
The Company utilized $2.2 million in the quarter ended September 30, 1999 and
$3.0 million for the nine months ended September 30, 1999 related to the accrued
integration costs. Of the remaining accrued integration costs of $5.9 million at
September 30, 1999, $0.3 million, $4.0 million, and $1.6 million relate to the
Financial Services, Output Solutions, and Customer Management Segments,
respectively.
The accrued costs relate primarily to employee severance benefits which are
expected to be paid in 1999 and 2000 and 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 2000 once
arrangements have been made to process continuing business at other facilities.
Four of the locations have been closed as of September 30, 1999. 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 costs and integration costs of moving to common internal
systems. Although precise estimates cannot be made, management does not believe
such costs will have a materially adverse effect on the Company's consolidated
results of operations, liquidity or financial position.
3. Business Acquisition
In August of 1998, USCS purchased 100% of the stock of Custima International
Holdings, plc ("Custima") for cash. The business acquired provides billing and
customer care software for the utilities industry. The cost of the acquisition
was approximately $15.4 million. The acquisition was accounted for as a
purchase, and accordingly, the financial statements include the results of
operations from the date of acquisition. The purchase included existing
technology, in-process research and development, trademarks and in-place
workforce with an aggregate value of approximately $18.1 million. Based on an
independent appraisal, $6.0 million was attributed to in-process research and
development and, in accordance with applicable accounting principles, was
charged to expense. In addition, a reorganization charge for redundant
facilities and workforce of $1.1 million was taken in connection with USCS's
purchase and consolidation of Custima. Intangible assets are being amortized on
a straight-line basis over periods ranging from 3 to 10 years. On a pro forma
basis, the acquisition did not have a material impact on the Company's
historical results of operations or financial position.
8
4. Investments
Investments are as follows (in millions):
<TABLE>
<CAPTION>
Carrying Value
-----------------------------------
Ownership September 30, December 31,
Percentage 1999 1998
-------------------- ---------------- ----------------
Available-for-sale securities:
<S> <C> <C> <C>
Computer Sciences Corporation 5% $ 607.0 $ 554.6
State Street Corporation 4% 387.7 420.8
Euronet Services, Inc. 12% 4.5 4.5
Other available-for-sale securities 47.9 38.7
---------------- ----------------
1,047.1 1,018.6
---------------- ----------------
Unconsolidated affiliates:
Boston Financial Data Services, Inc. 50% 46.8 39.4
European Financial Data Services Limited 50% 8.6 5.5
Argus Health Systems, Inc. 50% 6.0 3.8
Other unconsolidated affiliates 23.0 25.6
---------------- ----------------
84.4 74.3
---------------- ----------------
Other:
Net investment in leases 17.4 16.3
Other 24.3 21.3
---------------- ----------------
41.7 37.6
---------------- ----------------
Total investments $ 1,173.2 $ 1,130.5
================ ================
</TABLE>
Certain information related to the Company's available for sale securities is as
follows (in millions):
September 30, December 31,
1999 1998
----------------- -----------------
Cost $ 443.2 $ 427.9
Gross unrealized gains 606.4 591.2
Gross unrealized losses (2.5) (0.5)
----------------- -----------------
Market value $ 1,047.1 $ 1,018.6
================= =================
The following table summarizes equity in earnings (losses) of unconsolidated
affiliates (in millions):
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
1999 1998 1999 1998
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
Boston Financial Data Services, Inc. $ 2.3 $ 1.9 $ 7.3 $ 5.5
Argus Health Systems, Inc. 0.5 0.6 2.1 1.8
European Financial Data Services Limited (1.5) (2.7) (3.4) (7.5)
Other 0.2 (1.0) 0.3 (1.3)
------------ ------------- ------------- -------------
$ 1.5 $ (1.2) $ 6.3 $ (1.5)
============ ============= ============= =============
</TABLE>
9
5. Earnings Per Share and Comprehensive Income
Earnings per share. The computation of basic and diluted earnings per share is
as follows (in millions, except per share amounts):
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net income $ 33.9 $ 17.7 $ 100.9 $ 65.1
============= ============= ============= =============
Average common shares outstanding 63.4 62.8 63.2 62.7
Incremental shares from assumed
conversions of stock options 1.7 1.7 1.6 1.5
------------- ------------- ------------- -------------
Dilutive potential common shares 65.1 64.5 64.8 64.2
============= ============= ============= =============
Basic earnings per share $ 0.53 $ 0.28 $ 1.60 $ 1.04
Diluted earnings per share $ 0.52 $ 0.27 $ 1.56 $ 1.01
</TABLE>
Comprehensive income. Components of comprehensive income consist of the
following (in millions):
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
1999 1998 1999 1998
-------------- ------------- -------------- --------------
<S> <C> <C> <C> <C>
Net income $ 33.9 $ 17.7 $ 100.9 $ 65.1
-------------- ------------- -------------- --------------
Other comprehensive income:
Unrealized gains (losses) on investments:
Unrealized holding gains (losses) arising
during the period (115.4) (165.8) 18.9 92.5
Less reclassification adjustment for gains
included in net income (1.8) (5.7)
Foreign currency translation adjustments 1.4 0.9 (0.3) 0.6
Deferred income taxes 45.8 63.6 (5.1) (36.2)
-------------- ------------- -------------- --------------
Other comprehensive income (70.0) (101.3) 7.8 56.9
-------------- ------------- -------------- --------------
Comprehensive income $ (36.1) $ (83.6) $ 108.7 $ 122.0
============== ============= ============== ==============
</TABLE>
10
6. Segment Information
The Company evaluates the performance of its segments based on income before
taxes, non-recurring items and interest expense. Intersegment revenues are
reflected at rates prescribed by the Company and may not be reflective of market
rates. Summarized financial information concerning the segments is shown in the
following tables (in millions):
<TABLE>
<CAPTION>
Three Months Ended September 30, 1999
-----------------------------------------------------------------------------------------
Financial Output Customer Investments/ Consolidated
Services Solutions Management Other Eliminations Total
------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Revenues $ 139.6 $ 109.3 $ 47.0 $ 2.8 $ $ 298.7
Intersegment revenues 0.4 13.3 5.3 (19.0)
------------- ------------- ------------- ------------- ------------- -------------
140.0 122.6 47.0 8.1 (19.0) 298.7
Costs and expenses 93.1 103.0 39.7 4.8 (19.0) 221.6
Depreciation and amortization 15.2 8.3 3.4 1.9 28.8
------------- ------------- ------------- ------------- ------------- -------------
Income from operations 31.7 11.3 3.9 1.4 48.3
Other income (loss), net 0.9 0.2 (0.1) 3.2 4.2
Equity in earnings of
unconsolidated affiliates 1.2 0.3 1.5
------------- ------------- ---------------------------- ------------- -------------
Income before interest
and income taxes $ 33.8 $ 11.5 $ 3.8 $ 4.9 $ $ 54.0
============= ============= ============= ============= ============= =============
Three Months Ended September 30, 1998
-----------------------------------------------------------------------------------------
Financial Output Customer Investments/ Consolidated
Services Solutions Management Other Eliminations Total
------------- ------------- ------------- ------------- ------------- -------------
Revenues $ 128.9 $ 86.4 $ 51.0 $ 2.5 $ $ 268.8
Intersegment revenues 0.2 13.6 5.9 (19.7)
------------- ------------- ------------- ------------- ------------- -------------
129.1 100.0 51.0 8.4 (19.7) 268.8
Costs and expenses 92.0 87.7 42.8 4.2 (19.7) 207.0
Depreciation and amortization 14.1 6.8 3.2 2.1 26.2
Acquisition related charges 7.1 7.1
------------- ------------- ------------- ------------- ------------- -------------
Income from operations 23.0 5.5 5.0 2.1 (7.1) 28.5
Other income (loss), net 0.9 0.2 (0.2) 2.6 0.2 3.7
Equity in losses of
unconsolidated affiliates (0.3) (0.9) (1.2)
------------- ------------- ------------- ------------- ------------- -------------
Income before interest
and income taxes $ 23.6 $ 5.7 $ 4.8 $ 3.8 $ (6.9) $ 31.0
============= ============= ============= ============= ============= =============
11
Nine Months Ended September 30, 1999
-----------------------------------------------------------------------------------------
Financial Output Customer Investments/ Consolidated
Services Solutions Management Other Eliminations Total
------------- ------------- ------------- ------------- ------------- -------------
Revenues $ 411.8 $ 323.0 $ 147.5 $ 8.8 $ $ 891.1
Intersegment revenues 1.1 39.6 16.0 (56.7)
------------- ------------- ------------- ------------- ------------- -------------
412.9 362.6 147.5 24.8 (56.7) 891.1
Costs and expenses 274.7 299.5 126.7 13.2 (56.7) 657.4
Depreciation and amortization 44.7 23.3 10.4 5.7 84.1
------------- ------------- ------------- ------------- ------------- -------------
Income from operations 93.5 39.8 10.4 5.9 149.6
Other income (loss), net (1.5) 0.5 (0.3) 6.3 5.0
Equity in earnings of
unconsolidated affiliates 6.0 0.1 0.2 6.3
------------- ------------- ------------- ------------- ------------- -------------
Income before interest
and income taxes $ 98.0 $ 40.4 $ 10.1 $ 12.4 $ $ 160.9
============= ============= ============= ============= ============= =============
Nine Months Ended September 30, 1998
-----------------------------------------------------------------------------------------
Financial Output Customer Investments/ Consolidated
Services Solutions Management Other Eliminations Total
------------- ------------- ------------- ------------- ------------- -------------
Revenues $ 371.5 $ 266.8 $ 158.1 $ 8.2 $ $ 804.6
Intersegment revenues 0.9 42.3 17.7 (60.9)
------------- ------------- ------------- ------------- ------------- -------------
372.4 309.1 158.1 25.9 (60.9) 804.6
Costs and expenses 267.1 262.5 130.6 13.7 (60.9) 613.0
Depreciation and amortization 44.0 20.0 8.3 5.7 78.0
Acquisition related charges 7.1 7.1
------------- ------------- ------------- ------------- ------------- -------------
Income from operations 61.3 26.6 19.2 6.5 (7.1) 106.5
Other income (loss), net 1.1 0.6 (0.6) 4.4 0.5 6.0
Equity in losses of
unconsolidated affiliates (0.3) (1.2) (1.5)
------------- ------------- ------------- ------------- ------------- -------------
Income before interest
and income taxes $ 62.1 $ 27.2 $ 18.6 $ 9.7 $ (6.6) $ 111.0
============= ============= ============= ============= ============= =============
</TABLE>
The consolidated total income before interest and income taxes as shown in the
segment reporting information above less interest expense of $1.2 million and
$3.9 million for the three and nine months ended September 30, 1999,
respectively, and $2.0 million and $6.9 million for the three and nine months
ended September 30, 1998, respectively, is equal to the Company's income before
income taxes and minority interests on a consolidated basis for the
corresponding periods.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The discussions set forth in this Quarterly Report on Form 10-Q 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
Quarterly Report, including assumptions about risks and uncertainties faced by
the Company. Readers can identify these forward-looking statements by the 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/A 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 Quarterly Report to reflect future events or
developments.
The information contained in this Management's Discussion and Analysis of
Financial Condition and Results of Operations should be read in conjunction with
the Condensed Consolidated Financial Statements and Notes thereto included in
this Form 10-Q and the audited financial statements and notes thereto in the
Company's Annual Report on Form 10-K for the year ended December 31, 1998.
INTRODUCTION
The Company has several operating business units that offer sophisticated
information processing and software services and products. These operating
business units have been aggregated into three operating segments (Financial
Services, Output Solutions and Customer Management). 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.
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.
Customer Management
The Customer Management Segment provides sophisticated customer management
processing and computer software services and products to cable television,
direct broadcast satellite (DBS), wire-line telephony, utilities and
multi-service providers.
Investments and Other
The Investments and Other Segment holds certain investments in securities,
financial interests, the Company's real estate subsidiaries and the Company's
hardware leasing subsidiary.
13
RESULTS OF OPERATIONS
The following table summarizes the Company's operating results (dollars in
millions, except per share amounts):
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------------- -----------------------------
Operating results 1999 1998 1999 1998
------------- ------------- ------------- --------------
Revenues
<S> <C> <C> <C> <C>
Financial Services $ 140.0 $ 129.1 $ 412.9 $ 372.4
Output Solutions 122.6 100.0 362.6 309.1
Customer Management 47.0 51.0 147.5 158.1
Investments and Other 8.1 8.4 24.8 25.9
Eliminations (19.0) (19.7) (56.7) (60.9)
------------- ------------- ------------- --------------
$ 298.7 $ 268.8 $ 891.1 $ 804.6
============= ============= ============= ==============
% change from prior year periods 11.1% 15.4% 10.8% 16.5%
Income from operations
Financial Services $ 31.7 $ 23.0 $ 93.5 $ 61.3
Output Solutions 11.3 5.5 39.8 26.6
Customer Management 3.9 5.0 10.4 19.2
Investments and Other 1.4 2.1 5.9 6.5
Acquisition related charges (7.1) (7.1)
------------- ------------- ------------- --------------
48.3 28.5 149.6 106.5
Interest expense (1.2) (2.0) (3.9) (6.9)
Other income, net 4.2 3.7 5.0 6.0
Equity in earnings (losses) of unconsolidated
affiliates, net of income taxes 1.5 (1.2) 6.3 (1.5)
------------- ------------- ------------- --------------
Income before income taxes and
minority interests 52.8 29.0 157.0 104.1
Income taxes 19.0 11.3 56.4 39.2
Minority interests (0.1) (0.3) (0.2)
------------- ------------- ------------- --------------
Net income $ 33.9 $ 17.7 $ 100.9 $ 65.1
============= ============= ============= ==============
Basic earnings per share $ 0.53 $ 0.28 $ 1.60 $ 1.04
Diluted earnings per share $ 0.52 $ 0.27 $ 1.56 $ 1.01
</TABLE>
Consolidated revenues
Consolidated revenues for the three and nine months ended September 30, 1999
increased $29.9 million and $86.5 million, respectively, which represent an
increase of 11.1% and 10.8%, respectively, over the comparable periods in 1998.
U.S. revenues for the three and nine months ended September 30, 1999 were $259.9
million and $768.3 million, respectively, an increase of 13.5% and 10.8%,
respectively, over the same periods in 1998. International revenues for the
three and nine months ended September 30, 1999 were $38.8 million and $122.8
million, respectively, an increase of 2.8% and 10.2%, respectively, over the
same periods in 1998.
Financial Services Segment revenues for the three and nine months ended
September 30, 1999 increased $10.9 million and $40.5 million, respectively, or
8.4% and 10.9%, respectively, over the same periods in 1998. U.S. Financial
Services Segment revenues for the three and nine months ended September 30, 1999
increased $10.2 million and $29.6 million, respectively, or 10.3% and 10.4%,
respectively, over the same periods in 1998, primarily from an increase in
mutual fund shareowner accounts processed. International Financial Services
Segment revenues for the three and nine months ended September 30, 1999
increased $0.7 million and $10.9 million, respectively, or 2.4% and 12.7%,
respectively, over the same periods in 1998.
14
Output Solutions Segment revenues for the three and nine months ended September
30, 1999 increased $22.6 million and $53.5 million, respectively, or 22.6% and
17.3%, respectively, over the same periods in 1998. Revenue growth resulted from
increased volume of images and statements produced from U.S. mutual fund
shareowner account growth, new customers, and internal growth of existing
customers primarily in telecommunications and other industries.
Customer Management Segment revenues, exclusive of Tele-Communications, Inc.
("TCI"), a discontinued customer, for the three and nine months ended September
30, 1999 increased $1.9 million and $8.7 million, respectively, or 4.4% and
6.8%, respectively, over same periods in 1998, as processing and software
service revenues increased offset by decreases in equipment sales and services
for the three and nine months ended September 30, 1999. Processing and software
service revenues increased primarily from subscriber growth and increased
services. Overall Customer Management Segment revenues for the three and nine
months ended September 30, 1999 decreased $4.0 million and $10.6 million,
respectively, or 7.8% and 6.7%, respectively, over the same periods in 1998 as a
result of a decrease in processing and software service revenues and equipment
sales.
Investments and Other Segment revenues decreased $0.3 million and $1.1 million,
respectively, or 3.6% and 4.2%, respectively, for the three and nine months
ended September 30, 1999, as compared to the same periods in 1998. Segment
revenues are primarily rental income for facilities leased to the Company's
operating segments and hardware leasing activities.
Income from operations
Consolidated income from operations for the three and nine months ended
September 30, 1999, increased $19.8 million and $43.1 million, respectively, or
69.5% and 40.5%, respectively, over same periods in 1998. The growth during
these periods was primarily a result of respective increases for such periods in
the Financial Services Segment of $8.7 million and $32.2 million, or 37.8% and
52.5%, which resulted in respective operating margins of 22.6% and 22.6% for the
Financial Services Segment for the three and nine months ended September 30,
1999, compared to respective margins of 17.8% and 16.5% for the same periods in
1998. The increase in 1999 Financial Services Segment operating margin resulted
from increased U.S. revenues and capitalization of internal use software costs
under SOP 98-1.
Output Solutions Segment income from operations for the three and nine months
ended September 30, 1999 increased $5.8 million and $13.2 million, respectively,
or 105.5% and 49.6%, respectively, over the same periods in 1998. Output
Solutions Segment operating margin was 9.2% and 11.0%, respectively, for the
three and nine months ended September 30, 1999 compared to 5.5% and 8.6%,
respectively, for the same periods in 1998. The improvement in the 1999
operating margin results are primarily from increased U.S. revenue.
In the third quarter 1999, Customer Management Segment income from operations
decreased $1.1 million or 22.0% compared to the prior year quarter, resulting in
an operating margin of 8.3% as compared to 9.8% for the prior year quarter. For
the nine months ended September 30, 1999, Customer Management Segment income
from operations decreased $8.8 million or 45.8% compared to the nine months
ended September 30, 1998, resulting in an operating margin of 7.1% as compared
to 12.1% for the prior year. The decreases were primarily attributable to
increased product development costs, the consolidation of Custima International
Holdings, plc ("Custima") operations and a decrease in revenues, partially
offset by a decrease in equipment costs related to sales to customers.
15
Investments and Other Segment income from operations was $1.4 million and $5.9
million, respectively, for the three and nine months ended September 30, 1999,
as compared to $2.1 million and $6.5 million, respectively, for the three and
nine months ended September 30, 1998.
The Company experienced increases in costs necessary to hire and retain computer
programmers and other systems professionals. While these cost increases have not
materially affected the Company's overall cost structure to date, the Company
believes that the costs associated with computer programmers and other systems
professionals may continue to increase at least through the Year 2000 at rates
above general inflation.
Interest expense
Interest expense totaled $1.2 million and $3.9 million, respectively, for the
three and nine months ended September 30, 1999, down from $2.0 million and $6.9
million recorded in the comparable periods in 1998. Average debt balances were
lower in 1999 compared to 1998.
Other income, net
Other income was $4.2 million and $5.0 million, respectively, for the three and
nine months ended September 30, 1999, an increase of $0.5 million and a decrease
of $1.0 million over the comparable periods in 1998. The increase of $0.5
million for the quarter is a result of higher levels of interest and dividend
income and gains on dispositions on equipment, while the $1.0 million decrease
is principally from net losses on equipment dispositions of $2.3 million,
partially offset by higher levels of interest and dividend income. Included in
other income during the three and nine months ended September 30, 1999 were
gains from the sale of available-for-sale securities of $1.8 million and $5.7
million, respectively, offset by impairment charges related to other
available-for-sale securities of $3.5 million for the nine months ended
September 30, 1999.
Acquisition related charges
Income from operations for the third quarter 1998 includes $7.1 million of
one-time merger charges related to USCS' acquisition of Custima prior to the
Company's acquisition of USCS. The one-time charges include $6.0 million for an
in-process research and development charge and a $1.1 million integration
charge.
Equity in earnings (losses) of unconsolidated affiliates
Equity in earnings of unconsolidated affiliates respectively totaled $1.5
million and $6.3 million for the three and nine months ended September 30, 1999,
as compared to respective equity in losses of unconsolidated affiliates of $1.2
million and $1.5 million for the three and nine months ended September 30, 1998.
Increased earnings were recorded at Boston Financial Data Services from higher
levels of mutual fund activity. The Company recorded respective losses from
European Financial Data Services (EFDS) of $1.5 million and $3.4 million for the
three and nine months ended September 30, 1999, a reduction from $2.7 million
and $7.5 million of losses, respectively, for the three and nine months ended
September 30, 1998. EFDS losses decreased from the three and nine months ended
September 30, 1998 as a result of increased operating earnings as accounts
serviced totaled 1.9 million at September 30, 1999, an increase of 0.5 million
over both year-end 1998 and September 30, 1998, which was partially offset by
higher system development and conversion costs for FAST2000. In addition, the
Company's share of internal use software development costs capitalized by EFDS
for the three and nine months ended September 30, 1999 was $0.5 million and $2.1
million, respectively.
16
Income taxes
The Company's effective tax rate was 36.0% and 35.9%, respectively, for the
three and nine months ended September 30, 1999, as compared to 39.0% and 37.7%,
respectively, for the three and nine months ended September 30, 1998. The 1999
tax rate was affected by tax benefits relating to certain international
operations and recognition of state tax benefits associated with income
apportionment rules. The 1998 tax rate was affected by the Custima research and
development charge which was recognized without any associated tax benefit and
which was partially offset by certain benefits relating to USCS' international
operations and state income taxes.
Business Segment Comparisons
FINANCIAL SERVICES SEGMENT
Revenues
Financial Services Segment revenues for the three and nine months ended
September 30, 1999 increased 8.4% and 10.9%, respectively, over the same periods
in 1998 to $140.0 million and $412.9 million, respectively. U.S. Financial
Services revenue increased 10.3% to $108.3 million and 10.4% to $316.3 million
for the three and nine months ended September 30, 1999, respectively. U.S.
mutual fund processing revenues for the three and nine months ended September
30, 1999 increased 12.9% and 13.0%, respectively, over the prior year periods as
shareowner accounts serviced increased 10.5% from 49.6 million at September 30,
1998 to 54.8 million at September 30, 1999. In the first quarter 1998, the
Company recognized a one-time $2.6 million contract termination fee from Zurich
Kemper Investments as a result of its merged operations with Scudder. Exclusive
of the termination fee, U.S. Financial Services revenues would have increased
14.4% for the nine months ended September 30, 1999. U.S. AWD product revenues
for the nine months ended September 30, 1999 increased 6.3% over the same period
in the prior year primarily due to an increase in the number of AWD workstations
licensed.
Financial Services Segment revenues from international operations for the three
and nine months ended September 30, 1999 increased 2.4% to $31.6 million and
12.7% to $96.7 million, respectively. The growth for the quarter was
attributable to higher Canadian mutual fund shareowner processing and service
revenues and the increased maintenance and service revenues from investment
accounting products. This increase was partially offset by a decline in software
license revenues as compared to third quarter 1998 as installations of new
software have declined in anticipation of the Year 2000 rollover. Growth for the
year to date period was due to increased investment accounting software
maintenance and services and growth in Canadian mutual fund shareowner
processing and service revenues.
Costs and expenses
Segment costs and expenses for the three and nine months ended September 30,
1999 increased 1.2% to $93.1 million and 2.9% to $274.7 million, respectively,
over the comparable periods in 1998. Personnel costs for the three and nine
months ended September 30, 1999, exclusive of amounts capitalized for internal
use software, increased 4.2% and 6.1%, respectively, over the comparable prior
year periods as a result of increased staff levels to support volume growth and
increased wages for data processing professionals. The increase in personnel
costs was offset by the capitalization of costs related to internal use software
of $5.3 million and $13.9 million, respectively, for the three and nine months
ended September 30, 1999. Costs and expenses for the three and nine months ended
September 30, 1999 also include a one-time $3.1 million charge related to the
termination of an international software development contract. In addition, the
year to date amounts were affected by the renegotiation of certain third party
software agreements, effective March 31, 1998, which resulted in certain amounts
being recorded as costs and expenses instead of as depreciation expense.
17
Depreciation and amortization
Segment depreciation and amortization for the three and nine months ended
September 30, 1999 increased 7.4% or $1.0 million and 1.6% or $0.7 million over
the comparable periods in 1998. The increase is a result of increased equipment
acquisitions to support revenue growth. The smaller increase in the nine months
ended September 30, 1999 is primarily attributable to a one-time write-off of
intangible assets totaling $3.2 million in the first quarter 1998 and by the
renegotiation of certain third party software agreements, effective March 31,
1998, resulting in certain amounts being recorded as costs and expenses instead
of as depreciation expense.
Income from operations
The Segment's income from operations for the three and nine months ended
September 30, 1999 increased 37.8% to $31.7 million and 52.5% to $93.5 million,
respectively, over the comparable prior year periods. The Segment's operating
margins were 22.6% and 22.6%, respectively, for the three and nine months ended
September 30, 1999 and 17.8% and 16.5%, respectively, for the three and nine
months ended September 30, 1998. The increases in Financial Services Segment
operating margins are a result of increased U.S. revenues and capitalization of
costs for internal use software.
OUTPUT SOLUTIONS SEGMENT
Revenues
Output Solutions Segment revenues for the three and nine months ended September
30, 1999 increased 22.6% to $122.6 million and 17.3% to $362.6 million,
respectively, as compared to the same periods in 1998. The growth in segment
revenue was derived primarily from an increase in the volume of statements and
images produced because of the growth of existing customers in the Financial
Services Segment, new customers and internal growth of existing customers,
primarily in telecommunications and other high-volume markets. Output Solutions
Segment images produced for the three and nine months ended September 30, 1999
increased 24.4% and 25.5%, respectively, to 1.57 billion and 4.63 billion,
respectively, and statements mailed increased 19.5% and 12.8%, respectively, to
433.5 million and 1.26 billion, respectively, compared to the same periods in
1998.
Costs and expenses
Segment costs and expenses for the three and nine months ended September 30,
1999 increased 17.3% to $103.0 million and 14.1% to $299.5 million,
respectively, over the comparable prior year periods. Personnel costs for the
three and nine months ended September 30, 1999 increased 15.5% and 16.9%,
respectively, over the comparable prior year periods as a result of increased
staff levels to support volume growth and research and development costs
relating primarily to ongoing product development partially offset by the
capitalization of costs related to the development of software for internal use.
Depreciation and amortization
Depreciation and amortization for the three and nine months ended September 30,
1999 increased 22.1% to $8.3 million and 16.5% to $23.3 million, respectively,
as compared to the same periods in 1998 related to the expansion of certain bill
processing lines and other equipment.
Income from operations
The increase in the Segment's income from operations for the three and nine
months ended September 30, 1999 of $5.8 million or 105.5% and $13.2 million or
49.6%, respectively, over the same periods in 1998 is primarily attributable to
realizing processing efficiencies and economies of scale and the effect of
capitalizing $0.4 million and $2.1 million, respectively, of internal use
software development costs for the three and nine months ended September 30,
1999. The Segment's operating margins were 9.2% and 11.0%, respectively, for the
three and nine months ended September 30, 1999, and 5.5% and 8.6%, respectively,
for the three and nine months ended September 30, 1998.
18
CUSTOMER MANAGEMENT SEGMENT
Revenues
Exclusive of revenues from TCI, the revenue increase for the three and nine
months ended September 30, 1999 was $1.9 million or 4.4%, and $8.7 million or
6.8%, respectively, as compared to the prior year as processing and software
service revenues increased $3.2 million or 8.1% and $13.9 million or 12.2%,
respectively, for the three and nine months ended September 30, 1999, offset by
decreases in equipment sales and services of $1.3 million and $5.2 million,
respectively, for the three and nine months ended September 30, 1999. The growth
in Customer Management Segment software and services revenues, exclusive of
revenue from TCI, came primarily from increases in the number of subscribers of
existing and new clients in the U.S. and international markets, increases in
prices allowed by existing contracts, and the inclusion of $5.1 million of
revenues for the nine months ended September 30, 1999 from the acquisition of
Custima in the third quarter of 1998, offset by the one month of revenues
included from Custima in the third quarter of 1998 of $0.7 million. During the
nine months ended September 30, 1999, TCI continued to remove subscribers from
the Company's systems. TCI related revenues and percentage of total Customer
Management Segment revenues for the three and nine months ended September 30,
1999 totaled $2.2 million or 4.7%, and $10.5 million or 7.1%, respectively, as
compared to $8.1 million or 15.9%, and $29.7 million or 18.8%, respectively, for
the three and nine months ended September 30, 1998. TCI subscribers serviced by
the Company totaled 0.8 million, 2.4 million and 5.3 million, respectively, at
September 30, 1999, December 31, 1998 and September 30, 1998. The Company
expects the TCI subscriber count to decrease to approximately 0.2 million by the
end of 1999.
Customer Management Segment revenues for the three and nine months ended
September 30, 1999 decreased 7.8% to $47.0 million, and 6.7% to $147.5 million,
respectively, from $51.0 million and $158.1 million, respectively, for the three
and nine months ended September 30, 1998. Equipment sales and services revenue
decreased to $1.9 million and $6.7 million, respectively, for the three and nine
months ended September 30, 1999, from $3.9 million and $16.8 million,
respectively, for the three and nine months ended September 30, 1998.
Costs and expenses
Segment costs and expenses for the three and nine months ended September 30,
1999 decreased $3.0 million or 7.1%, and $3.9 million or 3.0%, respectively,
primarily attributable to a decrease in equipment costs related to sales to
customers offset by increased product development costs and the consolidation of
Custima's operations.
Depreciation and amortization
Depreciation and amortization increased $0.2 million and $2.1 million,
respectively, for the three and nine months ended September 30, 1999, or 6.3%
and 25.3%, respectively, of which $0.3 million and $1.2 million, respectively,
is intangible amortization related to the Custima acquisition.
Income from operations
The Segment's income from operations for the three and nine months ended
September 30, 1999 decreased $1.1 million and $8.8 million, respectively, or
22.0% and 45.8%, respectively, compared to the comparable periods in the prior
year, resulting in an operating margin of 8.3% and 7.1%, respectively, for the
three and nine months ended September 30, 1999, as compared to 9.8% and 12.1%,
respectively, for the three and nine months ended September 30, 1998.
19
INVESTMENTS AND OTHER SEGMENT
Revenues
Investments and Other Segment revenues totaled $8.1 million and $24.8 million,
respectively, for the three and nine months ended September 30, 1999, as
compared to $8.4 million and $25.9 million, respectively, for the three and nine
months ended September 30, 1998. Real estate revenues of $5.9 million and $17.7
million, respectively, for the three and nine months ended September 30, 1999,
as compared to $5.9 million and $19.1 million, respectively, for the three and
nine months ended September 30, 1998, were primarily derived from the lease of
facilities to the Company's other business segments. Revenues of $2.2 million
and $7.1 million, respectively, for the three and nine months ended September
30, 1999, as compared to $2.5 million and $6.7 million, respectively, for the
three and nine months ended September 30, 1998, were derived from the Segment's
hardware leasing activities.
Costs and expenses
Investments and Other Segment costs and expenses increased in the three months
ended September 30, 1999 as compared to the three months ended September 30,
1998 primarily as a result of additional real estate activities. Costs and
expenses for the nine months ended September 30, 1999 decreased compared to
September 30, 1998 primarily as a result of changes in real estate related costs
partially offset by additional costs incurred in real estate related projects.
Depreciation and amortization
Investments and Other Segment depreciation and amortization totaled $1.9 million
and $5.7 million, respectively, for the three and nine months ended September
30, 1999, as compared to $2.1 million and $5.7 million over the same periods in
1998.
Income from operations
The segment's income from operations totaled $1.4 million and $5.9 million,
respectively, for the three and nine months ended September 30, 1999, as
compared to $2.1 million and $6.5 million, respectively, for the three and nine
months ended September 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash flow from operating activities totaled $173.1 million for the
nine months ended September 30, 1999. Operating cash flows for the nine months
ended September 30, 1999 were impacted by net income of $100.9 million,
depreciation and amortization of $84.1 million, an increase in accounts payable
and accrued liabilities of $4.4 million and a net increase in accounts
receivable and other current assets of $4.3 million.
Cash flows used in investing activities totaled $104.2 million for the nine
months ended September 30, 1999. The Company expended $98.4 million during the
nine months for capital additions including $9.0 million for assets placed in
service in 1998 but not paid for until 1999. Investments and advances to
unconsolidated affiliates totaled $31.1 million relating to funding the
development of FAST2000 at EFDS and other investments. During the nine months
ended September 30, 1999, the Company received $14.8 million from the sale of
investments in available-for-sale securities.
Cash flows used in financing activities totaled $1.4 million for the nine months
ended September 30, 1999. Proceeds from debt to finance the Company's equipment
leasing activities totaled $11.5 million during the period. The Company also
received proceeds from the exercise of stock options of $20.6 million for the
nine months ended September 30, 1999. The Company maintains $90 million in bank
lines of credit for working capital requirements and general corporate purposes,
of which $60 million matures May 2000 and $30 million matures December 2000. The
Company also maintains a $125 million revolving credit facility with a syndicate
of U.S. and international banks which is available through December 2001. Net
payments under these facilities totaled $0.2 million for the nine months ended
September 30, 1999, bringing total borrowings under these facilities to $22.9
million.
20
In August 1999, the Board of Directors approved the expansion of its previously
announced 600,000 share repurchase program. The expansion authorized repurchase
of an additional 3,575,000 shares of DST common stock which, when added to the
425,000 shares remaining to be purchased under the earlier program results in a
program to repurchase 4,000,000 shares over a twenty-four month period beginning
in September 1999. Purchases will be at a rate of approximately 166,000 shares
per month. Such purchases will be made in private or open market transactions
and in compliance with SEC regulations. The share repurchase program will be
funded primarily from cash flow and other available sources. The Company
repurchased 362,000 shares during the nine months ended September 30, 1999 for
$22.4 million under this plan. The Company's share repurchase program was
designed to provide shares for use under various DST option and benefit plans.
The Board's expansion of the program is the result of expected additional share
requirements for such plans. In connection with this program, the Company may
utilize alternatives to minimize the cost of the share repurchase program,
including forward purchase contracts.
The Company believes that its existing cash balances and other current assets,
together with cash provided by operating activities and, as necessary, the
Company's bank and revolving credit facilities, will suffice to meet the
Company's operating and debt service requirements and other current liabilities
for at least the next 12 months. Further, the Company believes that its longer
term liquidity and capital requirements will also be met through cash provided
by operating activities and bank credit facilities, as well as the Company's
$125 million revolving credit facility described above.
OTHER
Software development and maintenance. Effective January 1, 1999, DST adopted, as
required, Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, which requires that certain
costs incurred for the development of internal use software be capitalized.
Prior to the adoption of SOP 98-1, the Company expensed the costs of internally
developed proprietary software as incurred. For the three and nine months ended
September 30, 1999, the Company capitalized $6.2 million and $18.1 million,
respectively, of costs related to the development of internal use software
consisting of $5.8 million and $16.1 million, respectively, for the Financial
Services Segment for the three and nine months ended September 30, 1999, and
$0.4 million and $2.0 million, respectively, for the Output Solutions Segments
for the three and nine months ended September 30, 1999. If internal use software
development costs had been expensed rather than capitalized, consolidated net
income for the three and nine months ended September 30, 1999 would have been
$29.9 million ($0.47 per basic share, $0.46 per diluted share) and $89.3 million
($1.41 per basic share, $1.38 per diluted share), respectively.
Comprehensive income. The Company's comprehensive loss for the three months
ended September 30, 1999 totaled $36.1 compared to a loss of $83.7 million for
the same period in 1998. For the nine months ended September 30, 1999, the
Company's comprehensive income was $108.7 million compared to $121.9 million for
the same period for 1998. Comprehensive income for the three months ended
September 30, 1999 and 1998 consists of net income of $33.9 million and $17.7
million, respectively, and other comprehensive losses of $70.0 million and
$101.3 million, respectively. Comprehensive income for the nine months ended
September 30, 1999 and 1998 consists of net income of $100.9 million and $65.1
million, respectively, and other comprehensive income of $7.8 million and $56.9
million, respectively. Other comprehensive income consists of unrealized gains
(losses) net of deferred taxes on available-for-sale securities and foreign
currency translation adjustments.
21
USCS Merger Integration Costs. In December 1998, DST's management approved plans
which include initiatives to integrate the operations of certain DST and USCS
subsidiaries and consolidate certain facilities. Total accrued integration costs
of $16.9 million were recorded in the fourth quarter of 1998, of which $0.7
million, $12.8 million and $3.4 million related to the Financial Services,
Output Solutions, and Customer Management Segments, respectively. $8.0 million
of these costs were utilized during 1998.
The Company utilized $2.2 million in the quarter ended September 30, 1999 and
$3.0 million for the nine months ended September 30, 1999 related to the accrued
integration costs. Of the remaining accrued integration costs of $5.9 million at
September 30, 1999, $0.3 million, $4.0 million, and $1.6 million relate to the
Financial Services, Output Solutions, and Customer Management Segments,
respectively.
The accrued costs relate primarily to employee severance benefits which are
expected to be paid in 1999 and 2000and 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 2000 once
arrangements have been made to process continuing business at other facilities.
Four of the locations have been closed as of September 30, 1999. 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 costs and integration costs of moving to common internal
systems. Although precise estimates cannot be made, management does not believe
such costs will have a materially adverse effect on the Company's consolidated
results of operations, liquidity or financial position.
Business Acquisition. In August of 1998, USCS purchased 100% of the stock of
Custima for cash. The business acquired provides billing and customer care
software for the utilities industry. The cost of the acquisition was
approximately $15.4 million. The acquisition was accounted for as a purchase,
and accordingly, the financial statements include the results of operations from
the date of acquisition. The purchase included existing technology, in-process
research and development, trademarks and in-place workforce with an aggregate
value of approximately $18.1 million. Based on an independent appraisal, $6.0
million was attributed to in-process research and development and, in accordance
with applicable accounting principles, was charged to expense. In addition, a
reorganization charge for redundant facilities and workforce of $1.1 million was
taken in connection with USCS's purchase and consolidation of Custima.
Intangible assets are being amortized on a straight-line basis over periods
ranging from 3 to 10 years. On a pro forma basis, the acquisition did not have a
material impact on the Company's historical results of operations or financial
position.
Seasonality. Generally, the Company does not have significant seasonal
fluctuations in its business operations. Processing and output volumes for
mutual fund customers are usually highest during the quarter ended March 31 due
primarily to processing year-end transactions and printing and mailing of year
end statements and tax forms during January. The Company has historically added
operating equipment in the last half of the year in preparation for processing
year-end transactions which has the effect of increasing costs for the second
half of the year. Software license revenues and operating results are dependent
upon the timing, size, and terms of the license.
22
Year 2000. Many computer programs use only two digits to identify a year in a
date field within the program (e.g., "98" or "02"). If not corrected, computer
applications making calculations and comparisons in different centuries may
cause inaccurate results, or fail by or at the Year 2000. These Year
2000-related issues are of particular importance to the Company. The Company
depends upon its computer and other systems and the computer and other systems
of third parties to conduct and manage the Company's business. Additionally, the
Company's products and services depend upon using accurate dates in order to
function properly. These Year 2000-related issues may also adversely affect the
operations and financial performance of one or more of the Company's customers
or suppliers. As a result, the failure of the Company's computer and other
systems, products or services, the computer systems and other systems upon which
the Company depends, or the Company's customers or suppliers to be Year 2000
ready could have a material adverse effect on the Company.
The Company has completed its review and evaluation of its mission critical U.S.
shareowner accounting and U.S. portfolio accounting related products, services
and internal systems and achieved material Year 2000 readiness in such products,
services and systems as of December 31, 1998. The Company has achieved readiness
for its other mission critical systems and products as of September 30, 1999.
The Company will continue testing its systems with clients and other third
parties for Year 2000-related issues as needed throughout 1999, as well as
assisting clients with interrelated hardware and software upgrades, subject to
the cooperation of such third parties. The Company licenses certain of its
software products to third parties. The Company has made available Year 2000
ready software to its customers as of September 30, 1999. In certain cases, the
Company may be required under applicable maintenance contracts to provide Year
2000 ready software free of charge. The Company believes that the cost of such
upgrades is immaterial.
The Company believes it will not experience any material Year 2000 problems from
most of its major vendors and suppliers; however, the Company is unable to
determine whether certain suppliers, principally the Company's utilities
providers, will likely be Year 2000 ready in time. As part of addressing its
Year 2000 issues, the Company is developing contingency plans. The Company has
had for several years formal contingency plans, including an uninterruptable
power supply with permanent generator backup, for its Winchester and Poindexter
Data Centers in the event of a natural disaster.
The contingency plans have been reviewed with respect to failures that could be
caused by Year 2000 issues. The Company has formalized contingency plans for its
mission critical products, services and systems which incorporate Year 2000
related contingencies and has tested these contingency plans. There can be no
assurances that an acceptable contingency plan can be developed for certain
suppliers, such as utilities, or that any such plan would successfully protect
the Company from any Year 2000 exposure.
The costs to address the Year 2000-related issues to date have not been
material, and the Company does not anticipate such costs to become material in
the future. Although the Company is not aware of any material operational or
financial Year 2000-related issues not being addressed, the Company cannot
assure that its computer systems, products, services or other systems or the
computers and other systems of others upon which the Company depends will be
Year 2000 ready on schedule, that the costs of its Year 2000 program will not
become material or that the Company's alternative plans will be adequate. The
Company is currently unable to anticipate accurately the magnitude, if any, of
the Year 2000-related issues arising from the Company's customers or suppliers.
If any such risks (either with respect to the Company or its customers or
suppliers) materialize, the Company could experience material adverse
consequences to its business.
23
Item 3. Quantitative and Qualitative Disclosures about Market Risk
In the operations of its businesses, the Company's financial results can be
affected by changes in interest rates, currency exchange rates and equity
pricing. Changes in interest rates and exchange rates have not materially
impacted the consolidated financial position, results of operations or cash
flows of the Company. Changes in equity values of the Company's investments have
had a material effect on the Company's comprehensive income and financial
position.
Interest rate risk
At September 30, 1999, the Company had $63.4 million of long-term debt, of which
$27.4 million was subject to variable interest rates (Federal Funds rates, LIBOR
rates, Prime rates). The Company estimates that a 10% increase in interest rates
would not be material to the Company's consolidated pretax earnings for 1999 or
to the fair value of its debt.
Foreign currency exchange rate risk
The operation of the Company's subsidiaries in international markets results in
exposure to movements in currency exchange rates. The principal currencies
involved are the Canadian dollar, the Australian dollar and the British pound.
As currency exchange rates change, translation of the financial results of
international operations into U.S. dollars does not now materially affect, and
has not historically materially affected, the consolidated financial results of
the Company.
The Company's international subsidiaries use the local currency as the
functional currency. The Company translates all assets and liabilities at
month-end exchange rates and income and expense accounts at average rates during
the year. While it is generally not the Company's practice to enter into
derivative contracts, from time to time the Company and its subsidiaries do
utilize forward foreign currency exchange contracts to minimize the impact of
currency movements.
Equity price risk
The Company's investments in available-for-sale equity securities are subject to
price risk. The fair value of such investments, as of September 30, 1999 was
approximately $1.0 billion. The potential change in the fair value of these
investments, assuming a 10% change in prices would be approximately $104.7
million on a pretax basis. As discussed under "Comprehensive Income" in Item 1
above, net unrealized gains and losses on the Company's investments in
available-for-sale securities have had a material effect on the Company's
comprehensive income and financial position.
24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is from time to time a party to litigation arising in the ordinary
course of its business. Currently, there are no legal proceedings that
management believes would have a material adverse effect upon the consolidated
results of operations or financial condition of the Company.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
If a stockholder desires to have a proposal included in DST's Proxy Statement
for next year's annual meeting of stockholders, the Corporate Secretary of DST
must receive such proposal on or before December 2, 1999, and the proposal must
comply with the applicable SEC regulations and with the procedures set forth in
DST's by-laws.
25
Item 5. Other Information
The following table presents operating data for the Company's operating business
segments:
<TABLE>
<CAPTION>
September 30 December 31,
1999 1998
--------------- ---------------
Financial Services Operating Data
Mutual fund shareowner accounts processed (millions)
<S> <C> <C>
U.S. 54.8 49.8
Canada 2.2 1.6
United Kingdom (1) 1.9 1.4
TRAC-2000 mutual fund accounts (millions) (2) 3.1 2.5
TRAC-2000 participants (millions) 1.1 0.9
IRA mutual fund accounts (millions) (2) 13.4 12.0
Portfolio Accounting System portfolios 1,768 1,962
Automated Work Distributor workstations 53,100 45,300
Customer Management Operating Data
Cable/satellite TV subscribers processed (millions)
Total before discontinued customer 38.5 35.6
Discontinued customer 0.8 2.4
--------------- ---------------
Total cable/satellite TV subscribers processed 39.3 38.0
=============== ===============
For the Nine Months
Ended September 30,
1999 1998
--------------- ---------------
Output Solutions Operating Data
Images produced (millions) 4,633 3,691
Items mailed (millions) 1,256 1,114
</TABLE>
(1) Processed by EFDS, an unconsolidated affiliate of the Company
(2) Included in U.S. mutual fund shareowner accounts processed
26
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit Number Document
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed under Item 5 of Form 8-K, the Company's Form 8-K dated
July 22, 1999, reporting the announcement of financial results for the
quarter ended June 30, 1999.
The Company filed under Item 5 of Form 8-K, the Company's Form 8-K dated
August18, 1999, announcing the expansion of the Company's program to
repurchase shares for use under various option and benefit plans.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized, and in the capacities indicated, on November 9, 1999.
DST Systems, Inc.
/s/ Kenneth V. Hager
Kenneth V. Hager
Vice President and Chief Financial Officer
(Principal Financial Officer)
27
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule, submitted as Exhibit 27.1 to Form 10-Q, contains summary
financial information extracted from the consolidated condensed balance sheet
and statement of income of DST Systems, Inc., Commission file no. 1-14036, and
is qualified in its entirety by reference to such financial statements.
</LEGEND>
<CIK> 0000714603
<NAME> DST Systems, Inc.
<MULTIPLIER> 1000000
<S> <C>
<PERIOD-TYPE> 9-mos
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<CASH> 96
<SECURITIES> 0
<RECEIVABLES> 291
<ALLOWANCES> 0
<INVENTORY> 17
<CURRENT-ASSETS> 453
<PP&E> 841
<DEPRECIATION> 511
<TOTAL-ASSETS> 2,008
<CURRENT-LIABILITIES> 265
<BONDS> 48
0
0
<COMMON> 1
<OTHER-SE> 1,274
<TOTAL-LIABILITY-AND-EQUITY> 2,008
<SALES> 0
<TOTAL-REVENUES> 891
<CGS> 0
<TOTAL-COSTS> 741
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4
<INCOME-PRETAX> 157
<INCOME-TAX> 56
<INCOME-CONTINUING> 101
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 101
<EPS-BASIC> 1.60
<EPS-DILUTED> 1.56
</TABLE>
