The Company owns its 700,000 square foot headquarters complex located on 145 acres in Blythewood, South Carolina. The Company leases space at 23 various locations for its regional and branch offices throughout the United States. Internationally, the Company leases space at 23 locations throughout Canada, Central and South America, Europe, Africa, Asia, Australia and New Zealand.
The Company's revenues are generated principally by licensing to customers standardized insurance software systems and providing automation and administrative support and information services to the global insurance and financial services industries. Licensing revenues are provided for under the terms of nonexclusive and nontransferable license agreements, which generally have a noncancelable minimum term of six years and provide for an initial license charge and a monthly license charge. Services revenues are derived from professional support services, which include implementation and integration assistance, consulting and education services, information and outsourcing services.
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 1997, 1996 and 1995:
Licensing revenues in the United States are being impacted by various market factors. Many insurance companies are spending significant amounts of money to solve their year 2000 problems. To date, the Company does not believe it has experienced a significant impact, positively or negatively, from year 2000 issues (see Year 2000 Readiness for further discussion of the year 2000 issue).
Professional and outsourcing services revenues for 1996 increased $49.2 million compared to 1995. This increase was principally related to services from both new and existing contracts amounting to $24.1 million for domestic property and casualty, $5.9 million for domestic life and financial solutions (includes a decrease in divested health services of $7.1 million) and $19.2 million for international. The increase in the international results was principally due to the acquisition of Co-Cam in August 1996, and micado in October 1995, and new services contracts in Europe.
Employee compensation and benefits for 1996 increased 28.9% compared to 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
Other operating costs and expenses for 1997 decreased 7.5% 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 the Company's S3+ property and casualty insurance software, CyberLife life insurance software and I+ international property and casualty software. 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.
Selling, general and administrative expenses for 1997 increased 23.5% compared to 1996, principally from the Company's investment in its international sales force and administrative infrastructure.
During the fourth quarter of 1995, the Company recorded charges aggregating $2.6 million relating principally to costs, previously deferred, of an acquisition in Europe expected to close during the fourth quarter of 1995, that was not consummated ($1.2 million), and the settlement of certain contracts acquired through previous acquisitions ($1.4 million).
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 center equipment by beginning migration from BIPOLAR technology to newer CMOS technology. The Company entered into renewable lease agreements to acquire this technology, which will also allow the Company to take advantage of technological advances in this area without the large capital burden and lack of flexibility resulting from the purchase of such technology. As a result of the migration, the Company disposed of its existing data processing 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 charges, aggregating $18.4 million, are recorded under Loss on disposition of computer equipment for the year ended December 31, 1995.
Operating income, after the effects of the gain from the sale of the health services business and special charges, was $19.6 million for the year ended December 31, 1995. These results include a gain from the sale of the Company's health services unit of approximately $8.1 million. Special charges aggregating $60.8 million recorded during the year ended December 31, 1995 relate to impairment and restructuring charges, net ($6.8 million), litigation settlement and other legal expenses ($18.5 million), charges incurred in connection with the restructure of the Company's data center facilities ($18.4 million), and certain charges related to business acquisitions ($17.1 million).
Due to reduced levels of investable funds during 1997, interest 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 37.4%, 36.2% and 61.1% for the years ended December 31, 1997, 1996 and 1995, respectively The effective income tax rate for 1995 increased as a result of the Company's expensing, for book purposes, purchased research and development associated with its October 1995 acquisition of micado (see Note 2 of Notes to Consolidated Financial Statements), nondeductible write-offs of goodwill impairment (see Note 11 of Notes to Consolidated Financial Statements) and the nondeductible amortization of goodwill. These effects were offset, in part, by the higher tax basis than book basis of the assets divested related to the sale of the Company's health services unit (see Note 10 of Notes to Consolidated Financial Statements) and differences between the US tax rate and tax rates imposed on the income of foreign subsidiaries.
During 1997, the Company capitalized $62.5 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.
Contracts with governmental agencies involve a variety of special risks, including the risk of early contract termination by the governmental agency and changes associated with newly elected state administrations or newly appointed regulators.
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 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.
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 selected solution is currently being implemented, is designed to meet Year 2000 requirements, and is scheduled to be operational at the end of 1998. In addition, the Company is commencing an inventory and assessing all of its network and PC hardware and software to determine if any Year 2000 remediation upgrades will be required.
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 or fluctuations.
The Company's domestic property and casualty segment has an outsourcing contract in Florida. In 1996, the state of Florida legislatively imposed six month homeowner policies as opposed to the normal twelve month policies. This decision was reversed later that year, but now has a carryover effect, which may last for several years and places most policy renewal dates in the latter part of the year. Since a significant percentage of the Company's revenue under this contract is derived from processing renewals, the carryover effect has caused a portion of the revenue to shift to the last half of the year.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995: Statements in this annual report that are not descriptions of historical facts may be forward-looking statements that are subject to risks and uncertainties, including economic, competitive and technological factors affecting the Company's operations, markets, products, services and prices, as well as other specific factors discussed in Note 13 of Notes to Consolidated Financial Statements and elsewhere herein and in the Company's filings with the Securities and Exchange Commission. These and other factors may cause actual results to differ materially from those anticipated.
The consolidated financial statements are prepared on the basis of generally accepted accounting principles and include the accounts of the Company and its subsidiaries, all of which are wholly-owned (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 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.
Software systems are licensed under the terms of substantially standard nonexclusive and nontransferable license agreements, which generally have a noncancelable minimum term of six years and provide for an initial license charge and a monthly license charge. The initial license charge, which grants a right to use the software system currently available at the time the license is signed, is recognized as revenue upon delivery of the product and receipt of a signed contractual obligation, if collectibility is probable and no significant vendor obligations remain. The monthly license charge provides access to Maintenance, Enhancements and Services Availability ("MESA"). Under the maintenance provisions of MESA, the Company provides telephone support and error correction to current versions of licensed systems. Under the enhancement provisions of MESA, the Company will provide any additions or modifications to the licensed systems, which the Company may deliver from time to time to licensees of those systems if and when they become generally available. The monthly license charge is recognized as revenue on a monthly basis throughout the term of the MESA provision of the license agreement. Services availability allows customers access to professional services, other than maintenance and enhancements, which are provided under separate arrangements during the MESA term.
Debt securities included in the Company's investment portfolio for which there is a positive intent and ability to hold to maturity are carried at amortized cost. Debt securities that may be sold prior to maturity and all marketable equity securities are classified as available-for-sale and carried at fair value. The fair value is estimated based on quoted market prices for those or similar investments. Net unrealized gains and losses, determined on the specific identification method, on securities classified as available-for-sale are carried as a separate component of Stockholders' Equity.
Other identifiable purchased intangible assets are being amortized on a straight-line basis over their estimated period of benefit ranging from 5 to 10 years.
Options to purchase 243,050, 3,000 and 375,000 shares of common stock at $69.38, $66.00 and $81.90 per share, respectively, were outstanding but were not included in the computation of diluted EPS because the options' exercise prices were greater than the average market price for the Company's common stock for the period.
In June 1997, Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"), was issued. FAS 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 adoption of FAS 130 is not expected to have a material effect on the Company's disclosures.
In August 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.
In October 1995, the Company acquired micado Beteiligungs-und Verwaltungs GmbH ("micado"). Headquartered in Germany, micado is principally a software provider to German insurance and financial services companies. The acquisition was financed principally from cash provided by operations and borrowings under the Company's credit facilities. The acquisition has been recorded using the purchase method of accounting. Accordingly, the Consolidated Statement of Operations for the year ended December 31, 1995, includes the results of operations of micado from the date of acquisition. In connection with the acquisition, the Company recorded an estimated liability of $0.4 million at October 1, 1995, included in Impairment and restructuring charges, net, in the accompanying Consolidated Statements of Operations, to provide for certain relocation and severance costs of consolidating existing operations in Germany with micado. At October 1, 1995, the Company also recorded a charge of $14.5 million representing purchased research and development for which technological feasibility had not yet been established and for which there is no alternative future use. Under the terms of the purchase agreement, payment of approximately $6.2 million of the purchase price was deferred at the date of acquisition and was paid during 1996.
Supplemental pro-forma information is not presented since this acquisition was not material to the Company's consolidated results of operations in the year of acquisition.
During the fourth quarter of 1995, the Company recorded charges aggregating $2.6 million relating principally to costs, previously deferred, of an acquisition in Europe which was expected to close during the fourth quarter of 1995 and was not consummated.
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 center equipment 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 computer equipment in the accompanying Consolidated Statement of Operations for the year ended December 31, 1995.
Amortization charged to expense was $33.9, $28.1 and $23.2 million for the years ended December 31, 1997, 1996 and 1995, 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 11).
On August 8, 1997, the Company entered into a new credit facility for $200 million with a syndicate of financial institutions to provide an additional source of funds for general corporate purposes. The facility bears a term of five years. Borrowings under the facility bear interest payable at per annum rates based upon the London Interbank Offering Rate plus a spread above certain of these rates ranging from 0.225% to 0.350% dependent upon certain financial ratios of the Company. Additionally, the Company pays a per annum facility fee on the aggregate amount of the commitments ranging from 0.10% to 0.15%. The Company is subject to certain covenants including, but not limited to, the maintenance of certain operating ratios and levels of tangible net worth. The average interest rate applicable to borrowings under credit facilities was 6.01% and 6.16% for the years ended December 31, 1997 and 1996, respectively.
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 $7.9, $7.5 and $4.9 million for the years ended December 31, 1997, 1996 and 1995, respectively.
The Company is also presently involved in litigation which commenced in January of 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 in excess of $160 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.
Based upon the allegations raised in a prior lawsuit and the SLD lawsuit, the Company's insurer, St. Paul Mercury Insurance Company ("St. Paul"), commenced in June 1995 a declaratory judgment action in the United States District Court for the District of South Carolina against the Company to determine St. Paul's obligation for defense costs and to indemnify the Company for any payment related to these claims. The Company filed a counterclaim against St. Paul seeking to recover the Company's defense costs in both matters, coverage for damages, if any, awarded in those matters, and consequential and punitive damages.
In connection with the dismissal of the prior lawsuit, St. Paul and the Company agreed to dismiss with prejudice all claims against each other with respect to the matter, and St. Paul agreed to reimburse the Company for the Company's legal fees. The action continues as to the parties' claims related to insurance coverage for the SLD matter.
An analysis of the net deferred income tax liability is as follows:
The Company generated a $23.9 million net operating loss for the year ended December 31, 1995 for federal and state tax purposes. These loss carryforwards expire in 2010. Certain foreign subsidiaries of the Company have net operating loss carryforwards at December 31, 1997 totaling approximately $5.1 million, which may be used to offset future taxable income. The foreign carryforwards have no expiration period.
The Company has foreign tax credit carryforwards at December 31, 1997 of $5.2 million which will expire as follows: $3.8 million on December 31, 2000, and $1.4 million on December 31, 2001. The Company recorded a valuation allowance of $3.1 million at December 31, 1995 related to certain deferred tax assets that are not anticipated to be utilized through normal operating results.
The Company offers the Policy Management Systems Corporation 401(k) Retirement Savings Plan to eligible employees. Effective January 1, 1995, the Company began matching 100% of the first 3% of salary contributed by the participant and matching 50% of the next 3% of salary contributed by the participant. Subject to limits imposed by the Internal Revenue Service, the Internal Revenue Code and the Plan, participants may also make additional before-tax and after-tax contributions that are not subject to matching contributions by the Company. Participants have several options as to how their contributions and vested Company contributions are invested. Effective July 1, 1995, non-vested and current Plan year Company contributions are invested in common stock of the Company. The Company's contribution on behalf of participating employees was $3.8, $3.3 and $3.6 million for the years ended December 31, 1997, 1996 and 1995, respectively.
The Company currently 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. Options under these plans expire ten years after the grant date except that options under the 1993 Long Term Incentive Plan for Executives (the "1993 Plan") expire in January 2003. During 1997, options were granted under the 1989 Stock Option Plan only. During 1996 and 1995, options were granted under the 1993 Plan and the 1989 Stock Option Plan.
In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). This Statement requires that companies with stock-based compensation plans either recognize compensation expense based on new fair value accounting methods or continue to apply the provisions of Accounting Principles Board Opinion No. 25 and disclose pro forma net income and earnings per share assuming the fair value method had been applied.
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 1997, 1996 and 1995, respectively: risk-free interest rates of 5.7%, 6.4% and 6.5%; volatility factors of the expected market price of the Company's common stock of 35.4%, 37.5% and 39.7%; and weighted-average expected life of the options of 4.4, 5.0 and 5.1 years.
The following table summarizes information about fixed options outstanding at December 31, 1997:
On August 31, 1997, the Company completed the sale of substantially all of the assets of its property and casualty information services business for cash proceeds of $2.9 million. The Company retained the working capital of this business (approximately $14.3 million). This transaction produced a non-recurring gain of $1.7 million. Also, during the third quarter of 1997, the Company abandoned a related business. As a result, the Company recorded a non-recurring charge of $1.8 million, principally related to capitalized software.
During 1997, the Company repurchased 79,900 shares of the Company's stock on the open market.
On April 8, 1996, the Company repurchased 759,512 of the 1,519,024 shares of the Company's common stock held by GAP Coinvestment Partners and General Atlantic Partner 14 L.P. (collectively "General Atlantic Investors") and the remainder of the Company's shares owned by General Atlantic Investors were purchased by Continental Casualty Company, a licensee of the Company's S3+ solutions. The repurchase by the Company, at a price of $50.00 per share, resulted in an aggregate cash expenditure (after related costs) of approximately $38.7 million.
On June 30, 1995, the Company sold its health services unit for a total consideration of $9.3 million in cash. After selling expenses of $0.5 million, the net book value of assets sold of $0.5 million, liabilities resulting from the sale, including severance liabilities for certain employees and other reserves of $1.5 million, and the present value of a sublease executed by the purchaser for certain office space of $1.3 million, the Company recorded a pre-tax gain of $8.1 million, for the year ended December 31, 1995.
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 ($0.7 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 and financial solutions business. A cash flow valuation performed by the Company indicated that the expected 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 $0.9 million to write-down the carrying value of the related goodwill to its estimated net realizable value.
The Company has classified its operations into five operating segments and revised its segment information accordingly. 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:
3. International. This segment provides software products, product support, professional services, outsourcing and information services to the property and casualty and life insurance markets primarily in Canada, Europe, Asia and Australia.
Currently, the Company's business is focused principally within the global property and casualty and life insurance 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 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.
Our report on the consolidated financial statements of Policy Management Systems Corporation is included on page 26 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page 25 of this Form 10-K.