The Company owns its 867,000 square foot headquarters complex located on 145 acres in Blythewood, South Carolina. The Company leases space at 25 various locations for its regional and branch offices throughout the United States. Internationally, the Company leases space at 31 locations throughout Canada, Europe, Africa, Asia, Australia and New Zealand.
The Company's data center in North Ryde, Australia has two mainframes and three mid-range computers, which have over 3,000 megabytes of disk storage and is capable of processing over 222 million instructions per second. The Company is currently utilizing 80% of this capacity.
The above should be read in conjunction with the Consolidated Financial Statements, Notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations appearing in this Annual Report. Prior year data has been reclassified to conform to current year presentation.
Initial license revenues for 1998 decreased $2.1 million compared to 1997 with the following increases or decreases by business segment: property and casualty down 12.7% ($3.1 million); life and financial solutions up 36.6% ($7.3 million); and international down 24.5% ($6.3 million).
Monthly license charges for 1997 increased $5.9 million compared to 1996 with the following increases by business segment: life and financial solutions up 42.4% ($3.8 million); and international up 18.3% ($2.1 million).
Professional and outsourcing services revenues for 1997 increased $71.3 million compared to 1996, with the following increases by business segment: property and casualty up 19.6% ($30.6 million); life and financial solutions up 61.4% ($26.5 million); and international up 12.9% ($14.2 million). The increases are principally due to increases in implementation services and in the processing volumes of services provided to new and existing customers. The increases were partially offset by the elimination of approximately $11.4 million in revenue that generated no profit related to the Florida Business Process Outsourcing ("BPO") unit.
The Company's confidence in forecasting the demand for new large enterprise licenses and new services agreements was lower at the end of 1998 than it was earlier in the year. This is primarily due to the continuing impact of Year 2000 demands on customer resources and decision processes and the emergence of the Internet and the resulting changing priorities of some insurance companies.
At the end of the third quarter and during the fourth quarter of 1998, the Company completed fewer transactions than were previously forecast. Some of these opportunities were deferred while others were foregone in favor of alternative strategies. Although the Company believes that the demands of the Year 2000 have provided licensing and servicing opportunities with some customers, it also has delayed or prevented other opportunities. In addition, the Year 2000 has caused an unprecedented level of investment in systems and remediation services. The Company is unable to accurately predict how the demand for new licensing and services will be affected by these investments.
Computer and communications expenses for 1998 increased 11.0% compared to 1997. At the beginning of the third quarter, the Company entered into a data center outsourcing agreement with Lockheed Martin. As a result, certain costs previously included in employee compensation and benefits are now included in computer and communications expense. Had these employee costs not been transferred, 1998 computer and communications expenses would have remained relatively unchanged by comparison to last year. The savings from the outsourcing agreement were offset by increased communications volumes, increased network and PC related expenses and increased license fees for operational data center software.
Depreciation and amortization of property, equipment and capitalized software costs for 1998 increased 7.6% compared to 1997 principally due to higher amortization expense resulting from various releases of the Company's internally developed software products. However, as a percentage of revenue, depreciation and amortization expense declined to 10.3% from 11.2% in 1997.
Other operating costs and expenses for 1997 decreased 29.0% compared to 1996. This decrease is primarily due to the elimination of costs (and previously referenced revenues) for the BPO unit in Florida and an increase in amounts capitalized principally related to the continued enhancement and development of S3+, CyberLife and I+. The decrease was partially offset by increased fees for the use of consultants and independent contractors to satisfy staffing needs for certain development and services activities, as well as increased rent and other facility costs.
Amortization of goodwill and other intangibles for 1998 increased 7.8% compared to 1997, principally due to the amortization of costs associated with the acquisition of TLG and the Lockheed Martin outsourcing arrangement.
The results of operations in 1998 include $13.3 million of special charges. These pre-tax charges include $3.7 million related to the acquisition of TLG and $9.6 million for the impairment of capitalized software development costs which resulted from certain technology related issues and changes in the Company's strategy (see Note 3 of Notes to Consolidated Financial Statements).
1998 operating income increased 10.4% compared to 1997. Increases in segment operating income were: property and casualty up 4.9%, life and financial solutions up 74.0% and international up 15.4%. The increase in operating income is primarily related to increases in professional services and outsourcing revenues while operating costs increased at a slower rate than the related revenue.
Excluding special charges and credits, operating income for 1998 was $100.8 million compared to $79.2 million for 1997 and $65.9 million for 1996. Operating income, as a percentage of total revenues, excluding the effects of the special charges described above, was 16.6% for 1998, 15.3% for 1997 and 15.6% for 1996.
Due to reduced levels of investable funds during 1997, investment income decreased $0.8 million compared to 1996. Interest expense was relatively unchanged.
The effective income tax rate (income taxes expressed as a percentage of pre-tax income) was 39.7%, 37.4%, and 36.2% for the years ended December 31, 1998, 1997 and 1996, respectively. The effective income tax rate on continuing operations was 37.8%, 37.2% and 35.8% for the years ended December 31, 1998, 1997 and 1996, respectively.
Loss from discontinued operations increased for 1998 compared to 1997, principally due to (i) an additional loss of $1.0 million, net of tax, recognized during 1998 related to the write down of capitalized software and receivables of the property and casualty information services segment; (ii) partial year operating results in 1998 compared to full year operating results in 1997 for the life information services segment; and (iii) no operating results in 1998 compared to eight months operating results in 1997 for the property and casualty information services segment.
Income from discontinued operations decreased for 1997 compared to 1996, principally due to partial year operating results in 1997 compared to full year operating results in 1996 for the property and casualty information services segment.
In June 1997, Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130") was issued. SFAS 130 establishes standards for reporting and display of comprehensive income and its components, and is effective for fiscal years beginning after December 15, 1997. The Company adopted SFAS
130 at January 1, 1998 and has included the appropriate disclosures in the Consolidated Statements of Changes in Stockholders' Equity and Comprehensive Income.
In October 1997, the American Institute of Certified Public Accountants issued Statement of Position 97-2, "Software Revenue Recognition" ("SOP 97-2"), subsequently amended. As amended, SOP 97-2 provides guidance on applying generally accepted accounting principles in recognizing revenue on software transactions, and is effective for transactions entered into in fiscal years beginning after December 31, 1997. The Company adopted SOP 97-2 at January 1, 1998 and the amendments in order of their issuance. The adoption did not have a material impact on the Company's financial statements.
The Company's current ratio (current assets divided by current liabilities) stood at 2.2 at December 31, 1998. Management believes this is sufficient when combined with the available credit facility to provide for day-to-day operating needs and the flexibility to take advantage of investment opportunities. At December 31, 1998, the Company had available $115 million of its five year $200 million credit facility. The Company also had available a $15 million uncommitted operating line of credit, all of which was outstanding at December 31, 1998.
During 1998, the Company capitalized $59.6 million of internal software development costs principally related to the development of its S3+ client/server property and casualty software (including the incorporation of object-oriented technology and support for Microsoft Windows NT ) and CyberLife object-oriented client/server life insurance software, as well as other ongoing projects in support of its domestic and international product strategies.
Significant expenditures planned for 1999, excluding any possible business acquisitions and stock repurchases, are as follows: acquisition of data processing and communications equipment, support software, buildings, building
The Company has historically used the cash generated from operations for the development and acquisition of new products, capital expenditures, acquisition of businesses and repurchase of the Company's stock. The Company anticipates that, subject to market conditions, it will continue to use its cash for all of these purposes in the future and that projected cash from operations, along with currently available borrowing capacity, will be able to meet presently anticipated needs.
The timing and amount of the Company's revenues are subject to a number of factors, such as the timing of customers' decisions to enter into large license agreements with the Company, which make estimation of operating results prior to the end of a quarter or year extremely uncertain. Additionally, while management believes that the Company's financing needs for the foreseeable future will be satisfied from cash flows from operations and the Company's currently existing credit facility, unforeseen events or adverse economic or business trends may significantly increase cash demands beyond those currently anticipated or affect the Company's ability to generate/raise cash to satisfy financing needs.
Many existing computer programs were designed to use only two digits to identify a year in date fields. If not corrected, these applications could fail or produce erroneous results when working with dates of the Year 2000 and beyond.
The Company has updated the code of its primary product offerings to process dates across the century boundary. Current testing has confirmed the ability of the applications to process data in both centuries. Beyond that, additional testing is scheduled on the Company's base products for the first half of 1999 in an environment that utilizes accelerated system dates (Year 2000 environment). This additional testing seeks to confirm that no unanticipated problems will occur due to third party products with which the Company's applications are designed to operate. Once all of the Company's base products have been tested in a Year 2000 environment, redundant testing will continue through the remainder of 1999.
The Company has completed Year 2000 application code remediation for all domestic property and casualty customers who will be Business Process Outsourcing ("BPO")/Information Technology Outsourcing ("ITO")
Internal systems consist primarily of third-party products used by the Company for its internal operations which include data center hardware and software, internal financial and human resource systems, and network and PC hardware and software. The Company's Blythewood data center has substantially completed its hardware and operating software inventory, assessments, remediation, and testing efforts in order to satisfy Year 2000 requirements. As of July 1, 1998, Lockheed Martin took over the data processing equipment and operational control of the Blythewood data center and remaining remediation efforts will be coordinated with Lockheed Martin. The Company's Australian and European data centers have substantially completed their inventory and assessment of hardware and operating software for Year 2000 requirements. Final implementation for all data centers is scheduled for completion by June 30, 1999.
In 1996, the Company commenced the process of identifying, selecting and implementing an enterprise wide financial and human resources system to replace its existing systems. The financial components of the selected solution are substantially operational. The solution's human resources functionality is scheduled to be fully operational during the third quarter of 1999. The selected solution meets Year 2000 requirements.
The Company is inventorying and assessing all of its network and PC hardware and software to determine if any Year 2000 remediation upgrades will be required. The majority of the inventory and assessment phases are complete. The Company has also assessed readiness with respect to non-IT systems which relate primarily to the ordinary maintenance and operation of its physical facilities, such as elevators, heating and air conditioning.
Since 1993, the Company estimates that it has incurred approximately $16 million of costs in addressing Year 2000 remediation issues and will spend approximately $3 million during 1999. Based on the Company's experience to date, it is not anticipated that the completion of the remaining Year 2000 remediation efforts will have a material adverse effect upon the Company's financial position or results of operations. The Company's past and anticipated future remediation costs are funded by operations.
On January, 1, 1999, certain member countries of the European Union established fixed conversion rates between their existing sovereign currencies and the euro and have agreed to adopt the euro as their common legal currency on that date. It is also possible that some of the non-participating countries may also choose to convert to the euro at a later date. From January 1, 1999, to December 31, 2001, there will be a transition period, during which the participating countries may conduct transactions in either their legacy currency or the euro. On January 1, 2002, new euro-denominated bills and coins will be issued, and by July 1, 2002, all legacy currency bills and coins will be withdrawn, finalizing the conversion to the euro.
The Company is surveying licensees of its products domiciled or doing business in the participating countries. The needs of each licensee may vary with regards to converting to the euro depending on how and when they choose to convert. The Company is preparing strategies to modify its products licensed in the participating countries to convert to the euro. These modifications will be made available to licensees for a fee. Implementation of the modifications is the responsibility of each licensee.
Company subsidiaries are incorporated in four of the participating countries: Germany, Austria, the Netherlands and Ireland. The Company has implemented new financial accounting systems that will enable it to convert the affected operations to the euro in a timely and effective manner.
Based upon the Company's experience to date, it is not anticipated that the euro conversion will have a material impact on the Company's consolidated financial statements.
The Company's operations have not proven to be significantly seasonal, though as with many companies in the software business, the fourth quarter tends to be the strongest quarter annually. Quarterly revenues and net income can be expected to vary at times. This is attributable principally to the timing of customers entering into license agreements with the Company. The Company is unable to control the timing of these decisions.
costs by periodically increasing prices. Additionally, most of the Company's license agreements and long-term services agreements provide for annual increases in charges.