UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number 1-14036
DST SYSTEMS, INC.
(Exact name of Company as specified in its charter)
DELAWARE 43-1581814
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
333 WEST 11TH STREET, KANSAS CITY, MISSOURI 64105
(Address of principal executive offices) (Zip Code)
(816) 435-1000
(Company's telephone number, including area code)
NO CHANGES
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the Company (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Company was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Number of shares outstanding of the Company's common stock as of July 27, 1998:
Common Stock $.01 par value - 48,991,152
1
DST SYSTEMS, INC.
FORM 10-Q
JUNE 30, 1998
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Introductory Comments 3
Condensed Consolidated Balance Sheet -
December 31, 1997 and June 30, 1998 4
Condensed Consolidated Statement of Income -
Three and Six Months Ended June 30, 1997 and 1998 5
Condensed Consolidated Statement of Cash Flows -
Six Months Ended June 30, 1997 and 1998 6
Notes to Condensed Consolidated Financial Statements 7-8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9-14
Item 3. Quantitative and Qualitative Disclosures about Market Risk 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 2. Changes in Securities 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 17-18
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 19
The Company's service marks and trademarks include without limitation, DST(TM),
Securities Transfer System(TM), TA2000(R), Portfolio Accounting System(TM),
Automated Work Distributor(TM), AWD(R), TRAC-2000(R), FAST2000(TM) referred to
in this Report.
2
DST SYSTEMS, INC.
FORM 10-Q
JUNE 30, 1998
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTRODUCTORY COMMENTS
The Condensed Consolidated Financial Statements of DST Systems, Inc. ("DST" or
the "Company") included herein have been prepared by the Company, without audit,
pursuant to the rules and regulations of the United States Securities and
Exchange Commission. Certain information and note disclosures normally included
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures are adequate to
enable a reasonable understanding of the information presented. These Condensed
Consolidated Financial Statements should be read in conjunction with the audited
financial statements and the notes thereto for the year ended December 31, 1997.
Additionally, the Condensed Consolidated Financial Statements should be read in
conjunction with Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations included in this Form 10-Q.
The results of operations for the three and six months ended June 30, 1998, are
not necessarily indicative of the results to be expected for the full year 1998.
3
DST Systems, Inc.
Condensed Consolidated Balance Sheet
(dollars in thousands, except per share amounts)
December 31, June 30,
1997 1998
--------------- ---------------
(unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 15,833 $ 24,971
Accounts receivable 170,699 187,226
Other assets 44,792 43,468
--------------- ---------------
231,324 255,665
Investments 820,577 1,091,384
Properties 242,153 229,953
Intangibles and other assets 61,350 55,096
--------------- ---------------
Total assets $ 1,355,404 $ 1,632,098
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Debt due within one year $ 13,898 $ 9,815
Accounts payable 49,763 27,249
Accrued compensation and benefits 28,319 30,035
Deferred revenues and gains 22,679 24,967
Other liabilities 26,334 33,992
--------------- ---------------
140,993 126,058
Long-term debt 92,005 103,572
Deferred income taxes 241,782 344,712
Other liabilities 43,534 29,581
--------------- ---------------
518,314 603,923
--------------- ---------------
Commitments and contingencies
--------------- ---------------
Minority interest 1,380 947
--------------- ---------------
Stockholders' equity
Common stock, $0.01 par; 125,000,000 shares authorized,
50,000,000 shares issued 500 500
Additional paid-in capital 408,610 409,305
Retained earnings 261,589 297,712
Treasury stock, (956,942 and 1,019,367 shares,
respectively), at cost (31,404) (36,758)
Accumulated other comprehensive income 196,415 356,469
--------------- ---------------
Total stockholders' equity 835,710 1,027,228
--------------- ---------------
Total liabilities and stockholders' equity $ 1,355,404 $1,632,098
=============== ===============
The accompanying notes are an integral part of these financial statements.
4
DST Systems, Inc.
Condensed Consolidated Statement of Income
(in thousands, except per share amounts)
(unaudited)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
1997 1998 1997 1998
---------------- ---------------- ---------------- ----------------
Revenues $ 155,394 $ 184,292 $ 314,077 $ 371,715
Costs and expenses 114,983 137,219 230,337 271,640
Depreciation and amortization 19,468 19,022 39,097 40,802
---------------- ---------------- ---------------- ----------------
Income from operations 20,943 28,051 44,643 59,273
Interest expense (1,884) (1,957) (4,046) (4,258)
Other income, net 1,231 1,150 2,210 1,990
Equity in earnings (losses) of
unconsolidated affiliates,
net of income taxes 820 77 1,864 (367)
---------------- ---------------- ---------------- ----------------
Income before income taxes
and minority interest 21,110 27,321 44,671 56,638
Income taxes 7,064 9,866 15,366 20,658
---------------- ---------------- ---------------- ----------------
Income before minority interest 14,046 17,455 29,305 35,980
Minority interests in income (losses) 229 (95) 385 (142)
---------------- ---------------- ---------------- ----------------
Net income $ 13,817 $ 17,550 $ 28,920 $ 36,122
================ ================ ================ ================
Average common shares outstanding 49,374 48,967 49,451 48,984
Basic earnings per share $ 0.28 $ 0.36 $ 0.58 $ 0.74
Diluted average shares outstanding 49,762 49,966 49,891 49,935
Diluted earnings per share $ 0.28 $ 0.35 $ 0.58 $ 0.72
The accompanying notes are an integral part of these financial statements.
5
DST Systems, Inc.
Condensed Consolidated Statement of Cash Flows
(dollars in thousands)
(unaudited)
For the Six Months
Ended June 30,
1997 1998
--------------- ---------------
Cash flows -- operating activities:
Net income $ 28,920 $ 36,122
--------------- ---------------
Depreciation and amortization 39,097 40,802
Undistributed (earnings) losses of unconsolidated affiliates (1,864) 367
Cash dividends received from unconsolidated affiliates 8,303
Changes in accounts receivable 1,963 (16,528)
Changes in other current assets (5,301) 1,010
Changes in accounts payable and accrued liabilities (22,473) (6,324)
Other, net 983 310
--------------- ---------------
Total adjustments to net income 12,405 27,940
--------------- ---------------
Net 41,325 64,062
--------------- ---------------
Cash flows -- investing activities:
Investments and advances to unconsolidated affiliates (12,318) (13,444)
Capital expenditures (25,697) (31,352)
Other, net 1,132 784
--------------- ---------------
Net (36,883) (44,012)
--------------- ---------------
Cash flows -- financing activities:
Principal payments on long-term debt (7,406) (5,762)
Net increase in credit facilities and notes payable 20,188 13,219
Common stock repurchased (9,353) (10,009)
Other, net (6,387) (8,360)
--------------- ---------------
Net (2,958) (10,912)
--------------- ---------------
Net increase in cash 1,484 9,138
Cash at beginning of period 8,279 15,833
--------------- ---------------
Cash at end of period $ 9,763 $ 24,971
=============== ===============
The accompanying notes are an integral part of these financial statements.
6
DST SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. SUMMARY OF ACCOUNTING POLICIES
The Condensed Consolidated Financial Statements of DST Systems, Inc. ("DST" or
the "Company") included herein have been prepared by the Company, without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations, although
the Company believes that the disclosures are adequate to enable a reasonable
understanding of the information presented. These Condensed Consolidated
Financial Statements should be read in conjunction with the audited financial
statements and the notes thereto for the year ended December 31, 1997.
Additionally, the Condensed Consolidated Financial Statements should be read in
conjunction with Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations included in this Form 10-Q.
In the opinion of management, the accompanying unaudited condensed consolidated
financial statements contain all adjustments (consisting of normal interim
closing procedures) necessary to present fairly the financial position of the
Company and its subsidiaries at December 31, 1997 and June 30, 1998, the results
of operations for the three and six months ended June 30, 1997 and 1998, and
cash flows for the six months ended June 30, 1997 and 1998.
The results of operations for the three and six months ended June 30, 1998, are
not necessarily indicative of the results to be expected for the full year 1998.
EARNINGS PER SHARE. The computation of basic and diluted earnings per share is
as follows (in thousands, except per share amounts):
Three Months Ended Six Months Ended
June 30 June 30
1997 1998 1997 1998
---- ---- ---- ----
Net income $ 13,817 $ 17,550 $ 28,920 $ 36,122
================= ================= ================== =================
Average common shares outstanding 49,374 48,967 49,451 48,984
Incremental shares from assumed
conversions of stock options 388 999 440 951
----------------- ----------------- ------------------ -----------------
Dilutive potential common shares 49,762 49,966 49,891 49,935
================= ================= ================== =================
Basic earnings per share $ 0.28 $ 0.36 $ 0.58 $ 0.74
Diluted earnings per share $ 0.28 $ 0.35 $ 0.58 $ 0.72
COMPREHENSIVE INCOME. As of January 1, 1998, the Company adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income." The
new statement requires that all changes in equity during a period except those
resulting from investments by and distributions to owners be reported as
"comprehensive income" in the financial statements. Upon implementation, the
Company included the net unrealized gain or loss on available-for-sale
securities and foreign currency translation adjustments together with net income
in the computation of comprehensive income. For the three months ended June 30,
1998, comprehensive income was $66.5 million as compared to $81.9 million for
the three months ended June 30, 1997. For the six months ended June 30, 1998,
comprehensive income was $196.2 million as compared to $59.5 million for the six
months ended June 30, 1997.
7
SOFTWARE REVENUE RECOGNITION. As of January 1, 1998, the Company adopted
Statement of Position ("SOP") 97-2, "Software Revenue Recognition" which was
effective for software licensing transactions entered into beginning in 1998.
Certain of the Company's products are licensed, however revenues for licensed
software products are not material to the Company as a whole. Implementation of
the new statement did not have a material effect on the three and six months
ended June 30, 1998 and the Company does not expect the statement to have a
material effect on the future consolidated results of operations of the Company.
2. EQUITY IN EARNINGS (LOSSES) OF UNCONSOLIDATED AFFILIATES
The following table summarizes equity in earnings (losses) of unconsolidated
affiliates:
For the Three Months For the Six Months
(in thousands) Ended June 30, Ended June 30,
1997 1998 1997 1998
--------------- --------------- --------------- ---------------
Boston Financial Data Services, Inc. $ 1,541 $ 1,987 $ 3,160 $ 3,627
Argus Health Systems, Inc. 1,475 549 2,713 1,169
European Financial Data Services Limited (2,111) (2,162) (3,794) (4,788)
Other (85) (297) (215) (375)
--------------- --------------- --------------- ---------------
$ 820 $ 77 $ 1,864 $ (367)
=============== =============== =============== ===============
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussions set forth in this Quarterly Report on Form 10-Q contain
statements concerning potential future events. Such forward-looking statements
are based upon assumptions by the Company's management, as of the date of this
Quarterly Report, including assumptions about risks and uncertainties faced by
the Company. Readers can identify these forward-looking statements by their use
of such verbs as expects, anticipates, believes or similar verbs or conjugations
of such verbs. If any of management's assumptions prove incorrect or should
unanticipated circumstances arise, the Company's actual results could materially
differ from those anticipated by such forward-looking statements. The
differences could be caused by a number of factors or combination of factors
including, but not limited to, those factors identified in the Company's Current
Report on Form 8-K/A dated August 4, 1998 ("Form 8-K/A"), which is hereby
incorporated by reference. The Form 8-K/A has been filed with the United States
Securities and Exchange Commission (the "SEC" or the "Commission") in
Washington, D.C. and can be obtained by contacting the SEC's Public Reference
Branch or in the SEC's EDGAR database accessible through the SEC's web site on
the World Wide Web at www.sec.gov. Readers are strongly encouraged to consider
the factors listed in the Form 8-K/A and any amendments or modifications thereof
when evaluating any forward-looking statements concerning the Company. The
Company does not currently intend to update any forward-looking statements in
this Quarterly Report to reflect future events or developments.
The information contained in this Management's Discussion and Analysis of
Financial Condition and Results of Operations should be read in conjunction with
the Condensed Consolidated Financial Statements and Notes thereto included in
this Form 10-Q and the audited financial statements and notes thereto in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997.
INTRODUCTION
The Company provides sophisticated information processing and computer software
services and products, primarily to mutual funds, insurance companies, banks and
other financial services organizations.
RECENT EVENTS
On February 10, 1998, Boston EquiServe, LP ("Boston EquiServe"), a 50% owned
joint venture between Boston Financial Data Services, Inc. ("BFDS") (a 50% owned
joint venture of the Company and State Street Corporation) and BankBoston
Corporation, announced an agreement to merge with First Chicago Trust Company of
New York ("First Chicago") which would create the largest corporate securities
transfer agent in the United States, processing approximately 25 million
accounts. The merger of the two businesses, to be named EquiServe, LP
("EquiServe"), is expected to be completed during the latter half of 1998.
9
DST is currently developing a new securities transfer system ("Fairway") to be
used by Boston EquiServe to process all of its accounts. In conjunction with the
merger, DST entered into a memorandum of understanding with Boston EquiServe and
First Chicago to complete development of Fairway for the exclusive use by
EquiServe to process all of its accounts. The Company has also agreed with
EquiServe to provide data processing services for EquiServe to use Fairway. The
terms and conditions of this memorandum of understanding will be set forth in a
definitive agreement, the completion of which is a condition to the closing of
the merger agreement between Boston EquiServe and First Chicago. Upon acceptance
of defined components of Fairway, DST will contribute Fairway and its
non-EquiServe securities transfer processing business (approximately 2 million
accounts) to EquiServe for a direct ownership interest in EquiServe. DST will
also continue to hold an indirect ownership interest in EquiServe through BFDS.
RESULTS OF OPERATIONS
SECOND QUARTER AND YEAR TO DATE 1997 VERSUS SECOND QUARTER AND YEAR TO DATE 1998
For the quarter ended June 30, 1998, DST's consolidated net income was $17.5
million, or $0.36 basic and $0.35 diluted earnings per share, as compared to
$13.8 million, or $0.28 basic and diluted earnings per share for the quarter
ended June 30, 1997.
For the six months ended June 30, 1998, DST's consolidated net income was $36.1
million, or $0.74 basic and $0.72 diluted earnings per share, as compared to
$28.9 million, or $0.58 basic and diluted earnings per share for the six months
ended June 30, 1997.
REVENUES
Consolidated revenues for the three and six months ended June 30, 1998 were
$184.3 million and $371.7 million, respectively, which represent increases of
18.6% and 18.4%, respectively, over the comparable 1997 periods.
U.S. revenues for the three and six months ended June 30, 1998 were $152.3
million and $309.8 million, respectively, which represent increases of 15.3% and
14.4%, respectively, over the comparable 1997 periods. This revenue increase
resulted from growth in mutual fund, output processing, automated work
distributor (AWD) and satellite television subscriber management fees. U.S.
mutual fund processing revenues for the three and six months ended June 30, 1998
have increased approximately 14.3% and 13.1%, respectively, over the prior year
as shareowner accounts serviced increased to 48.2 million at June 30, 1998, an
increase of 7.1% from 45.0 million at December 31, 1997 and 13.7% from 42.4
million at June 30, 1997. Increased IRA activity continued to contribute to
account growth. For the quarter ended June 30, 1998, new IRA accounts opened
increased by 700,000 accounts over the 1997 quarter, with approximately 13% of
the increase being new Roth or Educational IRA accounts. U.S. mutual fund output
processing revenues for the three and six months ended June 30, 1998 increased
17.2% and 12.8%, respectively, and total pages printed for the three and six
month periods increased 20.3% and 19.2%, respectively, over the comparable 1997
periods. U.S. AWD workstations licensed increased 9.7% over year-end 1997
levels. Satellite television subscriber management revenues have increased
nearly 50% over the prior year quarter due to an increased number of subscribers
and continuing systems development activities. Additionally, the Company
received a one-time $2.6 million contract termination fee from a portfolio
accounting client during the first quarter 1998.
The Company expects approximately 2.1 million mutual fund accounts from new
clients to be converted onto its system during the second half of 1998. As
expected and earlier reported, Prudential Financial Management Services
("Prudential") internalized the processing for approximately 1,100,000 mutual
fund shareowner accounts during the six months ended June 30, 1998. Also, an
existing mutual fund remote processing client with approximately 650,000
accounts is expected to convert off of the Company's system in the last half of
1998.
International revenues for the three and six months ended June 30, 1998 were
$32.0 million and $61.9 million, respectively, which represent increases of
37.4% and 43.0%, respectively, over the comparable 1997 periods. The increase
in international revenues was attributable to higher investment accounting
software and services revenues and increased Canadian mutual fund processing
revenues. The introduction of the European Monetary Unit, which will be
effective beginning January 1, 1999, contributed to increased demand for the
Company's investment management products.
10
COSTS AND EXPENSES
Consolidated costs and expenses for the three and six months ended June 30, 1998
increased 19.3% and 18.0%, respectively, over the comparable 1997 periods to
$137.2 million and $271.6 million, respectively, primarily as a result of higher
operating volumes and increased personnel costs to support increased revenues
both in the U.S. and internationally. In addition, the renegotiation of certain
third party software agreements, effective March 31, 1998, resulted in certain
amounts being recorded as costs and expenses instead of depreciation expense.
U.S. costs and expenses for the three and six months 1998 increased 17.5% and
16.6%, respectively. International costs and expenses for the three and six
months 1998 increased 27.6% and 23.9%, respectively.
The Company has continued to experience increases in compensation necessary to
hire and retain computer programmers and other systems professionals. While
these cost increases have not materially affected the Company's overall cost
structure to date, the Company believes that the costs associated with computer
programmers and other systems professionals may continue to increase at rates
above general inflation at least through 2000.
DEPRECIATION AND AMORTIZATION
Consolidated depreciation and amortization for the three months ended June 30,
1998 decreased 2.2% to $19.0 million. The decrease in depreciation is primarily
attributable to the renegotiation of certain third party software agreements
noted above. Consolidated depreciation and amortization for the six months ended
June 30, 1998 increased 4.4% as a result of a one-time write-off of intangible
assets totaling $3.2 million in the first quarter, primarily associated with the
$2.6 million contract termination fee referred to above.
INTEREST EXPENSE
Interest expense for the three and six months ended June 30, 1998 increased 3.9%
and 5.2%, respectively over the comparable 1997 periods on higher average debt
balances.
EQUITY IN EARNINGS (LOSSES) OF UNCONSOLIDATED AFFILIATES
Equity in earnings of unconsolidated affiliates was $0.1 million for the quarter
ended June 30, 1998 as compared to $0.8 million for the quarter ended June 30,
1997. Year-to-date, equity in earnings of unconsolidated affiliates was a loss
of $0.4 million in 1998 as compared to income of $1.9 million in 1997. The
Company's share of losses recorded at European Financial Data Services Limited
("EFDS") of $2.2 million during the second quarter 1998 were approximately even
with the prior year quarter. Year-to-date, losses recorded from EFDS totaled
$4.8 million in 1998 as compared to $3.8 million in 1997 due to continuing
development costs of FAST2000, which costs are being expensed as incurred and
costs of conversions of new and existing client accounts to the new system.
Lower earnings were recorded by Argus Health Systems due to the contract
termination of a large client in late 1997. Higher operating earnings were
recorded at Boston Financial Data Services, Inc. from increased levels of mutual
fund activity.
INCOME TAXES
DST's effective income tax rate was 36.1% and 36.5% for the three and six
months ended June 30, 1998, as compared to 33.5% and 34.4% for the three and six
months ended June 30, 1997. The Company's 1997 tax rate was affected by tax
benefits relating to certain international operations.
11
LIQUIDITY AND CAPITAL RESOURCES
The Company uses its cash available from operating activities, borrowings from
banks and financing from third-party vendors and others to fund operating,
investing and financing activities.
Cash flows from operating activities totaled $64.1 million for the six months
ended June 30, 1998. Operating cash flows were affected by an $8.0 million
dividend from Argus Health Systems and a $16.5 million increase in accounts
receivable related to revenue growth.
Cash flows used in investing activities totaled $44.0 million for the six months
ended June 30, 1998. The Company has expended $31.4 million year-to-date for
capital additions. Investments and advances to unconsolidated affiliates totaled
$13.4 million, primarily for funding the development of FAST2000 at EFDS and for
other investments.
Cash flows used in financing activities totaled $10.9 million for the six months
ended June 30, 1998. During the first quarter 1998, the Company repurchased
200,000 shares of common stock for $10.0 million, completing its 1.2 million
share repurchase program. Financing activities also include $10.8 million in
payments relating to accrued settlements of prior years' sales and use tax
matters.
The Company maintains a $50 million bank line of credit facility to finance
short-term working capital requirements available through May 1999, of which
total borrowings were $19.7 million as of June 30, 1998. Additionally, the
Company maintains a five-year revolving credit facility of $125 million with a
syndicate of U.S. and international banks. Total borrowings of $50.0 million
were outstanding on this facility at June 30, 1998.
The Company believes that its existing cash balances and other current assets,
together with cash provided by operating activities and, as necessary, the
Company's credit facilities, will be sufficient to meet the Company's operating
and debt service requirements and other current liabilities for at least the
next twelve months. Further, the Company believes that its longer-term liquidity
and capital requirements will be met through cash flows from operations and
existing bank credit facilities, as well as the Company's $125 million revolving
credit facility described above.
OTHER
UNREALIZED GAINS ON SECURITIES. The Company holds, among others, approximately
8.6 million shares of Computer Sciences Corporation common stock and
approximately 6.0 million shares of State Street Corporation common stock as
investments. At December 31, 1997 and June 30, 1998, the market value of the
Company's investments in available-for-sale securities reflected aggregate
unrealized gains (net of deferred taxes) of $197.0 million and $357.3 million,
respectively, which are included in Accumulated Other Comprehensive Income on
the Condensed Consolidated Balance Sheet. Included in the computation of
comprehensive income in accordance with Statement on Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" are the $67.2 million and
$49.7 million net unrealized gains for the second quarter 1997 and 1998
respectively. For the six months ended June 30, 1997 and 1998, net unrealized
gains of $31.4 million and $160.3 million were included respectively.
SOFTWARE USAGE AGREEMENT. On March 31, 1998, the Company entered into a software
usage and maintenance agreement for certain computer software to be utilized at
the Winchester Data Center. The new software agreement replaces an existing
agreement with the same vendor, extending the term from 2000 until 2003 and
provides for an increase in software usage capacity. Under the previous
agreement, the Company capitalized the total fixed costs to be incurred under
the agreement and recorded a corresponding liability. Capitalized costs under
the previous agreement were depreciated over the period of the contract while
variable payments for incremental usage were recorded as costs and expenses when
incurred. Based on the terms of the new agreement, annual payments will be
recorded as costs and expenses over the period which they benefit. As a result
of replacing the previous agreement, approximately $9.0 million of computer
software previously capitalized by the Company and related short-term and
long-term liabilities were removed from the Company's balance sheet on March 31,
1998. Although the new agreement will result in certain future costs being
recorded as costs and expenses instead of depreciation expense, the Company does
not believe that the new agreement will have a material adverse affect on the
Company's operating expenses.
12
SEGMENT INFORMATION. The Financial Accounting Standards Board issued Statement
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
in June 1997. This statement requires that publicly traded companies report
certain information about their operating segments, products and services,
geographic areas in which they operate, and major customers beginning with the
1998 annual report. The Company is currently evaluating the effect that
implementation of this new standard will have on the information disclosed in
its financial statements.
INTERNAL USE SOFTWARE. The Accounting Standards Executive Committee recently
issued Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." The new statement is effective
for fiscal periods beginning after December 15, 1998 and requires that certain
costs for the development of internal use software be recorded as an asset.
Accordingly, certain primary types of development activities will be required to
be capitalized, including coding and software configuration costs, costs of
testing and installing the software, and when clearly distinguishable from
maintenance, the costs of upgrades and enhancements. The Company currently
expenses costs of internally developed proprietary software as incurred. The
Company is currently evaluating the effect that implementation of this new
standard will have on its software development accounting policies and is unable
to determine the effects on the Company's results of operations at this time.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. The Financial Accounting
Standards Board recently issued Financial Accounting Standard No. 133,
"Accounting for Derivative Instruments and Hedging Activities." The new
statement is effective for fiscal quarters of fiscal years beginning after June
15, 1999 and requires that a company recognize all derivatives as either assets
or liabilities in the statement of financial position and measure those
instruments at fair value. The Company does not generally use derivative
instruments and believes that implementation of this new standard will not have
a material impact on the Company's results of operations.
SEASONALITY. Generally, the Company does not have significant seasonal
fluctuations in its business operations. Processing and output volumes for
mutual fund customers are usually highest during the quarter ended March 31 due
primarily to processing year-end transactions and printing and mailing of year
end statements and tax forms during January. The Company has historically added
operating equipment in the last half of the year in preparation for processing
year-end transactions which has the effect of increasing costs for the second
half of the year. Software license revenues and operating results are dependent
upon the timing, size, and terms of the license.
YEAR 2000. Many computer programs use only two digits to identify a year in a
date field within the program (e.g., "98" or "02"). If not corrected, computer
applications making calculations and comparisons in different centuries may
cause inaccurate results, or fail by or at the Year 2000. These Year 2000
related issues are of particular importance to the Company. The Company depends
upon its computer and other systems and the computer and other systems of
third-parties to conduct and manage the Company's business. Additionally, the
Company's products and services are dependent upon using accurate dates in order
to function properly. These Year 2000-related issues may also adversely affect
the operations and financial performance of one or more of the Company's
customers or suppliers. As a result, the failure of the Company's computer and
other systems, products or services, the computer systems and other systems upon
which the Company depends, or of the Company's customers or suppliers to be Year
2000 ready could have a material adverse effect on the Company's results of
operations, financial position and cash flows.
13
The Company recognizes the significance of the Year 2000 problem and is
executing a program to achieve Year 2000 readiness. The Company's Year 2000
program is supported by a corporate-wide structure of project teams, a
governance structure and a central Project Office. The Project Office was
established to lead the readiness efforts for the Company and manage the overall
progress of the project. The Company has redirected some of its development
employees to address the Year 2000 issues.
The program's purpose is to identify, evaluate and resolve potential Year 2000
related issues for the Company's products, services, internal systems, hardware,
communications and other systems. The program includes the following key steps:
1. Identification of systems and applications that must be modified
2. Evaluation of alternatives (modification, replacement or discontinuance)
3. Establishment of plans which include timely milestones and appropriate
testing to ensure that the systems and applications are ready for the
Year 2000.
The program also includes:
1. Projects to ensure that external vendors and services are also ready
2. The development of alternatives where necessary
3. Interoperability testing with clients and key organizations in the financial
services industry.
The Company's goal is to be ready, internally, for the Year 2000 by December 31,
1998. This goal allows for one full year of testing with clients and the
industry prior to the Year 2000. The Company's Year 2000 program is well under
way, and the Company expects to achieve its goal.
The expenses associated with the program will be expensed as incurred. The
Company does not believe the amount to be spent on Year 2000 issues will be
material to the Company's results of operations, liquidity or capital resources.
However, although the Company is not aware of any material operational or
financial Year 2000 related issues, the Company cannot make any assurances that
its computer systems, products, services or other systems or the computers and
other systems of others upon which the Company depends will be Year 2000 ready
on schedule, that the costs of its Year 2000 program will not become material or
that the Company's alternative plans will be adequate. The Company is currently
unable to anticipate accurately the magnitude, if any, of the Year 2000 related
issues arising from the Company's customers and suppliers. If any such risks
(either with respect to the Company or its customers or suppliers) materialize,
the Company could experience material adverse consequences to its business which
could have material adverse effects on the Company's results of operations,
financial position and cash flows.
14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is from time to time a party to litigation arising in the ordinary
course of its business. Currently, there are no legal proceedings that
management believes would have a material adverse effect upon the consolidated
results of operations or financial condition of the Company.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Meeting of Stockholders on May 12, 1998. Proxies for
the meeting were solicited pursuant to Regulation 14A; there was no solicitation
in opposition to management's nominees for directors as listed in such Proxy
Statement and all such nominees were elected. Listed below is the matter voted
on at the Company's Annual Meeting. This matter is fully described in the
Company's Definitive Proxy Statement dated March 31, 1998. A total of 45,128,415
shares of Common Stock, or 92.2% of the shares of Common Stock outstanding on
the record date, were present in person or by proxy at the annual meeting. These
shares were voted on the following matter as follows:
1) Election of two directors for terms ending in 2001
A. Edward Michael G. Fitt
Allinson
--------------- ------------------
For 44,984,901 44,973,669
Withheld 143,514 154,746
=============== ==================
Total 45,128,415 45,128,415
=============== ==================
Based upon votes required for approval, this matter passed.
The terms of office of Directors Thomas A. McDonnell and M. Jeannine Standjord
will continue until the Annual Meeting of Stockholders in 1999. The terms of
office Directors Thomas A. McCullough and William C. Nelson will continue until
the Annual Meeting of Stockholders in 2000.
If a stockholder desires to have a proposal included in DST's Proxy Statement
for next year's annual meeting of stockholders, the Corporate Secretary of DST
much receive such proposal on or before December 1, 1998, and the proposal must
comply with the applicable SEC regulations.
16
ITEM 5. OTHER INFORMATION
A. The following table presents the sources of the Company's revenues:
Sources of Revenue
Six Months Ended June 30,
1997 1998
----------------------------------- ---------------------------------
(dollars in thousands)
U.S. revenues
Mutual fund and
Investment management
Data processing services $ 139,801 44.5% $ 161,679 43.5%
Output processing 44,968 14.3% 50,698 13.6%
----------------- ---------------- -------------- ---------------
184,769 58.8% 212,377 57.1%
Other output processing 49,621 15.8% 56,008 15.1%
Other 36,434 11.6% 41,474 11.2%
----------------- ---------------- -------------- ---------------
Total U.S. revenues 270,824 86.2% 309,859 83.4%
International revenues 43,253 13.8% 61,856 16.6%
----------------- ---------------- -------------- ---------------
Total revenues $ 314,077 100.0% $ 371,715 100.0%
================= ================ ============== ===============
B. The following table identifies geographic operating results:
For the Three Months For the Six Months
Geographic information Ended June 30, Ended June 30,
(in thousands) 1997 1998 1997 1998
--------------- ---------------- --------------- ---------------
U.S. revenues $ 132,116 $ 152,310 $ 270,824 $ 309,859
U.S. income from operations 19,913 24,432 45,969 52,562
International revenues 23,278 31,982 43,253 61,856
International income (losses) from operations 1,030 3,619 (1,326) 6,711
17
C. The following table summarizes certain key operating and financial data for
the periods indicated:
December 31, June 30,
1997 1998
--------------------- ----------------------
Investment Market Values (in thousands) (1)
Computer Sciences Corporation $ 360,400 $ 552,470
State Street Corporation 347,509 415,069
Euronet Services, Inc. $ 9,136 $ 5,157
Other Operating Data
Mutual fund shareowner accounts processed (millions)
U.S. 45.0 48.2
Canada 0.9 1.4
United Kingdom 1.0 1.4
TRAC-2000 mutual fund accounts (millions) (2) 1.9 2.3
TRAC-2000 participants (thousands) 696 768
Portfolio Accounting System portfolios 1,925 2,012
Automated Work Distributor workstations 35,100 36,800
Six Months Ended June 30,
1997 1998
--------------------- ----------------------
Output Technologies pages printed (millions) 740.6 890.3
Argus pharmaceutical claims processed (millions) 74.0 65.7
<FN>
(1) Based upon the closing price on the last trading day of the applicable
period at the exchange where principally traded.
(2) Included in TA2000 mutual fund shareowner accounts processed.
</FN>
D. The SEC recently amended its proxy rules to require a registrant, such as the
Company, to disclose the date after which stockholder proposals that are not to
be included in the Company's proxy statement are considered "untimely" for proxy
solicitation purposes. Under the Company's By-laws, in order for such a
stockholder proposal to be timely and otherwise validly brought before the
Company's 1999 Annual Meeting of Stockholders, a stockholder must notify the
Company's Corporate Secretary no earlier than February 11, 1999 and no later
than March 13, 1999. The calculation of this notice period and By-law
requirements for the contents of such notice are set forth in the Company's 1998
Proxy Statement, which can be obtained by contacting the SEC's Public Reference
Branch or in the SEC's EDGAR database accessible through the SEC's web site on
the World Wide Web at www.sec.gov.
18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT NUMBER DOCUMENT
4.3.1 The First Amendment dated as of July 9, 1998 to the
Rights Agreement dated as of October 6, 1995 between
the Registrant and State Street Bank and Trust
Company attached as Exhibit 99 to Amendment No. 1,
dated July 30, 1998, to the Company's Registration
Statement on Form 8-A for its preferred Share
Purchase Rights (Commission file no. 1- 14036) is
hereby incorporated by reference as Exhibit 4.3.1
10.6.1 First Amendment to the Employee Stock Ownership Plan
and Trust Agreement of DST Systems, Inc.
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed under Item 5 of Form 8-K, the Company's Form 8-K/A dated
April 13, 1998 amending and restating its Form 8-K dated March 15, 1996
setting forth certain cautionary statements identifying important factors
that either individually or in combination with other factors could cause
the Company's actual operating results to differ materially from those
projected in forward-looking statements, whether oral or written,
concerning the Company and made by, or on behalf of, the Company.
The Company filed under Item 5 of Form 8-K, the Company's Form 8-K dated
April 22, 1998, reporting the announcement of financial results for the
quarter ended March 31, 1998.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized, and in the capacities indicated on August 7, 1998.
DST Systems, Inc.
/s/ Kenneth V. Hager
Kenneth V. Hager
Vice President and Chief Financial Officer
(Principal Financial Officer)
19