The Company owns its 867,000 square foot headquarters complex located on 145 acres in Blythewood, South Carolina. The Company leases space at 32 various locations for its regional and branch offices throughout the United States. Internationally, the Company leases space at 37 locations throughout Canada, Europe, Africa, Asia, Australia and New Zealand. Generally, the international properties support the international segment and the domestic properties support all segments.
The Company's data center in Bergen, Norway has one mainframe computer, which has over 1.5 terabytes of disk storage and is capable of processing over 265 million instructions per second. The Company is currently utilizing 80% of this capacity.
The Company's data center in Melborne, Australia has various UNIX systems which have over 120 gigabytes of disk storage and is capable of processing 90,000 transactions per minute. The Company is currently utilizing 85% of this capacity.
The Company uses a private common access network to support its operations. The network is tied together through a backbone located at headquarters in Blythewood, South Carolina, with hubs in Europe and Australia. The backbone accommodates all connectivity requiring access to multiple systems or sites and remote operations including international locations.
Remote connectivity to the backbone is accomplished through a Wide Area Network ("WAN") using point to point, frame relay, and dial-up connectivity. Operation and maintenance of the WAN is outsourced to Lockheed Martin. The Internet is accessed through T-1 connections and local ISP's. Security is provided through a series of firewalls.
There are over 140 Local Area Networks (LAN's) connected to the backbone and/or WAN. Aggregate network traffic over the average business day is approximately 5 terabytes. Traffic is typically not more than 50% of overall capacity. Network protocols include IPX/SPX, Netbios, TCPIP, SNA, and X.25. Third party operating systems used in production environments attached to the network include Netware, NT Server, OS/2, Linux, and UNIX. There are approximately 630 server systems supported as production devices, and approximately 1.6 terabytes of DASD.
The results of operations for 1999 include approximately $153.6 million of pretax special charges. These charges include approximately $118.4 million of non-cash charges related to acceleration of amortization of software, and the write-off of goodwill and other intangibles. The charges paid or to be paid in cash include approximately $12.0 million related to disputes with customers, approximately $12.9 million related to restructuring operations, approximately $9.6 million related to the settlement of litigation, and other similar charges of $0.7 million (see "Special Charges" under Management's Discussion and Analysis).
The Company's revenues are generated principally by licensing standardized insurance software systems and providing outsourcing and professional services to the global insurance and related financial services industries. Licensing revenues are provided for under the terms of nonexclusive and nontransferable agreements, which generally have a noncancelable minimum term of six years and provide for an initial license charge and a monthly license charge. Customers wishing to acquire perpetual rights to use the Company's software enter into additional agreements to acquire such rights.
- Initial license revenues for 1999 increased $4.5 million compared to 1998 with the following increases (decreases) by business segment: property and casualty up 81% ($16.8 million) primarily from $16.0 million on new Claims products and $3.0 million in PMSCiSolutions licensing; life and financial solutions down 43% ($11.7 million) primarily due to a decline in Banking Division licensing activity by comparison to 1998; and international down 3% ($0.6 million) primarily due to declining activity in Asia and Australia.
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 13% ($3.1 million) due to a decline in S3+ license activity; life and financial solutions up 37% ($7.3 million) on strong Banking Division licensing activity; and international down 24% ($6.3 million) due to lower licensing activity in Central Europe combined with decreasing foreign currency values.
Initial license charges include right-to-use licenses of $16.3, $15.5 and $10.2 million for 1999, 1998 and 1997, respectively. Right-to-use licenses represent the acquisition by certain customers of the right-to-use component of their remaining monthly license charge obligation, if any, plus the acquisition of a perpetual right to use the product thereafter. Since these types of licenses represent an acceleration of future revenues, they reduce future monthly license charges. Initial license charges also include contract termination fees of $1.0, $4.9 and $0.2 million for 1999, 1998, and 1997, respectively. Additionally, 1999 initial license charges include $2.5 and $4.1 million from the licensing of the recently acquired Legalgard and DORN products, respectively. Initial license revenues in 1999 also include $2.9 million for a COA license to the former owners of Legalgard, and $2.0 million for a license of several of the Company's life and financial solutions products to the former owners of FAS. Initial license revenues also include $3.3 million from the sale of hardware remarketed by the Company in conjunction with licenses of its software. In 1998, initial license charges include $4.9 million from licensing of acquired TLG products and $2.2 million of license agreements with the purchaser of the discontinued life information services segment. In 1997, initial license charges include $1.8 million of initial license agreements with the purchaser of the discontinued property and casualty information services segment.
Monthly license charges for 1999 increased $3.6 million compared to 1998, with the following increases (decreases) by business segment: property and casualty down 14% ($4.9 million) due to weak 1998 initial licensing and the effect of right-to-use licenses; life and financial solutions up 37% ($5.4 million) on strong 1998 initial license activity; and international up 19% ($3.1 million) principally due to increased initial license activity in the United Kingdom and the Asia/Pacific region during 1998.
Monthly license charges for 1998 increased $3.2 million compared to 1997. The life and financial solutions segment's monthly license charges increased 25% ($2.9 million) due to strong initial licensing activity of life and financial solutions products during 1997. The property and casualty and international segments' monthly license charges remained relatively unchanged.
BPO revenue for 1999 increased $36.4 million compared to 1998, with the following increases by business segment: property and casualty up 23% ($8.5 million) with declines in governmental business more than off-set by growth in commercial markets; life and financial solutions up 215% ($26.5 million) primarily due to the acquisition of FAS ($10.7 million) and internal growth; and international with $1.4 million.
BPO revenue for 1998 increased $2.1 million compared to 1997, with the following increases (decreases) by business segment: property and casualty down 8% ($3.0 million) primarily due to a loss of governmental business and life and financial solutions up 71% ($5.1 million) principally due to an increased presence in the traditional BPO market.
Employee compensation and benefits for 1998 increased 24% compared to 1997. The net increase results principally from higher salaries and related costs associated with the growth in professional services staffing being somewhat offset by the transfer of certain employee costs to computer and communication expenses as a result of the Company's data center outsourcing agreement with Lockheed Martin. Had these employee costs not been transferred, 1998 employee compensation and benefits would have increased 25% by comparison to 1997. Compensation and benefits increased 23% ($14.2 million) internationally and 24% ($37.0 million) domestically.
Computer and communications expenses for 1998 increased 19% compared to 1997 principally due to the data center outsourcing agreement with Lockheed Martin. Had the related employee costs not been transferred, 1998 computer and communications expenses would have increased 8% by comparison to 1997. Cost savings from the data center outsourcing agreement were offset by increased communications volumes, increased network and PC related expenses and increased license fees for operational data center software.
The following chart reflects Employee compensation and benefits and Computer and communication costs during 1999, 1998 and 1997 without the effect of moving certain salary costs related to the Lockheed Martin outsourcing contract.
Depreciation and amortization of property, equipment and capitalized software - -------------------------------------------------------------------------------- costs: - -----
Other costs and expenses for 1998 decreased 13% compared to 1997 principally due to lower consultant, contract loss and bad debt expense, partially offset by increased facility costs and decreased amounts of capitalized software development costs.
Amortization of goodwill and other intangibles for 1999 increased 94% compared to 1998, principally due to the impairment charges recorded in the third quarter that are described below under "Special Charges and Accounting Changes." Amortization related to the acquisition of TLG in 1998 and Legalgard, DORN and FAS in 1999 also contributed to the increase.
On December 3, 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB 101"). The Company identified approximately $3.2 million of revenue recognized previously in 1999 requiring adjustment due to SAB 101 (see "New Accounting Standards and Guidance," below).
Additionally, during the 1999 fourth quarter, the Company recorded restructuring charges of approximately $0.3 million related to payments to approximately 19 staff involuntarily terminated primarily in the property and casualty segment.
Additionally, the 1999 third quarter results include restructuring and other charges of approximately $12.6 million. These charges, paid or to be paid in cash, result from initiatives taken by the Company in 1999 to eliminate costs through worldwide reductions in force and space requirements. Approximately $7.3 million represents amounts payable to approximately 83 staff who were involuntarily terminated. Approximately $5.3 million relates to minimum lease obligations remaining on vacated offices, reduced by estimated sublease income. The charges related primarily to actions taken in the property and casualty and international business groups.
1999 produced an operating loss of $104.3 million compared with the 1998 operating income of $87.4 million. The 1999 operating loss results primarily from the write-off or write-down of certain software, intangibles related to business acquisitions and restructuring, and other charges described above in "Special Charges and Accounting Changes." Before these charges, operating income for 1999 decreased 38% compared with 1998. Also before these charges, decreases in segment operating income were: property and casualty decreased 17%, life and financial solutions decreased 19% and international decreased 64% (see discussion of "Revenues" and "Operating Expenses" above).
1998 operating income increased 10% compared to 1997. Increases in segment operating income were: property and casualty - 5%, life and financial solutions - - 74% and international - 15%. The increase in 1998 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.
Set forth below is a comparison of initial license revenues by quarter expressed as a percentage of annual initial license revenues and total revenues for each of the years presented:
Investment income for 1998 was relatively unchanged compared to 1997. Interest expense decreased 28% for 1998 compared to 1997, principally due to lower levels of borrowed funds under the Company's credit agreements and the capitalization of interest on construction in progress.
On December 3, 1999, the SEC issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB 101"), which among other guidance, clarifies certain conditions to be met in order to recognize revenue. The Company has identified approximately $3.2 million of revenue recognized previously in 1999 requiring adjustment due to SAB 101. These adjustments arose from fees of $3.0 million received on two joint marketing arrangements, and the existence of acceptance terms in a single DORN license agreement totaling $0.2 million. In addition, $1.0 million of DORN license revenue was deferred from the 1999 fourth quarter. As required by SAB 101, the Company has treated these adjustments as a change in accounting principle in accordance with Accounting Principles Board Opinion No. 20, Accounting Changes, and therefore has deferred this revenue in 1999.
The Company's total debt, net of cash and marketable securities, at December 31, 1999 was $213 million, a significant increase over the comparable amount ($75 million) at December 31, 1998. Historically, the Company has used cash from operations for the development and acquisition of new products, capital expenditures, acquisition of businesses and repurchases of the Company's stock. However, during 1999, the Company principally used its debt capacity to fund several strategic business acquisitions and investments aggregating $73 million and, to a lesser degree, repurchase its outstanding common stock ($33 million). Additionally, during 1999 the Company also invested $103 million in capitalized internal software development and property and equipment.
Future credit availability under the Company's amended loan agreements is dependent upon the Company achieving improvements in its operating performance. In light of the uncertainties surrounding future performance and the Company's current debt position, the Company has concluded that it must restructure its capital base in order to reduce debt and take advantage of various growth opportunities. Accordingly, the Board of Directors has authorized the Company's management to explore various alternatives to achieve efficiencies and obtain equity or other financing.
Significant expenditures planned for 2000, excluding new product development are as follows: acquisition of data processing and communications equipment, support software, buildings, building improvements and office furniture, fixtures and equipment and costs related to the continued enhancement of existing software products.
Currently, the Company's business is focused principally within the global property and casualty and life and financial services 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 significant 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 and the emergence of the Internet as a viable insurance distribution channel. 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.
A significant portion of both the Company's revenues and its operating income is derived from initial licensing agreements 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.
The Company's products are designed to be used with and require the use of third-party products, such as operating systems and compilers. Also, customers often modify the Company's products to suit their unique requirements. If these third parties experience or had experienced Year 2000 failures of their products, or if customers experience or had experienced system failures as a result of their modifications, the Company could become involved in disputes or litigation related to the cause of such system failures.
Since 1993, the Company estimates that it has incurred approximately $22 million in costs to address Year 2000 remediation issues. Based on the Company's experience, it is not anticipated that additional expenses to address Year 2000 concerns will be incurred. These Company costs were funded by operations.
The needs of each licensee of the Company's products domiciled or doing business in the participating countries may vary with regards to converting to the euro depending on how and when they choose to convert. The Company has developed strategies to modify its products licensed in the participating countries to convert to the euro. These modifications may be made available to licensees for a fee. Implementation of the modifications is the responsibility of each licensee.
The Company's 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.
The consolidated financial statements are prepared on the basis of generally accepted accounting principles and include the accounts of the Company and its majority owned subsidiaries (collectively, the "Company"). 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 Company provides professional support services, including systems implementation and integration assistance, and consulting and educational services. These support services are available under services agreements and are charged for separately under time and materials contracts and in some circumstances under fixed price arrangements. Revenues from time and materials arrangements are recognized as the services are performed. Under fixed price arrangements, revenue is recognized on the basis of the estimated percentage of completion of service provided. Changes in estimates to complete and revisions in overall profit estimates are recognized in the period in which they are determined (see Note 15). Provisions for losses, if any, are recognized in the period in which they first become probable and reasonably estimable.
From time to time the Company enters into joint development arrangements. Although these arrangements are varied, the Company will undertake custom development of a product or enhancement and typically retain all marketing rights and titles to such development. Joint development arrangements are generally provided for under fixed price agreements and in some circumstances on a time and materials basis. The Company recognizes revenue equal to direct cost on the same basis as professional support services; however, where technological feasibility has already been established, the Company will capitalize the portion of development costs which exceed customer funding provided under the joint development arrangement.
The Company also offers Information Technology ("ITO") and Business Process Outsourcing ("BPO") services ranging from making available Company software licensed on a remote processing basis from the Company's data centers, complete systems management, processing, administrative support and automated information services to addressing the complete back office processing of insurance transactions. Outsourcing services are typically provided under contracts having terms from three to ten years. Long-term arrangements consisting of multiple elements are accounted for under percentage of completion. Revenue is recognized as services are performed and the obligations are fulfilled. Changes in estimates to complete and revisions in overall profit estimates are recognized in the period in which they are determined (see Note 15). Provisions for losses, if any, are recognized in the period in which they become probable and reasonably estimable.
Accrued revenues on the Company's accompanying consolidated balance sheets represent revenues which the Company has earned in accordance with its accounting policies but that are not yet billable under the terms of the contracts as of the date of the balance sheet. These amounts are recoverable over the remaining life of the contract and are classified as either current or long-term. Generally, accrued revenues result from the timing of billings of license charges which are less than 12 months, the provisions of services and the application of percentage of completion accounting to the Company's long-term contracts.
The Company amortizes goodwill over an estimated life of 3 to 15 years. Other identifiable purchased intangible assets are being amortized on a straight-line basis over their estimated period of benefit ranging from 3 to 10 years.
The Company also capitalizes certain costs in accordance with Statement of Position 98-1, "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). For projects to acquire, internally develop or modify software solely to meet its internal needs and for which there are no marketing plans ("internal-use software"), the Company expenses costs that are incurred in the preliminary project stage and capitalizes certain costs once the criteria in SOP 98-1 are met. Capitalized costs include payments to third parties for materials and services consumed in developing or obtaining internal-use software, employee compensation and benefits costs directly associated with the internal-use software project, and interest costs incurred during the development of internal-use software. Capitalized costs are amortized over the estimated useful life of the internal-use software, generally between 5 to 8 years. Capitalized internal-use software costs are included in property and equipment (see Note 4).
Basic and diluted earnings per share ("EPS") are calculated according to the provisions of Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("FAS 128"). Weighted average common shares outstanding for all periods have been restated to reflect the stock split in June 1998 (see Note 11). For the Company, the numerator is the same for the calculation of both basic and diluted EPS. The denominator for basic and diluted EPS is the same for the period ended December 31, 1999 as the loss from operations would otherwise cause the inclusion of common stock options to be anti-dilutive. The following is a reconciliation of the denominator used in the EPS calculations (in thousands):
Weighted average shares for 1999 would have included 1,174,358 common stock equivalents if the Company had recorded net income. All options to purchase shares of common stock were included in the computation of diluted EPS for 1998.
The effect on the Company's operating revenues of adverse foreign currency exchange fluctuations (stated as current year international revenues translated at prior year average exchange rates) was $4.3 and $8.0 million for 1999 and 1998, respectively.
In June 1998, Statement of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") was issued, effective for fiscal years beginning after June 15, 1999, with earlier adoption encouraged. SFAS 133 requires companies to record derivative instruments on the balance sheet as assets and liabilities, measured at fair value. Gain or losses resulting from changes in the values of those derivatives are accounted for depending on the use of the derivative. The Company does not enter into derivative instruments except occasionally to hedge the foreign currency exchange and interest rate risk of specific projected transactions. The Company had no derivative instruments at December 31, 1999 or 1998.
On June 30, 1999, the Company purchased Financial Administrative Services, Inc. ("FAS"), a provider of business process outsourcing ("BPO"), for $13 million plus additional consideration of up to $12.0 million contingent on the future performance of FAS, to be capitalized as additional goodwill when paid until 2005. FAS uses the Company's PolicyLink system to support the rapid introduction of variable insurance products and annuities in a business process outsourcing environment. The Company intends to grow the business acquired.
On August 31, 1998, the Company purchased 100% of the outstanding common stock of The Leverage Group, Inc. ("TLG") for $25 million in cash. An independent appraiser estimated the fair market value of the assets acquired and liabilities assumed including the in-process research and development ("IPR&D"). TLG owns PolicyLink , a family of systems designed to support the administrative tasks associated with administration, commission processing, payout processing, and disbursement generation for life insurance and annuity contracts. In addition to continuing to market certain systems, the Company intends to integrate the family of systems with its existing product, Cyberlife , to provide a local area network solution that administers products ranging from traditional whole and term-life insurance to non-traditional, wealth-accumulation products including annuities and variable annuities. The Company recorded acquisition related charges of approximately $3.7 million related to the purchase of TLG (see Note 6).
Approximately $2.0 million of these charges represent estimated purchased IPR&D based on the income approach valuation method. This amount reflects the fair value of a single subsystem that was substantially complete, is not being marketed and will be used in the Company's research and development activities. Consistent with the Company's basis of accounting for costs incurred to develop its software, this subsystem is not capitalizable under SFAS 86 and has no alternative future use other than in Research and Development. The remainder of these charges represents the previously capitalized historical cost of software purchased and internal in-process development of the Company that is no longer capitalizable based on SFAS 86 as a result of the acquisition.
The acquisitions above have been recorded using the purchase method of accounting in accordance with Accounting Principles Board Option No. 16, "Accounting for Business Combinations." Accordingly, the Consolidated Statements of Operations of the Company include the results of operations from the date of acquisition.
During 1999, the Company recorded restructuring charges of approximately $12.9 million related to initiatives the Company took to eliminate costs through reductions in force of approximately 102 employees and reductions in space requirements. The Company also recorded $9.6 million cash charges incurred in connection with the settlement of litigation with Liberty Life Insurance Company. The 1998 and 1997 activity relates primarily to net rental payments on a facility previously vacated.
The following table reflects the activity related to restructuring charges for the three years ended December 31, 1999:
A summary of goodwill and other intangible assets is as follows (in thousands):
Amortization of goodwill and other intangibles during 1999 includes approximately $6.1 million of impairment charges related primarily to past international acquisitions. These impairment charges were determined in the 1999 third quarter in accordance with Statement of Financial Accounting Standards No. 121.
During 1999, the Company transferred $7.8 million of contract acquisition costs at net book value ($15.0 million gross cost) to other receivables which was paid in January 2000.
Amortization charged to expense was $149.4, $41.1 and $33.9 million for the years ended December 31, 1999, 1998 and 1997, respectively. During 1999, the Company recorded $9.0 and $7.5 million of purchased software related to the acquisitions of Legalgard and DORN, respectively. During 1998, the Company recorded $4.4 and $3.7 million of purchased software related to the acquisitions of CAF and TLG, respectively.
During the fourth quarter of 1999, the Company recorded approximately $18.1 million of accelerated amortization with $16.3 million related to its Banking Division and approximately $1.8 million for several smaller software products primarily in its international segment.
During the third quarter of 1999, the Company recorded approximately $94.3 million of accelerated amortization related to costs determined to be unrecoverable. Of this amount, approximately $77.6 million relates to Series II and S3+ , and approximately $16.7million relates to international operations.
During the fourth quarter of 1998, the Company recorded impairment charges which have been reclassified to amortization in the amount of $9.6 million to write-off the unamortized portion of capitalized software development costs of principally two products. The Company had invested approximately $4.2 million in the development of a new software product called Visual Product Builder ("VPB"). VPB was intended to allow insurance companies to easily design and implement computer code to administer new insurance products with reduced programming costs and time to market. During the Company's 1998 fourth quarter strategic planning, it became apparent that for technical and architectural reasons, VPB would not reach the level of market acceptance initially anticipated. Also during the fourth quarter, the Company identified CAF as a potential acquisition candidate, primarily based on CAF's successful development of VP/MS. VP/MS provides substantially the same function as VPB but without the technical and architectural issues that VBP presented. Therefore, the Company wrote off $3.9 million of unamortized previously capitalized VPB internal development costs. Also during its 1998 fourth quarter strategic planning, the Company determined to cease marketing its policy administration software in the Latin American market to pursue an alliance with another software vendor in that market. Consequently, the Company wrote off $4.5 million of unamortized internal development costs. The remaining amount of accelerated amortization related to unamortized development costs of lesser products that were determined to be unrecoverable.
Under these amendments, the line of credit will be reduced to $180 million and, further, to $125 million on April 1, 2001. The line of credit will mature on July 1, 2001. Borrowings under the agreement bear interest at rates based upon the applicable London Interbank Offering Rate ("LIBOR") plus a spread of 2.75%. During 1999, loans under this agreement ranged in rates from 6.475% to 6.85%. Additionally, the Company pays a per annum fee on the aggregate amount of the line of credit commitment of .50%.
Both the line of credit and term loan will be secured by assets of the Company in 2000. The Company is also restricted from making certain investments and will continue to be subject to certain covenants including, but not limited, to the maintenance of an operating ratio and levels of tangible net worth.
Future credit availability under the Company's amended loan agreements is dependent upon the Company achieving improvements in its operating performance. In light of the uncertainties surrounding future performance and the Company's current debt position, described above, the Company has concluded that it must restructure its capital base in order to reduce debt and take advantage of various growth opportunities. Accordingly, the Board of Directors has authorized the Company's management to explore various alternatives to achieve efficiencies and obtain equity or other financing.
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 was re-negotiated during 1999, has a term ending June 2009, and may be renewed and extended for an additional period of five years, subject to mutual agreement and other modifications. Minimum contract payments by the Company over the remaining ten year term total approximately $54.6 million payable in specified annual installments over the ten-year period. In addition to minimum contract payments, the Company will pay an annual supplemental revenue fee, subject to certain provisions in the agreement, equal to a specified annual percentage of the Company's applicable prior year annual gross revenues, less the specified annual installment for such period. Minimum contract payments will be expensed on a straight-line basis over the remaining ten-year term. Annual supplemental revenue fees, if any, will be accrued in the period in which determined. The agreement provisions for the supplemental revenue fee were not met for 1999 or 1998.
During 1997, the Company entered into two five year renewable lease and maintenance agreements to lease certain data processing equipment for use in its worldwide data center operations. Minimum lease payments over the initial terms of the agreements aggregate $8.6 million payable in specified monthly installments. At the end of the term of each agreement, the Company had the option to purchase the leased equipment at fair market value, upgrade the equipment with the latest technology, or discontinue each lease. Lockheed Martin assumed these leases.
The Company leased certain data processing and related equipment primarily under operating leases expiring through 2003. Rent expense under operating leases for such equipment was $2.8, $5.2 and $7.9 million for the years ended December 31, 1999, 1998 and 1997, respectively.
Future minimum lease obligations under noncancelable operating leases are stated below and include payments over 16 years aggregating $3.2 million related to a leasehold planned for future abandonment, net of subleases (in thousands):
On January 7, 2000, following a morning news release by the Company that fourth quarter earnings would be below analyst estimates, the Company and three of its officers were named as defendants in an purported class action complaint filed on behalf of purchasers of the Company's stock during the period between October 22, 1998 and January 6, 2000. Since this initial filing, additional purported class actions have been filed, three in the United States District Court for the District of South Carolina and two in the United States District Court for the Southern District of New York (which are in the process of being transferred to South Carolina), purportedly on behalf of purchasers of the Company's stock during the period between October 22, 1998 and February 9 or 10, 2000.
These class action lawsuits allege violations of Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934 based on, among other things, alleged misleading statements, alleged failure to disclose material adverse information, alleged false financial reporting, alleged failure to report trends, demands or uncertainties, and alleged failure to implement and maintain adequate internal controls. Each of the complaints seeks unspecified compensatory damages, including interest, costs and attorney fees.
Although the Company has not yet filed formal responses to these lawsuits, the Company believes the claims are without merit and is vigorously pursuing a full defense of these actions and allegations.
On April 29, 1999, the Company received notice from the Internal Revenue Service ("IRS") of proposed adjustments to its 1994, 1995 and 1996 federal income tax returns. Should the IRS prevail in its position, a charge to income of approximately $16.3 million would result. The Company has submitted a response to the IRS and is awaiting a formal decision. Furthermore, the Company strongly disagrees with the proposed adjustments and is vigorously defending its position.
A reconciliation of the difference between the actual income tax provision and the expected provision on pre-tax income (loss), computed using the applicable statutory rate, is as follows:
An analysis of the net deferred income tax assets and liabilities is as follows (in thousands):
No provision has been made for federal income taxes on unremitted earnings of certain of the Company's foreign subsidiaries (approximately $32 million at December 31, 1999) since the Company plans to permanently reinvest all such earnings. However, if such earnings were remitted, there would be additional federal income tax expense of $1.8 million.
The Company has foreign tax credit carryforwards at December 31, 1999 of $4.2 million which will expire as follows: $1.2 million on December 31, 2001 and $3.0 million on December 31, 2002.
In August 1998, the Company established the Restricted Stock Ownership Plan. Participation in the Plan is mandatory for United States-based officers and directors until they have satisfied the applicable guidelines. Under the guidelines, officers are required to hold Company stock in multiples of their base salary ranging from 1 times salary for vice presidents, to 5 times salary for the Chief Executive Officer. Directors who are not employees are required to hold 5 times the annual retainer for directors. Directors and officers have annual targeted percentages of ownership to achieve each year and are to achieve 100% of the guideline for their office within 6 years of the Plan's adoption or their first election to the office to which this guideline is applicable.
In May 1995, the Company established a stock ownership plan through which eligible employees of the Company and its participating affiliates may acquire shares of the Company's common stock through regular payroll deductions. Participants may make after-tax contributions in multiples of $5.00, with a minimum deduction per pay period of $10.00 and a maximum deduction per pay period of the lesser of $900.00 or 10% of regular salary. The Company makes a matching contribution equal to 15% of participants' contributions. Participants who withdraw shares acquired under the Plan within two years of the date of purchase are ineligible to make further contributions to purchase shares under the Plan for twelve months after such withdrawal.
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 FAS 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 (or exceeds) the market price of the underlying stock on the date of grant, no compensation expense is recognized.
Pro forma information regarding net income and earnings per share is required by FAS 123 and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1999, 1998 and 1997, respectively: risk-free interest rates of 5.9%, 5.2% and 5.7%; volatility factors of the expected market price of the Company's common stock of 38.9%, 36.2% and 35.4%; and weighted-average expected life of the options of 4.5, 4.3 and 4.4 years.
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 per share data):
In May 1998, the Company's Board of Directors approved a two-for-one stock split effected in the form of a stock dividend, whereby each shareholder of record as of June 1, 1998, received on June 15, 1998, one additional share of common stock for each share owned as of the record date. As a result of the split, 18,426,691 shares were issued and $0.2 million was transferred from Retained Earnings to Common Stock. Weighted average common shares outstanding and per share amounts for all periods presented have been restated to reflect the stock split. Share amounts reflected on the Consolidated Balance Sheet and Consolidated Statements of Changes in Stockholder's Equity and Comprehensive Income reflect the actual share amounts for each period presented.
Licensing revenues in 1999 include $2.5 and $4.1 million from the licensing of the recently acquired Legalgard and DORN products, respectively. Initial license revenues in 1999 also include $2.9 million for a COA license to the former owners of Legalgard, and $2.0 million for a license of several of the Company's life and financial solutions products to the former owners of FAS. License revenues in 1999 also include $3.3 million from the sale of hardware remarketed by the Company in conjunction with licenses of its software.
Licensing revenues in 1998 include $2.2 million of license agreements with the purchaser of the discontinued life information services segment.
The Company also recognized an additional loss during 1998 of $1.0 million, net of tax, on the sale of its property and casualty information services segment. This loss is included in discontinued operations in the accompanying Consolidated Statements of Operations.
During 1999 and 1998, the Company repurchased 1,015,513 and 2,143,400 shares (2,388,200 restated for stock split) of the Company's stock on the open market, respectively.
During 1997, the Company repurchased 79,900 shares (159,800 restated for stock split) of the Company's stock on the open market.
The Company has classified its operations into five operating segments. The operating segments are the five revenue-producing components of the Company for which separate financial information is produced for internal decision making and planning purposes. The segments are as follows:
2. Life and financial solutions enterprise software and services (generally referred to as "life and financial solutions"). This segment provides software products, product support, professional services and outsourcing primarily to the US life insurance and related financial services markets.
3. International. This segment provides software products, product support, professional services and outsourcing to the property and casualty and life insurance markets primarily in Europe, Asia and Australia and Canada.
4. Property and casualty information services. This segment provided information services, principally motor vehicle records and claims histories, to US property and casualty insurers. It was sold in August 1997.
Information about the Company's operations for the past three years is as follows:
The Company's operating results and financial condition may be impacted by a number of factors, including but not limited to the following, any of which could cause actual results to vary materially from current and historical results or the Company's anticipated future results.
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. Financial statement line items that include significant estimates include the allowance for uncollectible receivables, accrued revenues, accrued restructuring charges, goodwill and other intangibles, net, capitalized software and costs, net, and income tax balances. 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.
A significant portion of both the Company's revenue 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 is recorded at the time new systems are licensed, there can be significant fluctuations from period to period 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. The Company believes that current and potential customers' decisions to enter into license agreements with the Company may be significantly affected by investments that have been made in existing information systems for Year 2000 remediation and the uncertainty arising from the emergence of the Internet as a viable distribution channel for insurance. However, at this time the Company is unable to predict what the future impact of these items, if any, will be.
On December 3, 1999, the SEC issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB 101"), which among other guidance clarifies certain conditions regarding the culmination of an earnings process and customer acceptance requirements in order to recognize revenue. The Company identified approximately $3.2 million of revenue recognized previously in 1999 requiring adjustment due to SAB 101. These adjustments arose from fees of $3.0 million received on two joint marketing arrangements in the second quarter, and the existence of acceptance terms in a single DORN license agreement totaling $0.2 million in the third quarter. As required by SAB 101, the Company has treated these adjustments as a change in accounting principle in accordance with Accounting Principles Board Opinion No. 20, Accounting Changes, and therefore has deferred this revenue in 1999. A cumulative catch-up adjustment of $3.2 million was recorded in the fourth quarter of 1999.
During the fourth quarter of 1999 and continuing into the first quarter of 2000, rising interest rates caused significant declines in mortgage loan originations and reduced profits for mortgage loan originators. This in turn lead many existing and prospective customers of the Company's Banking Division to reevaluate their loan origination software system requirements. Consequently, the Company established reserves against approximately $8.3 million of accounts receivable based on disputes with several significant Banking Division customers. The Company is in continuing dialogue with these customers and is in various stages of negotiations or resolution concerning these disputes.
During the fourth quarter of 1999, the Company recorded approximately $18.1 million of accelerated amortization with $16.3 million related to its Banking Division and approximately $1.8 million for several smaller software products primarily in its internation segment.
The first and second quarters of 1999 have been restated to reflect principally the correction of an error caused by the oversight or misuse of the facts that existed at the time the financial statements were prepared surrounding the resolution of a dispute concerning a license agreement.
Our audits of the consolidated financial statements of Policy Management Systems Corporation referred to in our report dated March 30, 2000 appearing on page 27 of this Form 10-K also included an audit of the financial statement schedule listed in the index on page 28 of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.