Licensing 1996 Change 1995 Change 1994 (Dollars In Millions) Initial charges $ 51.9 6.4% $ 48.8 28.1% $38.1 Monthly charges 57.0 6.9 53.3 4.5 51.0 $108.9 6.7% $102.1 14.6% $89.1
Because a significant portion of initial licensing revenues are recorded at the time new systems are licensed, there can be significant fluctuations in revenue from period to period. Set forth below is a comparison of domestic and international initial license revenues for 1996, 1995 and 1994:
*Includes initial licensing revenues from the Health Division (divested June 30, 1995) of $.3 million and $6.9 million in 1995 and 1994, respectively.
Monthly license charges for 1996 increased $3.7 million (6.9%) compared to 1995. This increase is principally related to an increase of $3.1 million in licensing activities in the international segment due to the acquisitions of Co-Cam in August 1996 and micado in October 1995. The domestic life monthly licensing increased $1.2 million, excluding a $.5 million decline in the health insurance systems business.
Monthly license charges for 1995 increased $2.3 million (4.5%) compared to 1994. This increase is principally related to an increase of $2.8 million in international attributable to the acquisition of Creative and the Nordic market and a $1.6 million increase associated with licensing activities in the property and casualty domestic market. This increase was partially offset by a $2.2 million decline in domestic life licensing activity, principally in the health insurance systems business.
Professional and outsourcing services revenues for 1995 increased $52.0 million (24.9%) compared to 1994. This increase was principally related to an increase in new and existing contracts amounting to $23.8 million for property and casualty insurance business and $4.6 million for life insurance business, offset by a decrease in revenues from the health insurance division of $9.3 million. The domestic market produced an $11.8 million increase in volume related to new and existing professional and outsourcing services contracts and a $12.0 million increase in volume related to the governmental and residual markets for total policy management outsourcing services, while the increase in the international market of $32.8 million was principally due to the acquisition of Creative at December 31, 1994, and new services contracts in Europe, Canada and the Pacific region. The increase in life insurance business is principally the result of volume increases relating to both new and existing outsourcing contracts and a new agreement for total policy administration services in the domestic market.
Employee compensation and benefits increased $23.5 million (14.8%) for 1996 compared with 1995, and principally resulted from increased salaries and related costs associated with the acquisition of Co-Cam in August 1996, micado in October 1995 and increased costs associated with the growth in staffing for additional professional and outsourcing services to new and existing customers. Compensation and benefits increased $19.2 million internationally, while domestic only increased $4.3 million. The increases in costs were partially offset by a decrease in compensation and benefits of $19.3 million resulting from the Company's divestitures of its health and risk information services businesses in June 1995 and December 1995, respectively,(see Notes 11 and 12 of Notes to Consolidated Financial Statements), a decrease in performance compensation expense and a decrease in the use of temporary employees.
Employee compensation and benefits increased $11.5 million (7.7%) for 1995 compared with 1994, and principally resulted from the increased salaries and related costs associated with the acquisition of Creative in December 1994, increased costs associated with the growth in staffing for additional professional and outsourcing services to new and existing customers, and an increase in the accrual for performance compensation expense. These increased costs were offset in part by a decrease in the use of temporary employees and a decrease in compensation and other benefits related to the Company's sale of its health insurance systems division on June 30, 1995.
Information services and data acquisition costs increased $4.1 million (3.6%) for 1996 compared to 1995, principally due to an increase in the volume of expenses for attending physician statements related to the provision of certain life insurance information services.
Information services and data acquisition costs decreased $18.9 million (14.3%) for 1995 compared to 1994, principally due to a decrease in the volume of state fees for motor vehicle reports associated with the domestic property and casualty automobile and information services business (see Revenue discussion above and Note 12 of Notes to Consolidated Financial Statements).
Other costs and expenses decreased 3.8% for 1996 compared to 1995. Fees related to the use of consultants and independent contractors increased, principally the result of training costs in new technologies and the satisfaction of staffing needs for certain development and services activities. These increases were offset by an increase in amounts capitalized principally related to the increased use of outside resources in the continued enhancement and development of the Company's Series III property and casualty insurance software and CyberLife life insurance software as well as other ongoing development projects, and decreased costs associated with the depopulation of certain assigned risk pools serviced by the Company's total policy management business.
Selling, general and administrative expenses increased 26.2% for 1995 compared to 1994, principally due to the December 1994 acquisition of Creative and the Company's investment in its international sales force and infrastructure. These increases were offset in part by the divestiture of its health information services business in June 1995.
Amortization of goodwill and other intangibles increased 7.8% for 1995 compared to 1994, principally due to an increase in the amortization of intangibles associated with the December 1994 acquisition of Creative.
The Company, as of December 31, 1995, provided for $20.1 million in estimated litigation costs arising from proceedings to which the Company is a party. The costs provided for include, but are not limited to, legal fees paid or anticipated to be paid and other costs related to the Company's claims and defenses for those matters.
In December 1994, the Company reached an agreement, which was subsequently approved on May 26, 1995 by the United States District Court for the District of South Carolina, to settle a shareholder class action. The Company's portion of the settlement and associated litigation costs resulted in a special charge of $34.2 million ($21.3 million after tax) in the fourth quarter of 1994. In March 1995, the Company and its insurance carrier signed an agreement to settle amounts contested and the carrier agreed to pay an additional amount of $1.7 million in full settlement of the Company's claims. Accordingly, the Company recorded a credit of $1.7 million, in the first quarter of 1995, as a further adjustment to the estimated costs of settling the securities class action.
During the first half of 1993, the Company experienced a significant decrease in revenues from its health insurance systems business. The Company evaluated various options and during the second quarter of 1995 committed to sell the health insurance systems business and cease to market any health insurance related software systems. On June 30, 1995, the Company completed the sale of its health insurance systems business for a total consideration of $9.3 million in cash. After selling expense and other accrued costs, the Company recorded a pre-tax gain of $8.1 million (see Note 11 of Notes to Consolidated Financial Statements).
The Company expensed $2.6 million of purchased research and development, related to the Creative acquisition, at December 31, 1994.
For 1994 the Company incurred an operating loss of $19.7 million. This loss was solely attributable to various special charges aggregating $67.5 million, as discussed above.
Licensing revenues, as a percentage of total revenues, increased from 18.1% of total revenues for 1994 to 19.0% for 1995 and decreased to 18.7% for 1996 (see Revenues). If licensing revenues from the Company's health division (sold on June 30, 1995) are excluded licensing revenues as a percentage of total revenues increased from 16.9% for 1994 to 19.0% for 1995. A significant portion of both the Company's revenues and its operating income is derived from initial licensing charges received as part of the Company's software licensing activities. Because a substantial portion of these revenues are recorded at the time systems are licensed, there can be significant fluctuations from quarter-to-quarter and year-to-year in the revenues and operating income derived from licensing activities. This is attributable principally to the timing of customers' decisions to enter into license agreements with the Company, which the Company is unable to control.
1995 $11.9 $ 9.5 $11.3 $16.1 $ 48.8 Initial license revenues 24.5% 19.4% 23.1% 33.0% 100.0% Total revenues 8.9% 7.1% 8.6% 11.6% 9.1%
1994 $ 3.6 $10.4 $14.3 $ 9.8 $ 38.1 Initial license revenues 9.5% 27.4% 37.6% 25.5% 100.0% Total revenues 3.1% 8.4% 11.3% 7.8% 7.7%
Investment income decreased $3.4 million for 1995 compared with 1994, as a result of a lower level of investable funds, resulting from large cash expenditures for the acquisition of Creative ($19.9 million) in December 1994 and the repurchase in May 1994 of 3,274,037 shares of the Company's common stock ($91.9 million).
December 31, 1996 1995 (In Millions) Cash and equivalents, marketable securities and investments $ 30.8 $ 44.6 Current assets 173.0 165.6 Current liabilities 112.6 94.4 Working capital 60.4 71.2 Current portion of long-term debt 31.2 1.8 Long-term debt 34.3 14.9
During 1996, the Company capitalized $56.8 million principally related to the development of its Series III client/server property and casualty software (including the incorporation of object-oriented technology and support for Microsoft Windows) and CyberLife object-oriented client/server life insurance software, as well as other ongoing projects for the domestic as well as international products.
Significant expenditures planned for 1997, excluding any possible business acquisitions and stock repurchases, are as follows: acquisition of data processing and communications equipment, support software, building improvements and office furniture, fixtures and equipment ($25.0 million) and costs relating to the internal development of software systems ($59.0 million).
The Company has historically used the cash generated from operations for the development and acquisition of new products, 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 will be able to meet presently anticipated needs; however, the Company may also consider incurring debt, as discussed above, as needed to accomplish specific objectives in these areas and for other general corporate purposes.
The timing and amount of the Company's revenues are subject to a number of factors, including, but not limited to, 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 facilities, 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.
Although the Company cannot accurately determine the amounts attributable thereto, the Company has been affected by inflation through increased costs of employee compensation and other operating expenses. To the extent permitted by the marketplace for the Company's products and services, the Company attempts to recover increases in costs by periodically increasing prices. Additionally, most of the Company's license agreements and long-term services agreements provide for annual increases in charges. _____________________________________________________
Index to Consolidated Financial Statements and Supplementary Data Page Report of Independent Accountants 21 Consolidated Financial Statements and Notes: Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994 22 Consolidated Balance Sheets as of December 31, 1996 and 1995 23 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1996, 1995 and 1994 24 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 25 Notes to Consolidated Financial Statements 26 Quarterly Consolidated Results of Operations 44 Supplemental Schedules: Schedule II - Valuation and Qualifying Accounts 45 Report of Independent Accountants 46
The consolidated financial statements are prepared on the basis of generally accepted accounting principles and include the accounts of the Company and its subsidiaries ("the Company") all of which are wholly-owned. All material intercompany balances and transactions have been eliminated. The equity method of accounting is used when the Company does not have effective control and has a 20% to 50% interest in other companies. Under the equity method, original investments are recorded at cost and adjusted by the Company's share of undistributed earnings or losses of these companies. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The Company's revenues are generated primarily by licensing to customers standardized insurance software systems and providing automation and administrative support and information services to the worldwide insurance industry.
Property and equipment, including certain equipment acquired under capital leases and support software acquired for internal use, are stated at cost less accumulated depreciation and amortization. Property and equipment are depreciated on a straight-line basis over their estimated useful lives. Assets acquired under capital leases are amortized over the term of the related lease.
Identifiable intangible assets and goodwill are recorded and amortized over their estimated economic lives or periods of future benefit. The lives established for these assets are a composite of many factors which are subject to change because of the nature of the Company's operations. This is particularly true for goodwill which reflects value attributable to the going-concern nature of acquired businesses, the stability of their operations, market presence and reputation. Accordingly, the Company evaluates the continued appropriateness of these lives and recoverability of the carrying value of such assets based upon the latest available economic factors and circumstances. The Company evaluates the recoverability of all long-lived assets including specific intangible assets and goodwill based upon a comparison of discounted estimated future cash flows from the related operations with the then corresponding carrying values of those assets. A rate considered to be commensurate with the risk involved is used to discount the cash flows. Impairment of value, if any, is recognized in the period in which it is determined.
On August 9, 1996, the Company acquired certain assets of Co-Cam Pty Ltd. and related entities ("Co-Cam") for approximately $6.0 million. Co-Cam, headquartered in Australia, is principally a software and services provider for superannuation and pension administration systems. The acquisition has been recorded using the purchase method of accounting. Accordingly, the Consolidated Statement of Operations of the Company for the year ended December 31, 1996, includes the results of operations of Co-Cam from the date of acquisition.
The total costs of the acquisitions were determined, and assigned to the net assets acquired, as follows:
Supplemental pro-forma information is not presented since these acquisitions were not material to the Company's consolidated results of operations in the year of acquisition.
As of December 31, 1994, the amortized cost of the Company's marketable securities was $16.3 million, with a market value of $16.7 million.
The following is a summary of available-for-sale and held-to-maturity securities included in marketable securities as of December 31, 1996:
As a result of growth in the Company's existing client/user base, the addition of new outsourcing customers and advances in central processing unit technology, the Company, during the fourth quarter of 1995, restructured its data processing facilities by beginning migration from BIPOLAR technology to newer CMOS technology. The Company entered into renewable lease agreements for this technology. As a result of the migration, the Company disposed of its existing central processing unit and associated equipment, with a net book value of $18.0 million, for $4.2 million in cash, and recorded a one-time charge on the disposition of this equipment of $13.8 million. Concurrent with this technology upgrade, the Company upgraded certain of its data storage equipment to a more advanced architecture. As consideration for these storage systems upgrades, the Company exchanged existing data storage systems, with an aggregate net book value of $6.0 million, and paid $2.0 million cash, resulting in a one-time charge of $4.6 million. These one-time charges, aggregating $18.4 million, are recorded under Loss on disposition of data processing equipment in the accompanying Consolidated Statement of Operations for the year ended December 31, 1995.
A summary of goodwill and other intangible assets is as follows:
December 31, 1996 1995 (In Thousands) Goodwill $ 65,639 $ 61,341 Customer lists 20,860 20,503 Contract acquisition costs 15,000 15,000 Covenants not to compete 5,136 5,291 Other 6,662 6,189 113,297 108,324 Less: Accumulated amortization (29,934) (19,005) Goodwill and other intangible assets, net $ 83,363 $ 89,319
Amortization charged to expense was $28.1, $23.2 and $19.8 million for the years ended December 31, 1996, 1995 and 1994, respectively. Purchased software with an aggregate carrying value of $1.5 million was written off as part of impairment and restructuring charges recorded during the year ended December 31, 1995 (see Note 12).
Long-term debt is as follows: December 31, 1996 1995 (In Thousands) Credit facility borrowings (net of unamortized deferred arrangement costs) $ 62,000 $ 14,746 Notes payable 3,490 1,893 65,490 16,639
Less: Current portion 31,222 1,766 Long-term debt $ 34,268 $ 14,873
On March 27, 1995, the Company entered into a long-term license and maintenance agreement in order to acquire rights to certain operating system management software products for use in the Company's worldwide data center operations. The agreement, which has an initial term of ten years, may be renewed and extended for an additional period of five years, subject to mutual agreement and other modifications. The March 27, 1995 agreement replaced three five-year term agreements executed in 1993, and other related agreements. Minimum contract payments by the Company over the initial ten-year term aggregate $33.0 million payable in specified annual installments which escalate over the ten-year period. The first annual installment due March 31, 1995 was reduced by $1.5 million to reflect the application of a pre-payment credit relating to a prior agreement which was terminated. In addition to minimum contract payments, the Company will pay an annual supplemental revenue fee (beginning 1997 for the 1996 annual period) equal to a specified annual percentage of the Company's applicable annual gross revenues, less the specified annual installment for such period. Minimum contract payments will be expensed on a straight-line basis over the initial ten-year term. Annual supplemental revenue fees, if any, will be accrued in the period in which determined.
The Company is also presently involved in litigation which commenced in January 1996 in the Circuit Court in Greenville County, South Carolina with Liberty Life Insurance Company and certain of its affiliates ("Liberty") arising out of the parties prior contractual relationship related to the development and licensing of Series III life insurance systems and the subsequent licensing of the Company's Cybertek life insurance systems. Liberty's complaint alleges breach of contract, breach of express and implied warranties, fraudulent inducement, breach of contract accompanied by a fraudulent act, and recission. Liberty has alleged actual and consequential damages of approximately $30 million and also seeks treble and punitive damages. The Company has asserted various affirmative defenses and is pursuing counterclaims against Liberty for breach of contract, recoupment, breach of good faith and fair dealing, and breach of contract accompanied by a fraudulent act. The Company is seeking equitable relief, including injunctive relief, and currently unspecified actual, compensatory and consequential damages.
An analysis of the income tax provision (benefit) is as follows:
Current deferred assets: Net operating loss carryforward $ 8,743 $ 745 Litigation settlements 2,847 4,915 Restructuring loss from foreign operations 790 849 Accrued bonuses and commissions 606 1,197 Other 2,357 2,555 Current deferred assets 15,343 10,261
Long-term deferred assets: State tax credits 907 2,307 Depreciation from foreign operations 436 - Other 217 29 Long term deferred assets 1,560 2,336 Total deferred assets $16,903 $12,597
Current deferred liabilities: Other $ 39 $ 61 Current deferred liabilities 39 61 Long-term deferred liabilities: Depreciation and amortization of property, equipment and intangibles 16,335 16,378 Capitalized software development costs 53,844 43,959 Net operating loss carryforward (9,095) (19,049) Foreign tax credit carryforward (3,846) (3,771) Impairment and restructuring of operations (789) (4,202) Other 1,921 337 Long-term deferred liabilities 58,370 33,652 Total deferred liabilities $58,409 $33,713
During 1994 the Company reached a final settlement with the Internal Revenue Service resulting in a $3.9 million payment and a $6.0 million reduction in the Company's provision for income taxes for the year ended December 31, 1994.
Prior to July 1, 1995, eligible employees were covered under the Policy Management Systems Corporation Profit Sharing Plan and Trust. The Company's contributions to this Plan were determined by the Board of Directors of the Company. Employees made no contributions to this Plan. The Company made no contributions to the Plan for 1995 and 1994 and on July 1, 1995, all accounts of all Participants in this Plan were merged into the Company's 401(k) Retirement Savings Plan.
The Company has various plans under which options to purchase shares of the Company's common stock have been granted to eligible employees and members of the Board of Directors of the Company and its subsidiaries. In January 1993, options were granted under the Company's 1993 Long-Term Incentive Plan for Executives, subject to approval by the Company's stockholders. At the annual meeting of the Company's stockholders in April 1993, the 1993 Long-Term Incentive Plan for Executives was approved.
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25)and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS 123 requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (in thousands except for earnings per share information):
In 1995, the Company performed a detailed assessment of the on-site medical correspondence information services business and determined that the expected future cash flows of this business did not support the carrying value of the related goodwill and identifiable intangible assets. As a result, at October 1, 1995, the Company recorded impairment charges of $1.8 million to write-off the carrying value of the identifiable intangible assets ($1.1 million) and goodwill ($.7 million).
As part of a 1983 business acquisition, the Company acquired a billing and collection system (CABILS), which was originally utilized in specialty processing or the processing of assigned risk business for the Company's customers (principally those customers acquired in the business acquisition) and, later, evolved into the basis for a portion of the Company's full property and casualty total policy management processing for voluntary as well as assigned risk business. During 1995, several of the Company's customers of this business opted to either move some or all states served by them to LAD servicing carriers or to not renew their agreements for these services for other reasons. In addition, the Texas Plan implemented rate increases and a mandatory takeout plan which had the effect of further decreasing the number of policies served by the Company. During 1995, the Company decided to migrate its property and casualty total policy management processing to its Series III technology, replacing the software acquired in 1983. Based on a detailed business assessment performed by the Company, the anticipated cash flows for this business for the period until the Series III migration was completed did not support the carrying value of the software and related goodwill associated with this business. As a result, the Company recorded, at October 1, 1995, impairment charges of $2.8 million to write-off the carrying value of the software ($.4 million) and related goodwill ($2.4 million).
During 1995, the Company ceased the active marketing of certain processing software utilized in the processing of Individual Accident and Health business by the Company's life business. A cash flow valuation performed by the Company under the above assumptions indicated that the expected discounted future cash flows of this business did not entirely support the carrying value of the goodwill associated with this business, which was originally acquired in 1987. As a result, the Company recorded at December 31, 1995 impairment charges of $.9 million to write-down the carrying value of the related goodwill to its estimated net realizable value.
The Company decided that in the fourth quarter of 1994 it would cease to do business in certain markets with respect to the CAPSIL business and operations acquired from Capsco Pallm Systems, Inc. The Company determined that the functionality and technical platform represented by acquired software for the domestic market would be replaced by software that has been and or is being developed in conjunction with its future strategic direction. The acquired software, however, is being marketed and licensed in Southeast Asia and, based on a detail analysis of recoverability, the Company determined that no write-down of the software was necessary. The Company did, however, record impairment charges of $1.8 million to reduce the carrying value of certain identifiable intangible assets ($.7 million) and goodwill ($1.1 million) relating to the acquired business in the United States.
During 1994, the Company changed its estimates and reduced its restructuring reserves (established in June 1993) associated with its health insurance systems business by $4.4 million. Of this reduction, $2.6 million resulted from a change in the scheduled downsizing of the Company's health staff and a corresponding reduction in amounts established for severance and outplacement costs while $1.8 million of the reduction resulted from a lease termination at amounts less than those established for the planned future abandonment of certain leased office facilities.
1. Property and casualty enterprise software and services (generally referred to as the "domestic property and casualty business"). This unit provides software products, product support, professional services and outsourcing to the US property and casualty insurance market.
2. Life enterprise software and services (generally referred to as the "domestic life business"). This unit provides software products, product support, professional services and outsourcing to the US life insurance and financial services markets. Additionally, in 1995 and 1994 this unit included the Company's Health division which was sold in June 1995.
3. International. This unit provides software products, product support, professional services, outsourcing and information services to the property and casualty and life insurance markets primarily in Canada, Europe and Asia/Pacific.
Currently, the Company's business is focused principally within the global property and casualty and life insurance industries. Significant changes in the regulatory or market environment of these Industries could impact demand for the Company's software products and services. Additionally, there is increasing competition for the Company's products and services, and there can be no assurance that the Company's current products and services will remain competitive, or that the Company's development efforts will produce products with the cost and performance characteristics necessary to remain competitive. Furthermore, the market for the Company's products and services is characterized by rapid changes in technology. The Company's success will depend on the level of market acceptance of the Company's products, technologies and enhancements, and its ability to introduce such products, technologies and enhancements to the market on a timely and cost effective basis, and maintain a labor force sufficiently skilled to compete in the current environment.
As discussed in Note 1, the preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Amounts affected by these estimates include, but are not limited to, the estimated useful lives, related amortization expense and carrying values of the Company's intangible assets and capitalized software development costs and accrued reserves established for contingencies such as litigation and restructuring activities. Changes in the status of certain matters or facts or circumstances underlying these estimates could result in material changes to these estimates, and actual results could differ from these estimates.
Concentration of credit risk with respect to trade accounts receivable is generally diversified due to the large number of entities comprising the Company's customer base across the insurance industry. The Company performs ongoing credit evaluations on certain of its customers' financial conditions, but generally does not require collateral to support customer receivables. The Company establishes an allowance for uncollectible accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information.