1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
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 000-22409
LHS GROUP INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 58-2224883
(STATE OR OTHER JURISDICTION OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
SIX CONCOURSE PARKWAY, SUITE 2700
ATLANTA, GEORGIA 30328
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(770)280-3000
(REGISTRANT'S TELEPHONE NUMBER)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant: (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
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
The aggregate market value of the Common Stock held by non-affiliates
of the registrant (assuming, for purposes of this calculation, without
conceding, that all executive officers and directors are "affiliates") was
$2,826,284,000 at March 20, 2000, based on the closing sales price of $47.875
per share for the Common Stock on such date on the Nasdaq National Market.
The number of shares of the registrant's Common Stock outstanding at
March 20, 2000 was 59,034,654.
2
DOCUMENTS INCORPORATED BY REFERENCE
The information called for by Part III will be included pursuant to
General Instruction G-3 of Form 10-K in an amendment to this Annual Report on
Form 10-K which will be filed with the Securities and Exchange Commission not
later than 120 days after December 31, 1999.
-2-
3
LHS GROUP INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
TABLE OF CONTENTS
ITEM PAGE
NUMBER NUMBER
- ------ ------
PART I
1. BUSINESS.................................................................................................4
2. PROPERTIES..............................................................................................15
3. LEGAL PROCEEDINGS.......................................................................................15
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.....................................................15
PART II
5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...................................16
6. SELECTED FINANCIAL DATA.................................................................................16
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...................17
7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..............................................28
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.............................................................28
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE....................29
PART III
10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......................................................30
11. EXECUTIVE COMPENSATION..................................................................................30
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..........................................30
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..........................................................30
PART IV
14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K..........................................30
SIGNATURES
-3-
4
PART I
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the matters discussed in this document and in documents
incorporated by reference herein may constitute forward-looking statements for
purposes of the Securities Act of 1933, as amended, and the Securities Exchange
Act of 1934, as amended, and as such may involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of LHS to be materially different from future results,
performance or achievements expressed or implied by such forward-looking
statements. The words "expect," "anticipate," "intend," "plan," "believe,"
"seek," "estimate," and similar expressions are intended to identify such
forward-looking statements. Our actual results may differ materially from the
results anticipated in these forward-looking statements due to a variety of
factors, including without limitation those discussed above in "Factors
Affecting Future Performance". All written or oral forward-looking statements
attributable to us are expressly qualified in their entirety by these
cautionary statements.
ITEM 1. BUSINESS.
INTRODUCTION
LHS Group Inc. ("LHS" or the "Company") provides client/server-based
billing and customer care, enhanced messaging and call routing, customer
acquisition and management, and other business and operations support solutions
to providers of wireless, wireline, satellite and data communications services
throughout the world. The Company was organized as a corporation under the laws
of the State of Delaware in 1995.
A majority of the Company's revenues are generated by two distinct
products lines - the Business Support and Control System ("BSCS") billing and
customer care solution and the Oryx enhanced services platform. The Company
also generates revenue from its InfoCell ConVerge customer acquisition solution
and various BSCS add-on modules and third party products. The Company's Business
Support and Control System ("BSCS") software, with its Targys architecture, and
add-on modules, such as the BSCS Advise decision support system, provide a
scaleable, modular billing and customer care solution that can be implemented
quickly and can support innovative marketing and pricing of communications
services. The Company's Oryx enhanced services platform is a scaleable and
modular solution that enables service providers to offer a variety of
value-added services, such as enhanced messaging, pre and postpaid calling, one
number and other enhanced routing services. The Company's ConVerge customer
acquisition solution is a client/server based solution that enables service
providers to manage customer acquisition, inventory, orders, cash, and
referrals. The Company is also a licensed distributor of Athene Software's
Advanced Predictive Technology ("APT") customer management platform, that, among
other things, enables service providers to predict customer churn or turnover
and recommends corrective action. The Company's products are used throughout the
world by more than 300 service providers that service more than 60 million
subscribers. Together, the Company's solutions provide a broad array of business
and operations support solutions for the global communications industry.
RECENT DEVELOPMENTS
On March 15, 2000, LHS and Sema Group plc, an English public limited
company ("Sema"), announced that they had entered into a Plan and Agreement of
Merger, dated as of March 14, 2000 (the "Merger Agreement"). The Merger
Agreement sets forth the terms and conditions of the proposed merger of LHS and
a wholly owned subsidiary of Sema, pursuant to which LHS will become a
subsidiary of Sema (the "Merger").
In the Merger, each currently outstanding share of LHS common stock
will be exchanged for American Depositary Shares that represent 2.6 ordinary
shares of Sema (the "Sema ADSs"). LHS shareholders may at their option elect to
receive ordinary shares of Sema instead of Sema ADSs. Sema intends to have the
Sema ADSs quoted on the Nasdaq National Market. The ordinary shares will trade
on the London Stock Exchange and the Paris Bourse.
-4-
5
LHS shares held by certain German stockholders, including LHS's
Chairman of the Board, Hartmut Lademacher, will remain outstanding. In certain
circumstances, these shares may be exchanged for Sema ADSs or Sema ordinary
shares on the same terms as provided in the Merger.
Completion of the Merger is subject to the satisfaction of various
conditions contained in the Merger Agreement, including: (1) the approval of
the Merger by the stockholders of both LHS and Sema; (2) the Securities and
Exchange Commission declaring effective a registration statement relating to
the Sema ADSs and ordinary shares that LHS stockholders will receive; (3) the
authorization of the listing of the Sema ADSs on the Nasdaq National Market;
(4) the authorization of the listing on the London Stock Exchange and the Paris
Bourse of any Sema ordinary shares issued to LHS stockholders in the Merger or
upon exchange of Sema ADSs; (5) the expiration of all applicable waiting
periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976; and (6)
the receipt of any required approval under applicable English or European Union
competition laws.
The Merger Agreement contains a $105 million termination fee, payable
to Sema upon certain circumstances described in the Merger Agreement. LHS has
also entered into an agreement granting Sema an option to purchase up to 17.5%
of its common stock (the "Stock Option Agreement"), which terminates at the
termination of the Merger Agreement.
Certain significant stockholders of both LHS and Sema, including
Chairman of the Board of LHS, Hartmut Lademacher, General Atlantic Partners and
France Telecom, have entered into stockholder voting agreements under which
they have agreed to vote their shareholdings in favor of the Merger.
INDUSTRY BACKGROUND
Communications Industry
For most of this century, telecommunications service providers around
the world provided wireline services in heavily regulated environments. Often
characterized by monopoly dominance, the telecommunications industry offered
basic telephony services and underwent little change. More recently, however,
the deregulation of the telecommunications industry coupled with the
development and widespread adoption of new wireless communications services,
such as paging, analog cellular, digital telephony, satellite communications,
the Internet and other fixed and wireless data technologies, and other emerging
communication technologies, has resulted in significant growth in the number of
new service providers and in the overall size of the communications services
market. As existing service providers attempt to maintain market share in their
traditional markets while simultaneously entering new markets, and as new
entrants seek to capture market share in emerging markets, communications
markets worldwide have become increasingly competitive and dynamic.
Governments around the world continue to relax regulatory constraints
on the communications industry. Within the United States, deregulation
commenced in the long distance market with the breakup of AT&T in 1984 and the
subsequent entry of additional long distance service providers. In 1994, the
U.S. government similarly allowed new competitors to enter the cellular
industry by auctioning significant radio spectrum for digital telephony, PCS
and other services to new service providers. More recently, the
Telecommunications Act of 1996 has increased competition across U.S. markets by
allowing new and existing local and long distance wireline, wireless and cable
TV companies to provide competing services. New radio spectrums will be
auctioned for emerging technologies such as G3, UMDS and MMDS. Although the
Telecommunications Act of 1996 and new radio spectrum used for various wireless
technologies has not increased competition to the extent anticipated when the
Act was passed, as a result of deregulation, the number of communications
service providers in the U.S. market has increased and is expected to continue
to increase.
Outside the United States, deregulation, privatization, and new
operating licenses are also resulting in the emergence of new service
providers, increased competition and the broader availability of communications
services. The general trend toward deregulation and the adoption in 1996 of
less stringent uniform regulatory schemes within wireline markets of the
European Union, Latin America and Asia, along with continued growth in
European, Latin American, and Asian wireless markets, are expected to increase
the number and types of services offered and to intensify competition within
wireless and wireline markets across Europe. New licenses continue to be
offered for various competitive offerings throughout the world.
-5-
6
In conjunction with deregulation, advances in telecommunications
technology have stimulated the growth in the number and types of communications
service providers. In the wireless sector, the trend in technology has been to
migrate from analog to digital, and to wireless data, with digital technologies
promising service providers and consumers lower infrastructure costs, greater
privacy, fraud protection and new, enhanced features. Most established service
providers using older analog cellular standards such as AMPS (Americas and
Asia), NMT (Europe and Asia) and TACS (Europe) are building new networks that
utilize digital standards. Although the GSM digital standard and its
derivatives have gained widespread acceptance and continue to expand,
particularly among service providers in Europe and Asia, other digital
telephony and PCS standards such as TDMA (U.S.) and CDMA (U.S., Canada and
Asia) are being deployed rapidly. A more recent trend in wireless technology
has been to offer wireless data transmission services. These rapid changes in
telecommunications technology have created significant market opportunities for
new and existing service providers, resulting in greater competition and a
wider range of service offerings for consumers.
During 1999, the global communications market experienced increasing
consolidation on both a national and international basis with new and larger
multi-national service providers such as Vodafone Airtouch. Within the United
States, service providers offering common services have merged to form
nationwide wireless networks. These new, larger service providers present
opportunities to support very large subscriber bases and to implement
technologies that can enable the consolidated service providers to migrate from
several billing, customer care and enhanced services platforms to unified,
enterprise-wide technologies.
As competition intensifies, communications service providers
increasingly differentiate their service offerings, not only on the basis of
pricing and reliability, but also by offering value-added features, bundling
multiple services and marketing innovative, targeted rate and service plans.
Service providers are utilizing technology advancements to compete by offering
service features in addition to basic telephony, including voice mail, call
forwarding, caller identification, fax and data transmission. As service
providers established in one market attempt to enter other formerly distinct
markets in wireline, wireless, satellite and Internet services, many are
bundling multiple services into convergent offerings to retain existing
customers and to attract new customers. Increasingly, service providers are
relying on innovative marketing of rate and service plans to successfully
segment and attract potential customers.
To compete effectively, communications service providers require
business systems that enable innovative and flexible marketing and support
multiple service offerings. These systems, which provide billing, customer care
and management, and enhanced services, have become critical to the business
success of service providers. Business support systems are no longer
back-office operations. Service providers today demand that their support
systems provide innovative and flexible marketing of services, robust customer
management capabilities, subscriber data and feedback and service plan
flexibility in addition to the rating, invoicing and collection features
provided by yesterday's billing systems. Increasingly, business support systems
are deployed by service providers as a strategic business weapon.
Business and Operations Support Systems
Billing and support systems for telecommunications services were first
developed to meet the needs of large monopoly service providers that offered
fixed line voice service, and offered a simple, single-service billing
function, including rate tariffing and invoicing. These systems lacked advanced
customer care functionality, which typically provides the initial establishment
and management of customer accounts, assignment of phone numbers, service
selection and provisioning, issuance and reporting of calling card usage,
maintenance of customer history, directory listings, and generation and
management of marketing feedback. While sufficient for the regulated
environment in which service providers then operated, these early billing
systems typically were mainframe-based, were built around proprietary, closed
hardware and software platforms, and were inflexible and costly to maintain.
The rapid advance of communications technology and the introduction of
new wireless and data technologies, the deregulation of markets around the
globe and the increasing importance of reducing time-to-market have motivated
communications service providers to install, maintain and update advanced
business support systems. These systems are essential for both existing and
emerging service providers to compete effectively as they seek to introduce new
services, enter new markets and offer a high level of customer service. In some
cases, service
-6-
7
providers may choose to outsource the fulfillment of these activities to
service bureaus for financial or other business reasons. Regardless of whether
service providers rely on a purchased solution operated internally or on an
outsourced solution from a service bureau provider, a strong market opportunity
exists for a billing, customer care and management, and enhanced services
solutions that provide the following benefits:
Flexibility. Communications service providers need billing and
customer care, enhanced services and other business support solutions
that enable innovative, sophisticated and dynamic marketing and pricing of
multiple communications technologies and services, payment options, and
management of their customer relationships. They also need solutions that are
based on open technology standards for easy integration of third party software
and different networks, including wireline, wireless, satellite and data
networks.
Rapid Time-to-Market. Service providers entering new markets for
telecommunications services place a significant premium on rapid launch of
services. Thus, they require solutions that can be implemented quickly.
Proven Track Record. With little margin for error in a very
competitive environment, communications service providers seek billing, customer
care and management, enhanced services, and other business support solutions
with a proven track record and capable of uninterrupted operation to minimize
deployment risk during the critical launch of new services and to ensure the
availability of services once launched.
Scaleability. Service providers seek solutions that will scale with
subscriber growth to avoid service disruption and to minimize recurring staff
training and support system investments.
Multiple Service Support. As established service providers enter new
markets, business support solutions must support multiple communications
services and standards. Solutions supporting wireline, wireless, data and
satellite offerings enable innovative marketing of multiple services that
require centralized customer billing.
International Support. As service providers enter new geographic
markets, their business support solutions must increasingly support multiple
languages and currencies while providing consistent functionality across
diverse market environments.
Access to Customer Information. In the increasingly competitive market
for communications services, rapid access to customer information and effective
customer service is a top priority to communications service providers.
THE LHS SOLUTIONS
The Company believes that it currently meets, and will continue to
meet, the needs of a wide variety of service providers with BSCS, Oryx,
InfoCell ConVerge, and its complimentary software products, and the Company's
broad range of customization, installation and maintenance services.
The LHS solutions offer the following features and benefits:
- Flexible Solutions. LHS solutions can be tailored to each
service provider's particular needs in order to keep pace with
a highly competitive, dynamic market for communications
services. For instance, BSCS enables service providers to
dynamically update rate and pricing plans tailored to time of
day, day of week, previous usage levels, call destinations,
credit characteristics and numerous other marketing
parameters. BSCS also allows service providers to rate based
upon events, duration, volume of usage, location, time of day,
and quality of service. Oryx enables service providers to
offer a variety of enhanced services such as pre-paid calling,
one number, and advanced messaging services. Service providers
can initially purchase small systems and selected enhanced
services applications and later grow their systems into very
large, fully redundant systems that include a broad range of
enhanced services that work seamlessly with their existing
networks and services.
- Open Architecture. LHS solutions utilize open architectures
that support multiple hardware platforms and operating
systems, enabling service providers to benefit from continued
advances in
-7-
8
technology. LHS solutions also support multiple wireline,
wireless and data technologies. As a packaged application
customized to meet the needs of each particular customer, LHS
solutions offer service providers rapid installation relative
to complete custom solutions and are more flexible than
in-house legacy mainframe solutions. LHS' open architectures
enable efficient integration of LHS solutions with leading
financial, human resources, operational and other third party
software applications.
- Modular Configuration. The LHS solutions offer service
providers efficient, rapid customization and cost effective
implementation. The Company's modular architectures provide
service providers with the flexibility to modify or add
applications with little or no impact to existing LHS
applications. This allows service providers to easily tailor
LHS solutions to meet their unique system requirements.
- Multiple Services and Network Technology Support. LHS
solutions support and interface with multiple
telecommunications technology standards with minimal
modification to the software. LHS solutions currently support
the GSM, CDMA, TDMA, iDEN, LDMS, MMDS, and AMPS wireless
standards, as well as various satellite, wireline, paging, and
data standards.
- Comprehensive International Solutions. LHS solutions support
multiple currencies and the requirements of different
geographic markets. LHS solutions currently are installed in
more than 70 countries and support multiple languages,
including Czech, Chinese, English, French, German, Hebrew,
Indian, Italian, Japanese, Korean, Polish, Portuguese, Russian
and Spanish.
- More Reliable Replacement. For established service providers
with maturing legacy systems, the challenge is to upgrade to a
more competitive system without putting their existing
investment at risk. LHS provides smooth and reliable
replacement of legacy systems with its new Targys technology.
The Targys object-oriented applications increase efficiencies
in workflow through faster customization and dedicated
solutions. Migration to enhanced customer care and billing
solutions like BSCS is easier and less expensive with the
Targys technology.
- Higher Profits Per Subscriber. As competition continues to put
pressure on subscription revenues, communications service
providers want to improve the average profit earned from each
subscriber. Service providers offer value-added services and
service bundles to increase their profit per subscriber. With
the Company's Oryx product suite, service providers get a
broad range of features and applications such as prepaid
calling, credit/debit-card calling, call routing and enhanced
messaging available in a single platform. With BSCS, service
providers can now rate and bill for data services based on
events, usage locations, time of day and quality of service.
- Getting Closer To The Customer. Quality customer service
requires detailed customer knowledge. The combination of LHS'
BSCSAdvise decision support system and Athene Software, Inc.'s
Advanced Predictive Technology ("APT") product suite provides
a powerful way to extract BSCS customer information into
datamarts for faster and more potent analysis of customer
behavior.
- Complete Customer Services. In addition to software, the
Company provides service providers with complete solutions,
including initial customization and installation and ongoing
maintenance, upgrades and customer support. The Company offers
ongoing maintenance and customer support at varying levels of
service and pricing designed to meet the needs of the service
provider.
THE LHS STRATEGY
The Company's vision is to be the leading billing, customer care and
management, and operations support system provider to the global communications
industry. The Company's strategies include:
-8-
9
- Remain a Market Leader in Billing and Customer Care and
Enhanced Services Solutions. LHS currently has a significant
installed base of wireless, wireline and satellite customers
utilizing the BSCS billing and customer care system and its
Oryx enhanced services platform. The Company intends to
leverage its experience and broad customer base to compete for
new billing and customer care and enhanced services
installations worldwide.
- Become the Market Leader in Business Support Solutions for the
Convergent Communications Services Industry. The Company
believes there is a significant market opportunity to leverage
its position as a leading provider of client/server-based
billing and customer care and enhanced services solutions, to
become the market leader in comprehensive business support
solutions for the growing number of service providers who
offer multiple communications services.
- Become the Leading Provider of Data and IP Business Support
Solutions. Version 5.3 of LHS' BSCS billing and customer care
system includes functionality to support data services GPRS,
LMDS, MMDS and U-NNI Band, and Internet services (e-mail, web
browsing, web hosting and newgroups). In June 1999, the
Company announced a strategic alliance with XACCT
Technologies, Inc., the developer of the XACCT Usage metering
and mediation solution for IP networks in order to develop
usage-based IP billing solutions for the global communications
industry. In the first quarter of 2000, the Company announced
a strategic alliance with Portal Software, Inc. to deliver a
best-of-breed solution to support wireless Internet services.
Through a combination of continuing to develop functionality
in its own software products and strategic alliances with
companies that offer complimentary technologies, the Company
will pursue its strategy to become the leading provider of IP
billing and support systems.
- Expand Globally. LHS intends to continue expanding its
marketing focus to be well-positioned for global growth in
demand for business and operations support systems for
communications services providers. The Company will continue
to deploy software development, sales, service and management
resources to its regional offices in Frankfurt, Germany;
Atlanta, Georgia, United States; and Kuala Lumpur, Malaysia,
and various local sales and project offices within the three
regions, and will continue to customize its products to
support additional languages and currencies. Toward this end,
in early 2000, the Company signed an agreement to jointly
pursue the mainland China market with its long time partner,
Alcatel.
- Expand Product and Services Offerings. Through a combination
of in-house development, technology alliances such as the
current XACCT, Athene and Portal agreements, and strategic
acquisitions like the Priority Call transaction in 1999 and
the InfoCellular transaction in 1998, the Company intends to
continue to expand its product and services offerings to meet
the growing and changing needs of communications service
providers.
- Develop and Maintain Customer Relations. The Company believes
that the development of long-term customer relations will
result in repeat business, a strong reputation for the Company
within the global communications industry and opportunities
for future product development. As a means to develop and
maintain good customer relations, LHS holds management,
consulting and sales staff accountable for the quality of
relations with specific customers, each of which is assigned a
dedicated contact person within the Company.
- Leverage Third-Party Relationships. The Company seeks to
maintain its relationships with leading systems integrators
such as Andersen Consulting, Electronic Data Systems
Corporation ("EDS"), Cap Gemini, and Logica, leading vendors
of telecommunications equipment, such as Ericsson,
-9-
10
and international telecommunications service providers, such
as Telecom Italia Mobile, Bell Atlantic Global Wireless,
France Telecom, and Vodaphone Airtouch. Many of these systems
integrators, equipment vendors and international service
providers operate on a global basis across wireless, wireline
and other communications technology lines, and the Company
expects these relationships to facilitate the Company's
penetration of non-wireless and non-European markets. The
Company also seeks to maintain its relationships with
technology partners such as XACCT Technologies, Portal
Software and Athene Software and expects these relationships
to facilitate the Company's penetration of the data and
Internet communications market and the growing customer
management solutions market.
PRODUCTS
The Company derives most of its revenues from sales of its BSCS
software product and its Oryx enhanced services platform, and related services
to implement and support these products. A small percentage of the Company's
revenues are derived from its other software products such as Infocell ConVerge
and BSCS add-on modules such as the BSCSAdvise decision support system, the VMD
vendor mediation device, and the Targys-based Web Service Center.
BSCS
BSCS is structured in a kernel/non-kernel hierarchy: the kernel
comprises the set of core software modules common to all BSCS configurations,
while non-kernel modules primarily provide interface functions. Kernel and
non-kernel modules can be customized to meet individual carrier requirements.
Kernel and non-kernel software modules are organized as follows:
Customer Care Administration - This module enables carrier customer
service representatives to establish and maintain subscriber contact by
creating and maintaining account information that tracks initial service
requests from service activation and through service termination. This module
also supports registration of the customer data, maintenance of subscriber
service and feature profiles, provisioning, sales of services and equipment,
administration of contracts, initiation of on-demand bills, complaint tracking,
adjustment processing and bill and payment inquiries. The Company's BSCS
products provide a customer service feature that enables carrier service
representatives to quickly make a variety of changes to a customer's account
with a few simple keyboard strokes. These include adding discount or promotion
plans, credit or debit adjustments to multiple accounts at once, based on
specific selection criteria such as rate plans, service, and customer groups.
The functionality included in the customer administration modules (as
well as additional functionality) is being introduced in the Targys customer
care client applications, such as the Targys Customer Inquiry application
introduced in 1999.
Network Resource Administration - After a customer service
representative has initiated a subscriber's account, this module assigns
subscribers a telephone number. This module also maintains an inventory of
network resources, including telephone numbers and network devices. BSCS
monitors the level of network resource inventory and distributes the resources
to sales channels.
Carrier Administration - The customer service representative uses this
Carrier Administration module to assign a long distance carrier. In addition,
this module provides roaming agreement maintenance, generates roaming bills,
enables reconciliation of incoming roaming calls and supports long distance
interconnect traffic settlement.
Services and Tariffs Administration - This module allows a carrier to
develop innovative marketing and billing plans through use of tariff tables for
multiple services which can reflect usage-sensitive or flat rate charging. This
module enables service-specific usage, one-time and recurring charges, volume
and free usage discounting, rate plan queries, processed calls monitoring,
tailored tariffing, roaming charges and competitor tariff analysis.
Event Processing - This module allows service providers to rate calls
as subscriber call records are received. Validation and pricing of call detail
records are performed in this module, which also provides on-line
-10-
11
monitoring of credit limits and customer rate plan optimization. The module has
been designed to provide near real-time rating over an entire subscriber base.
Bill Processing - This module processes bills by calculating all bill
charges and creating the services invoice on a periodic basis. Key functions
include tax calculation, discounting, late fee calculations, invoice
scheduling, general ledger postings and revenue reporting. The module supports
multiple currencies and multiple languages. BSCS also provides a revenue
assurance feature that permits the carrier to track the processing of all data
applicable to a bill to ensure charges are billed correctly.
Financial Administration - This module reconciles billing with a
service provider's financial records and statements and handles payments from
customers. Payment processing, accounts receivable and this module enables
general ledger posting activities. Payments may be made via cash, credit card,
direct debit or lock-box bank transfer. The module also supports advance
payments, deposits, bad debt write-offs, adjustments, corrections and account
query. Delinquent accounts can be automatically identified as suspended,
deactivated, or written-off. A sales administration function maintains sales
force data and enables sales tracking for commission processing.
Customizable Interface Modules - A number of customizable non-kernel
interface modules are included within BSCS to enable close integration with a
service provider's network and business infrastructure. These non-kernel modules
are organized as follows: Call Record Input, which receives, edits,
authenticates and formats call detail records into a standard event record that
can be used in downstream BSCS functions such as event and bill processing;
Activation, which activates, deactivates and modifies a subscriber's equipment
and services at the switch; Authentication, which provides an interface to a
central repository of subscriber authentication keys used in a validation
algorithm to determine whether a subscriber should have network access; Payment
Processing, which encompasses the acceptance, validation, and automated entry of
payments and Bill Formatting, which provides service providers with the
flexibility to define their own bill format, printing and delivery mechanisms.
ORYX
LHS offers an enhanced services solution through its Oryx platform.
Enhanced services are services, in addition to traditional telephone service,
that improve the efficiency and effectiveness of telecommunications, such as
messaging, prepaid calling and one number services. The following features
distinguish the Oryx enhanced services platform from other enhanced services
solutions:
Scaleability. The Oryx platform is expandable. Scaleability is an
important feature because it allows LHS to provide service to service providers
with any size subscriber base and later adjust for increases in the number of
subscribers.
Modularity. LHS offers its enhanced services through individual
software applications. As a result, service providers can purchase the software
applications for the enhanced services they initially require and purchase
further software applications as the need arises.
Reliability. The Oryx platform offers back-up systems with automatic
switchover so that no single failure will interrupt the service.
As a result of the features listed above, service providers can
initially purchase small systems and selected enhanced services software
applications and grow their systems into very large, fully redundant systems
that include a broad range of enhanced services that work seamlessly with their
existing networks and services.
The Company offers a variety of software applications that run on the
Oryx platform. The software applications provide service providers with the
opportunity to offer the following services:
Enhanced Messaging Services. Enhanced messaging services provide
subscribers the opportunity to manage their messages more efficiently. For
example, subscribers can:
- Access and manage messages from any telephone;
- Store and forward messages with urgent or confidential labels;
-11-
12
- Utilize the services of an automated attendant;
- Return messages from voice mail with one key call return;
- Unify the numbers and accounts for faxes and voice mail; and
- Receive short messages over digital handsets, including caller
name, pages, emails and text messages.
Enhanced messaging service provides an additional source of revenue
for service providers, helps service providers attract and retain subscribers
and, because it increases the number of completed calls, increases revenues from
existing usage.
Prepaid and Debit Calling. Prepaid calling and debit calling offer
subscribers an alternative payment method. By offering prepaid calling and
debit calling, service providers can expand their subscriber base to include
budget-conscious individuals, such as students and business travelers, and
subscribers who previously did not meet minimum credit requirements.
One Number Service. One number service links subscribers' wired and
wireless telephones, pagers, and messaging devices to a single number. This
eliminates the need for callers to dial different numbers to reach subscribers
at various locations. One number service provides service providers with an
additional source of revenue, increases the percentage of calls that are
completed and helps service providers attract and retain subscribers.
Internet Personal Communications Management. Internet personal
communications management allows subscribers to manage calls and messages on
their personal computers. By using their mouse, subscribers can:
- Listen to voice messages;
- View and print faxes;
- Place calls; and
- Send voice or fax messages as email attachments.
LHS also offers software applications that integrate voice recognition
with other enhanced services permitting subscribers to dial and manipulate
other enhanced services with voice commands.
INFOCELL CONVERGE
InfoCell ConVerge is a client/server based customer acquisition and
point-of-sale application. InfoCell ConVerge includes functionality for
customer acquisition, inventory management, order interfaces, cash management,
reference management and inventory management.
SERVICES
The Company derives significant revenues from project consulting
undertaken to customize and support its solutions for particular service
providers. For BSCS, LHS offers service providers the choice of initial
installation directly from the Company or through leading systems integrators,
including Andersen Consulting, Cap Gemini, EDS and Logica plc. The first phase
of a project typically consists of an analysis to identify and specify BSCS
system tailoring requirements and to define the overall project and budget. The
second phase involves customization to modify BSCS non-kernel modules to meet
the resulting system specifications for that customer. The resulting custom BSCS
solution is then tested and installed in the carrier's information and
telecommunications infrastructure. Project duration, from initial analysis
through implementation and acceptance, typically ranges from six to twelve
months. The Company typically implements its Oryx enhanced services platform
and InfoCell ConVerge customer acquisition solution without the involvement of
third party systems integrators. As of December 31, 1999, the Company employed
631 projects and services personnel compared to 520 at December 31, 1998.
After installation, the Company maintains close contact with the
customer, even in projects implemented through a systems integrator. LHS
holds management, consulting and sales personnel accountable for the quality of
relations with specific customers, by assigning a consulting and sales contact
to each customer, and through control
-12-
13
over upgrades and maintenance. As a result, the Company is often well positioned
to earn substantial revenues from additional customization of its solutions
after installation. The Company also generates additional revenues from
maintenance agreements as a carrier's subscriber base and service offerings
continue to grow and expand.
The total value of an initial contract for BSCS software and services
typically ranges from $1 million to $5 million, depending on the size of the
customer, the number of the subscribers serviced by the customer, the number and
type of telecommunications services supported by BSCS and the scope of
customization and installation requirements. The total value for an initial Oryx
installation typically ranges from $500,000 to $2 million, depending on the
number of systems purchased, the system configuration, and services to be
offered by the carrier. Maintenance pricing is based on the level of service
desired by the customer and is calculated as a percentage of the BSCS license
fee or total Oryx product cost paid as of the beginning of each annual
maintenance period.
PRODUCT DEVELOPMENT
The Company directs its product development efforts toward refining and
enhancing BSCS and Oryx. Significant emphasis is placed on the Company's
compliance with world-wide development standards and quality benchmarks during
product development. To this end, in 1998, the Company's technology group
received worldwide ISO 9001 certification and in 1999, LHS Priority Call
received ISO 9001 certification.
During 1999, the Company introduced the first applications that utilize
its new Targys object-oriented technology and BSCS Version 5.3. BSCS 5.3 added
functionality to support the GPRS, LMDS, MMDS and U-NNI Band wireless data
technologies, Internet services, such as e-mail, web browsing, web hosting and
newsgroups, and long distance. BSCS 5.3 also added functionality to allow
service providers to rate based upon events, duration and volume of usage,
location, time of day and quality of service.
Some of the Company's short-term focus areas for development are IP
and wireless data technologies, unified messaging, local number portability,
dual-mode handsets, call analysis and customer management. The Company will
continue to utilize available technology to provide its clients and integrators
with the best solutions. In keeping with that philosophy the Company adheres to
an open interface strategy and continues to endorse object oriented programming
technologies. The Company's development staff consisted of 637 employees as of
December 31, 1999, compared to 442 employees as of December 31, 1998. See "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Factors Affecting Future Performance-We must adopt to changes in
technology, products, industry standards and customer needs."
MARKETING AND SALES
The Company's marketing efforts are focused on targeting key service
providers in each geographical market through advertising in communications
industry publications, participation in trade shows, presentations at technical
conferences and other initiatives. The Company relies on direct and indirect
channels of distribution for its products. Its direct sales approach develops
relationships with service providers through a consultative, problem-solving
sales process and works closely with service providers to define and determine
how their needs can be fulfilled by the Company's products. The Company had a
sales organization of 156 employees as of December 31, 1999 compared to 92
employees as of December 31, 1998, and intends to expand its direct sales
operations at various locations, including Frankfurt, Germany; Milan and Rome,
Italy; Stockholm, Sweden; Atlanta, Miami and Boston, United States; Zurich,
Switzerland; Kuala Lumpur, Malaysia; Hong Kong, China; New Delhi, India, and Sao
Paulo, Brazil. Due to the sophisticated nature of the Company's products and
services, the duration of a sales cycle can range from as short as thirty days
to as long as one year or more. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Factors Affecting
Future Performance."
Because third parties play an important role in the general deployment
of information technology with service providers, the Company has developed a
number of indirect sales channels. These indirect channels, through systems
integrators and telecommunications equipment vendors, are built on
relationships and references developed through cross-selling and
problem-solving. LHS markets its products through a number of systems
integrators and equipment manufactures, particularly for systems serving larger
service providers. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Factors Affecting Future
Performance -- Our success is dependent on our relationships with consulting
firms and systems integration firms."
CUSTOMERS
The Company's products have been licensed to approximately 317 service
providers in more than 70 countries, and supports a total of approximately 60
million subscribers. Much of the Company's early growth was accomplished by
focusing on GSM-based wireless service providers in Europe. LHS plans to
continue expanding
-13-
14
beyond the European wireless market and to serve wireless, wireline and IP
service providers around the world. LHS also plans to expand the market for its
Oryx and InfoCell ConVerge products in Europe, Asia and Latin America.
The Company had no customers that accounted for more than ten percent
of its total revenues in 1999.
COMPETITION
The markets for billing and customer care and enhanced services systems
are highly competitive, and the Company expects this competition to increase.
The Company competes with independent providers of billing systems and services,
such as AMDOCS, Inc. ("AMDOCS"), Kenan Systems Corporation ("Kenan") (now a
wholly-owned subsidiary of Lucent Technologies Inc.), Convergys Corporation,
Kingston-SCL and SEMA Group plc, with systems integrators and with internal
billing departments of larger telecommunications service providers. The
Company's principal competitors in the enhanced services market are Comverse
Technology Inc., Brite Voices Sytems, Inc., Glenayre Electronics, Inc. and
Logica plc. The Company expects to continue to encounter substantial competition
from its existing competitors and that additional competitors will enter the
market.
The principal competitive factors in the Company's market include
responsiveness to service providers' needs, timeliness of implementation,
quality and reliability of products, price, project management capability and
technical expertise. The Company believes that its ability to compete depends
in part on a number of competitive factors, including the development by others
of software that is competitive with the Company's products and services, the
price at which others offer competitive software and services, the extent of
competitors' responsiveness to customer needs and the ability of the Company's
competitors to hire, retain and motivate key personnel. The Company competes
with a number of companies that have longer operating histories, larger
customer bases, substantially greater financial, technical, sales, marketing
and other resources, and greater name recognition than the Company. Current and
potential competitors have established, and may establish in the future,
cooperative relationships among themselves or with third parties to increase
their ability to address the needs of the Company's prospective customers.
Accordingly, new competitors or alliances among competitors may emerge and
rapidly acquire significant market share. As a result, the Company's
competitors may be able to adapt more quickly than the Company to new or
emerging technologies and changes in customer requirements, or to devote
greater resources to the promotion and sale of their products. There can be no
assurance that the Company will be able to compete successfully with existing
or new competitors. Failure by the Company to adapt to emerging market demands
and to compete successfully with existing and new competitors could have a
material adverse effect on the Company's business, results of operations and
financial condition.
In addition, as the Company expands, it will market its products and
services to service providers in markets not currently served by the Company.
Upon its entrance into these markets, the Company may encounter new
competitors, many of which have significantly greater financial, technical,
personnel and marketing resources than the Company. There can be no assurance
that the Company will be able to properly identify and address the demands for
these new markets or that the Company can continue to be competitive in its
current markets Failure by the Company to maintain its competitiveness in
current or new markets could have a material adverse effect on the Company's
business, results of operations and financial condition. See "Part II, Item 7,
Factors Affecting Future Performance -- The telecommunications billing and
customer care systems industry is very competitive."
PATENTS, INTELLECTUAL PROPERTY RIGHTS, AND LICENSES
The Company currently holds a total of four United States patents.
While the Company files patent applications periodically, no assurance can be
given that patents will be issued on the basis of such applications or that, if
patents are issued, the claims allowed will be sufficiently broad to protect
the Company's technology. In addition, no assurance can be given that any
patents issued to the Company will not be challenged, invalidated or
circumvented or that the rights granted under the patents will provide
significant benefits to the Company.
In order to safeguard its unpatented proprietary know-how, trade
secrets and technology, the Company relies primarily upon a combination of
statutory and common law copyright, trademark, trade secret protections and
non-disclosure provisions in agreements with employees and others having access
to confidential information.
-14-
15
There can be no assurance that these measures will adequately protect the
Company from disclosure or misappropriations of its proprietary information.
The Company and its customers from time to time receive communications
from third parties, including some of the Company's competitors, alleging
infringement by the Company of such parties' patent rights. While such
communications are common in the computer and telecommunications industries and
the Company has in the past been able to obtain any necessary licenses on
commercially reasonable terms, there can be no assurance that the Company would
prevail in any litigation to enjoin the Company from selling certain of its
products on the basis of such alleged infringement, or that the Company would
be able to license any valid patents on reasonable terms.
The Company licenses certain technology, know-how and related rights
for use in the manufacture and marketing of its products, and pays royalties to
third parties under such licenses and under other agreements entered into in
connection with research and development financing. The Company believes that
its rights under such licenses and other agreements are sufficient for the
manufacturing and marketing of its products and, in the case of licenses,
extend for periods at least equal to the estimated useful lives of the related
technology and know-how.
The Company believes that because of the rapid pace of technological
change in the communication and software industries, the legal protections for
its products are less significant factors in the Company's success than the
knowledge, ability and experience of the Company's employees and the timeliness
and quality of support services provided by LHS. See "Part II, Item 7,
Affecting Future Performance - We have only limited protection of our
proprietary rights and technology."
EMPLOYEES
As of December 31, 1999, the Company employed a total of 1,589
employees. None of the Company's employees are represented by a labor union.
The Company has experienced no work stoppages and believes that its employee
relations are good.
ITEM 2. PROPERTIES
LHS leases office space in Atlanta, Miami, Boston and San Francisco,
United States; Frankfurt, and Ulm, Germany; Paris, France; Milan, Italy; Kuala
Lumpur, Malaysia; Stockholm, Sweden; Zurich, Switzerland; New Delhi, India; Sao
Paulo, Brazil; and Hong Kong, China. The Atlanta, Boston, Miami, Zurich, Ulm,
Milan, and Frankfurt offices are also used for software development, and the
Atlanta office is the Company's corporate headquarters. The Company believes
that its facilities are adequate for its current needs and that suitable
additional space will be available as required.
ITEM 3. LEGAL PROCEEDINGS
The Company from time to time is subject to claims in legal
proceedings arising in the ordinary course of business. There are currently no
such claims that individually or in the aggregate are believed by management to
pose any material risk to its business or financial condition.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the
fourth quarter of the Company's fiscal year ended December 31, 1999.
-15-
16
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
LHS' common stock began trading on the Nasdaq National Market on May
16, 1997 under the symbol "LHSG". The common stock began trading on the
Frankfurt Neuer Market Exchange on May 21, 1997 under the symbol "LHI." The
following table sets forth, for the fiscal quarters indicated, the high and low
sales prices of LHS' common stock as reported by Nasdaq. As of March 20, 2000,
LHS had 59,034,654 shares outstanding. There were 53 holders of record of the
Company's common stock on March 20, 2000.
1999 High Low
---- ---- ---
First Quarter $59.13 $28.63
Second Quarter $37.50 $25.50
Third Quarter $39.75 $29.19
Fourth Quarter $36.38 $21.00
1998 High Low
---- ---- ---
First Quarter $50.38 $25.50
Second Quarter $73.75 $44.50
Third Quarter $76.50 $43.94
Fourth Quarter $57.38 $36.75
The Company has not declared or paid any cash dividend on its common
stock since 1994. The Company currently intends to retain its future earnings,
if any, to fund the development and growth of its business and therefore does
not intend to pay any cash dividends in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
YEARS ENDED DECEMBER 31,
1999 1998 1997 1996 1995
(in thousands, except per share data)
CONSOLIDATED STATEMENT OF INCOME DATA $262,596 $194,118 $125,522 $67,899 $33,241
Total revenues.............................. 56,778 31,099 15,350 4,025 1,246
Earnings before interest and taxes..........
Net earnings per share:
Basic.................................. $0.67 $0.33 $0.22 $0.06 $0.01
Diluted................................ $0.65 $0.32 $0.20 $0.05 $0.01
CONSOLIDATED BALANCE SHEET DATA
Total assets................................ $280,562 $210,324 $141,930 $56,069 $29,851
Long-term obligations....................... 985 2,772 1,245 1,693 420
Total stockholders' equity.................. 208,018 155,755 100,948 21,481 13,886
- ---------------
(1) See Note 2 of the Notes to Consolidated Financial Statements.
(2) The 1998 amount includes a one-time charge relating to the write off of
in-process research and development of $8.2 million.
(3) The 1999 amount includes merger costs totaling $4.3 million relating to
the Priority Call merger.
-16-
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
OVERVIEW
On June 10, 1999, the Company completed its merger with Priority Call
Management, Inc. ("PCM"), in which PCM became a wholly owned subsidiary of LHS
Group Inc. The Company exchanged shares of Common Stock for all the outstanding
common shares, preferred shares, and stock options or stock appreciation rights
in PCM. The merger was accounted for under the pooling-of-interests method of
accounting and, accordingly, the accompanying financial statements and
footnotes have been restated to include the operations of PCM for all periods
presented. The Company recorded a charge of $4.3 million in the second quarter
ended June 30, 1999 related to direct external costs incurred as a result of
the merger with PCM. PCM is a provider of network-based solutions that enable
telecommunications providers to offer subscribers a range of enhanced services,
including prepaid calling, credit/debit card calling, enhanced messaging and
one-number "follow-me" services.
In June 1998, the Company acquired the stock of Infocellular, Inc.
("InfoCellular") for $8.5 million, paid by the issuance of 117,885 shares of
Common Stock and $1.3 million in cash. InfoCellular, which operates as a
wholly-owned subsidiary of the Company, is engaged in the business of providing
point of sale and customer acquisition software and related services to
telecommunication service providers.
This acquisition was accounted for under the purchase method of
accounting and in accordance with Accounting Principles Board Opinion No. 16,
"Accounting for Business Combinations." The Company allocated the cost of the
acquisition to the assets acquired and the liabilities assumed based on their
estimated fair values using valuation methods that were appropriate at the
time. The acquired intangible assets included in-process technology projects,
among other assets, which were related to research and development that had not
reached technological feasibility and for which there was no alternative future
use. The Company recorded a one time charge relating to the write-off of
in-process research and development of $8.2 million for the year ended December
31, 1998, in accordance with applicable accounting pronouncements.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
REVENUES. Total revenues increased 35.3% to $262.6 million in the year
ended December 31, 1999 from $194.1 million in the year ended December 31,
1998. License revenues increased 38.5% to $108.8 million in 1999 from $78.6
million, while service revenues increased 33.1% to $153.8 million from $115.6
million for the same period. Total revenues increased primarily due to the
addition of new customers and license revenue from subscriber growth of
existing customers and increased implementation and support revenue from
existing customers.
License revenues increased as a percentage of total revenues to 41.4%
in 1999 from 40.5% in 1998, while service revenues decreased as a percentage of
total revenues to 58.6% from 59.5% for the same period. This change in mix of
revenues is primarily due to the timing of recurring license revenue from
subscriber growth experienced by existing customers, the completion of
implementation work for existing customers and the start of implementation work
for new customers.
No individual customer accounted for more than 10% of total revenues
in 1999.
COST OF SERVICES. Cost of services decreased as a percentage of total
revenues to 34.0% in the year ended December 31, 1999 from 38.5% in the year
ended December 31, 1998. Costs of services increased 19.5% to $89.4 million in
1999 from $74.8 million in 1998, primarily due to compensation expense
associated with increased staffing for new projects in Europe, the Americas and
Asia. This increase was partially offset by an increase in the productivity and
efficiency of the implementation and services functions. Cost of services
consists primarily of salaries and benefits of those employees associated with
the installation of software products and other product support activities. It
also includes third-party costs associated with systems integrators, hardware
costs and costs related to providing software maintenance and end-user training
to customers.
SALES AND MARKETING. Sales and marketing expenses increased as a
percentage of total revenues to 11.6% in the year ended December 31, 1999 from
10.0% in the year ended December 31, 1998. Sales and marketing expenses
-17-
18
increased 56.8% to $30.5 million in 1999 from $19.5 million in 1998. The
increase in sales and marketing expenses was principally due to the growth in
the number of worldwide sales and marketing personnel responsible for developing
business, particularly in Europe, Asia and Latin America and increased
participation in trade shows and other worldwide marketing activities. Sales and
marketing expenses consist primarily of the salaries, benefits and travel
expenses of those employees responsible for acquiring new business and
maintaining existing customer relationships, as well as marketing expenses
related to trade publications, advertisements and trade shows.
RESEARCH AND DEVELOPMENT. Research and development expenses increased
as a percentage of total revenues to 21.8% in the year ended December 31, 1999
from 20.5% in the year ended December 31, 1998. These expenses increased 44% to
$57.2 million in 1999 from $39 million in 1998. This increase is the result of
growth in the number of personnel associated with the development of new
software releases in both the Americas and Europe, including ongoing
development of the Company's new Targys technology. The Company has implemented
its Targys Customer Server and Customer Inquiry Application for one customer in
Europe and one customer in North America. The Company will continue a phased
rollout of additional Targys applications during 2000.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
decreased to 9.3% of total revenues in the year ended December 31, 1999 from
10.7% in the year ended December 31, 1998. These expenses increased 16.7% to
$24.3 million in 1999 from $20.8 million in 1998. This increase was principally
due to increases in the number of administrative personnel and increases in
office rent and other expenses incurred as a result of the general growth of
the Company's business. General and administrative expenses consist primarily
of salaries and benefits of management and administrative personnel, general
office administration expenses such as rent and occupancy, telephone expenses
and other supply costs, and fees for legal, accounting and other professional
services.
INCOME TAXES. The provision for income taxes was 37.6% and 47.7% of
earnings before income taxes for the years ended December 31, 1999 and 1998,
respectively. The effective tax rate was higher than the statutory tax rate of
34% primarily because of the partial deduction for merger charges in 1999 and
the non-deductible write-off of in-process research and development in 1998, as
well as higher tax rates in foreign countries.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUES. Total revenues increased 54.6% to $194.1 million in the year
ended December 31, 1998 from $125.5 million in the year ended December 31,
1997. License revenues increased 70.0% to $78.6 million in 1998 from $46.2
million, while service revenues increased 45.7% to $115.6 million from $79.3
million for the same period. Total revenues increased primarily due to the
addition of new customers and increased implementation and support revenue from
existing customers.
License revenues increased as a percentage of total revenues to 40.5%
in 1998 from 36.8% in 1997, while service revenues decreased as a percentage of
total revenues to 59.5% from 63.5% for the same period. This change in mix of
revenues is primarily due to the timing of recurring license revenue from
subscriber growth experienced by existing customers, the completion of
implementation work for existing customers and the start of the implementation
work for new customers.
No individual customer accounted for more than 10% of total revenues
in 1998. During 1997, o-tel-o, an LHS customer in Europe, accounted for 12% of
total revenues.
COST OF SERVICES. Cost of services decreased as a percentage of total
revenues to 38.5% in the year ended December 31, 1998 from 45.1% in the year
ended December 31, 1997. Costs of services increased 32.0% to $74.8 million in
1998 from $56.6 million in 1997, primarily due to compensation expense
associated with increased staffing for new projects in Europe, the Americas and
Asia. This increase was partially offset by an increase in the productivity and
efficiency of the implementation and services functions. Cost of services
consists primarily of salaries and benefits of those employees associated with
the installation of software products and other product support activities. It
also includes third-party costs associated with systems integrators, hardware
costs and costs related to providing software maintenance and end-user training
to customers.
SALES AND MARKETING. Sales and marketing expenses decreased as a
percentage of total revenues to 10.0% in the year ended December 31, 1998 from
11.6% in the year ended December 31, 1997 although sales and marketing
-18-
19
expenses actually increased to $19.5 million in 1998 from $14.6 million in 1997.
The increase in sales and marketing expenses was principally due to the growth
in the number of worldwide sales and marketing personnel responsible for
developing business, particularly in Europe and Asia and increased participation
in trade shows and other worldwide marketing activities. Sales and marketing
expenses consist primarily of the salaries, benefits and travel expenses of
those employees responsible for acquiring new business and maintaining existing
customer relationships, as well as marketing expenses related to trade
publications, advertisements and trade shows.
RESEARCH AND DEVELOPMENT. Research and development expenses increased
as a percentage of total revenues to 20.5% in the year ended December 31, 1998
from 17.6% in the year ended December 31, 1997. This increase in research and
development costs as a percentage of revenues was principally due to increases
in the number of personnel associated with the development of new releases of
BSCS in both the Americas and Europe. Research and development expenses are
comprised of salaries and benefits of the employees involved in product and
enhancement development. All development costs are expensed by the Company as
incurred.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
decreased to 10.7% of total revenues in the year ended December 31, 1998 from
13.2% in the year ended December 31, 1997. These expenses increased 25.3% to
$20.8 million in 1998 from $16.6 million in 1997. This increase was principally
due to increases in the number of administrative personnel and increases in
office rent and other expenses incurred as a result of the general growth of
the Company's business. General and administrative expenses consist primarily
of salaries and benefits of management and administrative personnel, general
office administration expenses such as rent and occupancy, telephone expenses
and other supply costs, and fees for legal, accounting and other professional
services.
INCOME TAXES. The provision for income taxes was 47.7% and 41.7% of
earnings before income taxes for the years ended December 31, 1998 and 1997,
respectively. The effective tax rate was higher than the statutory tax rate of
34% primarily because the non-deductible write-off of in-process research and
development in 1998 and higher tax rates in foreign countries in 1998 and 1997.
IN-PROCESS RESEARCH AND DEVELOPMENT. During 1998, the Company
completed the acquisition of InfoCellular and, in conjunction with this
acquisition, the Company allocated a portion of the purchase price to
in-process research and development. Since the date of acquisition, the Company
has used the acquired in-process technology to develop new product offerings
and enhancements, which will become part of the Company's suite of products
when completed. The Company completed the development of the remaining research
and development projects referred to as Brookfield and Cohasset during 1999.
The Company is currently offering products to its customers, which incorporate
the functionality developed in these research and development projects.
No assurance can be given that actual revenues and operating profit
attributable to acquired in-process research and development will not deviate
from the projections used to value such technology. Ongoing operations and
financial results for the acquired technology, and the Company as a whole, are
subject to a variety of factors which may not have been known or estimateable at
the date of such transaction, and the estimates discussed below should not be
considered the Company's current projections for operating results for the
acquired assets or licensed technology or the Company as a whole.
The fair value of the in-process technology was based on analyses of
the markets, projected cash flows and risks associated with achieving such
projected cash flows. In developing these cash flow projections, revenues were
estimated based on relevant factors, including aggregate revenue growth rates
for the business as a whole, individual service offering revenues,
characteristics of the potential market for the service offerings and the
anticipated life of the underlying technology. Operating expenses and resulting
profit margins were estimated based on the characteristics and cash flow
generating potential of the acquired in-process research and development. The
Company assumed material net cash inflows would commence in 1999. Appropriate
adjustments were made to operating income to derive net cash flow, and the
estimated net cash flows of the in-process technologies were then discounted to
present value using a rate of return that the Company believes reflects the
specific risk/return characteristics of the research and development projects.
The selection of discount rates for application was based on the consideration
of: (i) the weighted average cost of capital, which measures a company's cost
of debt and equity financing weighted by the percentage of debt and percentage
of equity in its target capital structure; (ii) the corresponding weighted
average return on assets which measures the after-tax return required on the
assets employed in the business weighted by each asset group's percentage of
the total asset portfolio; and (iii) venture
-19-
20
capital required rates of return which typically relate to equity financing for
relatively high-risk business projects. The risk adjusted discount rate utilized
in the valuation analysis of the acquired in-process technology was 20%.
Revenues attributable to the acquired in-process technology were
assumed to increase between the first three years of the six-year projection
period at annual rates of 46% to 569% before decreasing over the remaining
years at rates of 3% to 40% as other products are released into the
marketplace. Projected annual revenue attributable to the product ranged from
$1.6 million to $15.7 million over the term of the projection. This projection
was based on the aggregate revenue growth rate for the business as a whole,
individual product revenues, anticipated growth rates for the billing software
market, anticipated product development and product introduction cycles, and
the estimated life of the underlying technology. Projected revenues from the
in-process research and development were assumed to peak during 2000, and
decline from 2001 to 2003 as other new products are expected to enter the
market.
Gross profit was assumed to increase in the first three years of the
projection period at annual rates of 46% to 569% before decreasing over the
remaining years at rates of 3% to 40%, resulting in annual gross profits that
ranged from $1.0 million to $10.2 million over the term of the projection.
Operating profit was assumed to increase in the first three years of
the projection from $0.01 million to $5.6 million before decreasing over the
remaining years at rates of 3% to 40%, resulting in annual operating profits
that ranged from $0.01 million to $5.6 million over the term of the projection.
The Company used a discount rate of 20% for valuing the in-process
research and development acquired in these transactions, which the Company
believes reflected the risk associated with the completion of the individual
research and development projects acquired and the estimated future economic
benefits to be generated subsequent to the projects' completion.
The in-process research and development acquired from InfoCellular
consisted of the Brookfield and Cohasset technology. These new releases of the
Converge software product include new features that provide the ability to
recognize/accommodate multi-language and multi-currency operations and
functionality that extends beyond the basic level of POS functionality. The
Company estimated that this project was approximately 80% complete at the date
of acquisition. At the date of valuation, the expected cost to complete these
projects was approximately $1.1 million. The Company completed the projects
during the third quarter of 1999 within the estimated cost of completion.
There can be no assurance that the Company will not incur additional
charges in subsequent periods to reflect costs associated with these
transactions or that the Company will be successful in its efforts to integrate
and further develop these technologies.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities totaled $42.3 million in
1999 compared to $21.5 million in 1998 and $15.0 million 1997. The increase in
cash provided by operations in 1999, 1998 and 1997 was primarily the result of
increased earnings coupled with strengthened cost controls and cash management
practices.
Net cash used in investing activities totaled $10.3 million, $28.5
million and $56.6 million during 1999, 1998 and 1997, respectively. The Company
invested $10.8 million, $11.3 million and $6.8 million in furniture, fixtures
and equipment during 1999, 1998 and 1997, respectively. These investments were
primarily for computer hardware and software and improvements to new leased
office space required to accommodate the growth in the number of employees.
Net cash from financing activities totaled $11.5 million, $14.0
million and $66.5 million during 1999, 1998 and 1997, respectively. During
1999, 1998 and 1997, the Company received proceeds from the exercise of
employee stock options totaling $13.3 million, $14.0 million and $1.9 million,
respectively. In May 1997, the Company sold 4,865,000 shares of its Common
Stock in an Initial Public Offering ("IPO") in which it received approximately
$70.6 million, net of $7.2 million in costs of the offering.
-20-
21
The Company has a short-term overdraft facility with a bank, which
provides for borrowings of up to $2.5 million and bears interest at 7.5% per
annum.
The Company's Priority Call subsidiary has a security agreement with a
bank, which allows the Company to borrow the lesser of (i) $2 million or (ii)
80% of eligible accounts receivable (working capital line) and up to $1 million
for equipment purchases (equipment line). Borrowings under the working capital
line accrue interest at the bank's prime rate (7.75% at December 31, 1999) and
borrowings under the equipment line accrue interest at the bank's prime rate
plus 1/2%. At December 31, 1998, the Company had a $1 million advance against
the equipment line and no borrowings against the working capital line. The
Company made net payments on the security agreement totaling $1.5 million and
$1.2 million during 1999 and 1998, respectively. The Company made net borrowings
on the security agreement during 1997 totaling $0.7 million.
At December 31, 1999 no borrowings were outstanding under the
short-term overdraft facility or the security agreement.
At December 31, 1999 the Company did not have any material commitments
for capital expenditures. The Company believes that its existing cash balances,
available credit facilities, and funds generated by operations, will be
sufficient to meet its anticipated working capital and capital expenditure
requirements for the foreseeable future.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
On January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130").
The Company reported comprehensive income in its statement of stockholders'
equity. The adoption of SFAS 130 resulted in revised and additional disclosures
but had no effect on the financial position, results of operations, or
liquidity of the Company.
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131"), which establishes standards for the way public
business enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. Operating segments are components of an enterprise about which
separate financial information is available which is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. SFAS 131 also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
The Company adopted SFAS 131 in 1998, and the effect of the adoption was not
material to the consolidated financial statements. (see Note 12).
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities", which requires the recognition of all derivatives as either assets
or liabilities in the balance sheet and the measurement of those instruments at
fair value. The accounting for changes in the fair value of a derivative
depends on the planned use of the derivative and the resulting designation. The
Company is required to implement the statement in the first quarter of the year
2001. The Company has not used derivative instruments and believes the impact
of adoption of this statement will not have significant effect on the financial
statements.
The American Institute of Certified Public Accountants issued SOP
97-2, SOP 98-4 and SOP 98-9 to clarify guidance on applying generally accepted
accounting principles to software transactions and to provide guidance on when
revenue should be recognized and in what amounts for licensing, selling,
leasing, or otherwise marketing computer software. The Company adopted this
guidance during 1997. Such adoption had no effect on the Company's methods of
recognizing revenue.
On December 3, 1999, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 101 ("SAB 101"). SAB 101 summarizes certain areas
of the Staff's views in applying generally accepted accounting principles to
revenue recognition in financial statements. The Company believes that its
current revenue recognition principles comply with SAB 101.
RISK FACTORS AFFECTING FUTURE PERFORMANCE
A failure to complete our merger with Sema Group plc may result in a
material adverse effect on our business and results of operations.
On March 14, 2000, we entered into a plan and agreement of merger with
Sema Group plc pursuant to which LHS would become a subsidiary of Sema. We
expect for this merger to be completed in the second half of 2000. The
announcement of the pending transaction may have adverse effects on our
business and operations. Employees that are key to our continuing successful
operation may leave LHS as a result of the pending transaction. Customers who
do not believe that the transaction will be favorable to their relationship
with LHS in terms of the future quality of the products and services we provide
to them or otherwise may decide to terminate or diminish in some way their
relationship with LHS. Potential customers of LHS may delay entering into, or
decide not to enter into, a business relationship with LHS because of the
pending transaction with Sema. Any of the factors discussed above may result in
a material adverse effect on our business and results of operations. In
addition, if the transaction is not consummated on schedule or at all, for any
reason, including without limitation, reasons that would result in our making
substantial payments to Sema or other parties, our business, financial
condition and results of operations would be materially adversely affected. See
"Item 1 - Business."
We must adapt to changes in technology, products, industry standards
and customer needs.
The telecommunications industry is characterized by rapidly changing
technology and evolving industry standards. Also, customer needs frequently
change, and competitors constantly introduce new products and services. To be
successful, we must:
- use leading technologies effectively;
- continue developing our technical expertise;
- enhance our existing products and services;
- develop new products and services;
- meet changing customer needs on a timely and cost-effective
basis; and,
- introduce scaleable solutions that support our customers'
growing subscriber bases
If we fail to do any of these things, our customers may choose to purchase
products and services from our competitors.
We continually introduce our products and services into new markets.
If our products do not adequately meet the demands of these new markets, we
could experience decreased revenues. We could experience difficulties in the
development of products and services for new and existing markets that could
delay or prevent the successful
-21-
22
development, introduction and marketing of these products and services. Our
failure to develop and introduce new products and services in a timely manner,
or the lack of success of a new release of a product in the market, would likely
result in a material adverse effect on our business, operating results and
financial condition.
We may not effectively manage our growth.
Over the last three years, we have greatly expanded our operations,
placing considerable demand on our administrative, operational and financial
personnel and systems. Further expansion may place additional strains on our
resources. To address these expansion issues, we may have to make substantial
expenditures and devote further management time and resources to:
- improve or replace our management information, financial and
other reporting systems;
- standardize installation methods;
- further develop our infrastructure;
- develop and coordinate strategies, operations and product
development among our operations in the Americas, Europe and
Asia;
- maintain customer satisfaction;
- manage changing business conditions; and
- recruit, train and retain qualified consulting, technical,
sales, financial, marketing and management personnel.
- integrate acquired businesses
We cannot assure you that our existing resources, systems and space
will be able to adequately support our further expansion. Our failure to
respond appropriately to growth and change would likely result in a material
adverse effect on the quality of our services, our ability to retain key
personnel and our business.
We depend on large contracts from a limited number of customers.
We provide customized billing and customer handling systems to
communications service providers. Although no single customer accounted for
more than 10% of our revenues in 1999, we have traditionally relied upon, and
expect to continue to rely upon, large contracts from a limited number of
customers. This can cause our revenues and earnings to fluctuate between
quarters based on the timing of orders and realization of revenues from these
orders.
Some of the communications industry's established players are forming
alliances, while others are consolidating. If a consolidation or alliance
involves one of our customers, that customer may switch to another billing
system. In addition, none of our major customers has any obligation to purchase
additional products or services from us. The loss of one or more of our major
customers because of industry consolidation or otherwise would likely result in
a material adverse effect on our business, operating results and financial
condition.
Our success depends on developing relationships with new customers in
a very competitive communications market.
The global communications services markets have grown significantly
and become much more competitive in recent years. This growth may not continue,
and we may not be able to successfully market and sell our products in these
competitive markets. It is critical to our continued success that we develop
relationships with new customers. Our failure to develop relationships with new
customers, or the failure of our customers to compete effectively in the
telecommunications market, would likely result in a material adverse effect on
our business, operating results and financial condition.
Many of our potential customers are new entrants in the communications
services markets and lack significant financial and other resources. We may be
required to offer them alternative pricing arrangements, including deferred
payments, if we want these new market entrants to be our customers. We may not
be able to develop customer relationships with these new entrants, but even if
we do, there is no guarantee that these customers will be successful. If they
are not successful, they may reduce or discontinue their purchases from us and
we may be
-22-
23
unable to collect payments from these customers. Any one of these factors could
have a material adverse effect on our business, operating results and financial
condition.
Expansion of our products and services into new geographic markets and
applications may be unsuccessful.
We plan to continue expanding our products and services into new
geographic markets and to service providers offering new applications of their
communications services. Our failure to successfully establish ourselves in new
markets would likely result in a material adverse effect on our business.
Likewise, delays in the introduction of new communications technologies may
result in decreased demand for our products and services for use in connection
with new communications services.
Our strategy of expanding our business through acquisitions of and
mergers with other businesses and technologies presents special risks.
LHS may continue to expand through the acquisition of and mergers with
businesses, technologies, products, and services from other businesses.
Acquisitions involve a number of special problems, including:
- difficulty integrating acquired technologies, operations and
personnel with the existing business;
- diversion of management attention in connection with both
negotiating the acquisitions and integrating the assets;
- strain on managerial and operational resources as management
tries to oversee larger operations;
- exposure to unforeseen liabilities of acquired companies;
- potential issuance of securities in connection with the
acquisition which securities lessen the rights of holders of
our currently outstanding securities;
- the need to incur additional debt; and
- the requirement to record additional future operating costs
for the amortization of goodwill and other intangible assets,
which amounts could be significant.
We may not be able to successfully address these problems. Moreover,
our future operating results will depend to a significant degree on its ability
to successfully manage growth and integrate acquisitions. In addition,
companies whom we may acquire or with which we may merge may be early-stage
companies with limited operating histories and limited or no revenues. We may
not be able to successfully develop these young companies into profitable units
of LHS.
Our success is dependent on our relationships with consulting firms
and systems integration firms.
Consulting firms and systems integration firms help us with marketing,
sales, lead generation, customer support and installation of our products. In
order to grow successfully, we must maintain our relationships with these firms
and generate new business opportunities through joint marketing and sales with
them.
We also serve as subcontractor to consulting firms and systems
integration firms where those firms provide information technology to end-user
customers. In these cases we depend heavily on these firms to install our
products and to train end-users to use our products. Incorrect product
installation, failure to properly train the end-user, or general failure of the
firm to satisfy the customer could have a negative effect on our relationships
with the contracting firm and the customer. Such problems could damage our
reputation and the reputation of our products and services.
Obstacles we may encounter to forging long-term relationships with
consulting and systems integration firms include:
- we have no exclusive agreements with any consulting and
systems integration firms;
- many consulting and systems integration firms have more
established relationships with our principal competitors; and
-23-
24
- many consulting and systems integration firms have the
resources to compete with us by developing their own products
and services.
These firms may discontinue their relationships with us and/or develop
relationships with our competitors. Our inability to establish and maintain
effective, long-term relationships with these firms, and their failure to meet
the needs of our customers, would likely adversely affect our business.
Prior to 1996, we had contracts pursuant to which we gave certain
systems integration firms our kernel source code and the right to market and
sell versions of our products that these firms independently modified. A few
U.S. service providers had problems with our products as modified and installed
by these firms. This damaged our reputation and credibility and that of our
products, and we may have lost the confidence of the affected service
providers. Although we have terminated all of these types of contracts, there
may be further damage to our reputation and credibility in the U.S. that could
have a material adverse effect on our business.
The communications billing and customer care and enhanced services
systems industries are very competitive. We expect competition to increase
in the future.
Some of the independent providers we compete with are:
- Alltel
- AMDOCS
- Convergys
- Kenan
- Kingston-SCL
- Portal Software
- SEMA Group
- Comverse Technology
- Brite Voice
- Glenayre
- Logica
We also compete with systems integrators and internal billing
departments of larger telecommunications service providers.
Many of our competitors have advantages over us, including:
- longer operating histories;
- larger customer bases;
- substantially greater financial, technical, sales, marketing
and other resources; and
- greater name recognition.
Our current and potential competitors have established, and may
continue to establish in the future, cooperative relationships among themselves
or with third parties to increase their ability to compete with us. In
addition, competitors may be able to adapt more quickly than us to new or
emerging technologies and changes in customer needs, or to devote more
resources to promoting and selling their products. New competitors or alliances
among competitors could also result in these competitors quickly gaining
significant market share.
We believe that our ability to compete successfully in our markets is
affected by these principal factors:
- development of competing software and services;
- price of competing software and services;
- responsiveness to customer needs; and
- hiring, retaining and motivating key personnel.
Our failure to adapt to market demands and to compete successfully
with existing and new competitors would have a material adverse effect on our
business.
-24-
25
As we expand, we will market our products and services to service
providers in markets that we do not currently serve. We may encounter new
competitors upon entry into these markets that may have greater financial,
technical, personnel and marketing resources than we do. We cannot assure you
that we will be able to successfully identify and address the demands for these
new markets or that we can continue to compete effectively in our current
markets. Our failure to maintain our competitiveness in current or new markets
would have a material adverse effect on our business, operating results and
financial condition.
Our success depends upon our ability to attract and retain key
personnel.
Our future success depends in large part on the continued service of
our key management, sales, product development and operational personnel,
including Gary Cuccio, our Chief Executive Officer. Since it is our goal to
continue our expansion, our success also depends on our ability to attract and
retain highly qualified technical, managerial, sales and marketing personnel.
Competition is intense for the recruitment of highly qualified personnel in the
software and telecommunications services industry. We may not be able to
successfully retain or integrate existing personnel or identify and hire
additional personnel. Our inability to hire and retain qualified personnel
would likely have a material adverse effect upon our current business, new
product development efforts and future business prospects. We do not currently
maintain key person insurance coverage for any of our employees.
The success of our international business operations is subject to
many uncertainties.
We conduct a substantial portion of our business outside of the
Americas. In each of 1998 and 1999, our sales outside the Americas represented
approximately 60% of our total revenues. We expect a majority of our revenues
to continue to be provided from our European and Asian operations. Our
international business may be adversely affected by the following:
- unexpected changes in regulatory requirements;
- tariffs and other trade barriers;
- difficulties in customizing our products for use in foreign
countries;
- longer accounts receivable payment cycles;
- difficulties in managing international operations;
- availability of trained personnel to install and implement our
systems;
- political instability;
- potentially adverse tax obligations; restrictions on the
repatriation of earnings; and, the burdens of complying with
a wide variety of foreign laws and regulations.
In addition, the laws of some foreign countries do not protect our
intellectual property rights to as great an extent as the laws of the United
States. There can be no assurance that such factors will not have a material
adverse effect on our international revenues and earnings or our overall
financial performance.
If we cannot provide financing for potential customers, we may not get
their business.
Certain of our potential customers may require financing to fund
purchases of our products. In particular, our ability to increase sales to
start-up telecommunications service providers with limited financial resources
in the future will depend significantly upon our ability to arrange financing
for these customers. We may not be able to successfully implement a vendor
financing program for these customers or to assist them in obtaining
alternative financing for our products. In such event, we will have decreased
revenues.
Exchange rate fluctuations between the U.S. dollar and other
currencies in which we do business may result in currency translation losses.
A significant portion of our revenues are denominated in the German
Deutsche Mark. We also have revenues denominated in the Swiss Franc and the
Malaysian Ringgit. The value of the German Deutsche Mark against the Euro was
fixed upon the introduction of the Euro in January 1, 1999. Consequently,
fluctuations in
-25-
26
exchange rates between the U.S. Dollar and the Euro, Swiss Franc and Malaysian
Ringitt may have a material adverse effect on our business, operating results
and financial condition and could also result in significant exchange losses.
Foreign currency transaction gains and losses are a result of transacting
business in certain foreign locations in currencies other than the functional
currency of the location. We attempt to balance our revenues and expenses in
each currency to minimize net foreign currency risk. To the extent that we
are unable to balance revenues and expenses in a currency, fluctuations in
the value of the currency in which we conduct our business relative to the
functional currency have caused and will continue to cause currency
transaction gains and losses. We cannot accurately predict the impact of
future exchange rate fluctuations on our results of operations.
We have not sought to hedge the risks associated with fluctuations in
exchange rates but may undertake such transactions in the future. Any hedging
techniques which we implement in the future may not be successful, and exchange
rate losses could be exacerbated by hedging techniques that we use.
Our European operations expose us to heightened euro conversion risks.
Because of our significant operations in Europe, we are particularly
exposed to risks resulting from the conversion by certain European Union member
states of their respective currencies to the Euro as legal currency on January
1, 1999. The conversion rates between such European Union member states'
currencies and the Euro have been fixed by the European Union's council;
however, the mandatory switch to the Euro will not occur until June 30, 2002.
We will be modifying our software during the period of conversion to the Euro
and intend to complete such work and have our products Euro compliant by such
time. Risks to us related to the conversion of the Euro include:
- effects on pricing due to increased cross-border price
transparency;
- costs of modifying information systems, including both
software and hardware;
- costs of modifying our software products to accommodate Euro
conversion;
- costs of relying upon third parties whose systems also require
modification;
- changes in the conduct of business; and
- changes in the currency exchange rate.
The actual effects of the Euro conversion could have a material
adverse effect on our business, operating results and financial condition.
We have only limited protection of our proprietary rights and
technology.
We rely primarily on a combination of registered patents, and
statutory and common law copyright, trademark and trade secret laws, customer
licensing agreements, employee and third-party nondisclosure agreements and
other methods to protect our proprietary rights and technology. These laws
and contractual provisions provide only limited protection. We have only a
limited number of registered copyrights, trademarks and patents. It may be
possible for a third party to copy or otherwise obtain and use our technology
without authorization or to develop similar technology independently. Also,
the laws of certain countries in which we sell our products do not offer as
much protection of our proprietary rights as the laws of the United States.
Unauthorized copying or misuse of our products or proprietary rights could
have a material adverse effect on our business, operating results and
financial condition.
We may not be successful in avoiding claims that we infringe others'
proprietary rights.
Many patents, copyrights and trademarks have been issued in the
general areas of information and communications. We expect that software
developers will be increasingly subject to infringement claims as the number
of products and competitors providing products and services to the
telecommunications industry grows. Third parties may claim that our current
or future products infringe their proprietary rights. Infringement claims,
with or without merit, could
- result in costly litigation;
- require significant management resources;
- cause product shipment delays;
-26-
27
- require us to enter into unfavorable royalty or licensing
agreements
- cause us to discontinue the use of the challenged trade name,
service mark or technology; or
- pay money damages.
Consequently, infringement claims could have a material adverse effect on our
business, operating results and financial condition.
Our software may contain undetected errors.
The software that we have developed and licensed to our customers may
contain undetected errors. Although we test our software prior to installing it
in a customer's network, we may discover errors after the installation. The
cost to fix the errors or to develop the software further could be high. These
errors may subject us to product liability claims. We have not experienced any
product liability claims to date, but we may be subject to such claims in the
future. We have insurance that would cover certain of these claims; however, a
successful product liability claim brought against us could have a material
adverse effect on our business, operating results and financial condition.
Certain measures that we have adopted may have anti-takeover effects.
The Board of Directors has the authority to issue up to 225,000 shares
of preferred stock and to determine the price, rights, preferences, privileges
and restrictions, including voting rights, of those shares, without stockholder
action. The rights of the holders of common stock will be subject to, and may
be adversely affected by, the rights of the holders of any preferred stock that
may be issued in the future. The issuance of preferred stock could discourage
or make difficult the acquisition of a majority of our outstanding voting stock
by a third party.
Certain provisions of our Certificate of Incorporation and By-Laws and
the Delaware General Corporation Law could delay or make more difficult a
merger, tender offer or proxy contest involving us. In addition, our Board of
Directors is divided into three classes with only one class being elected each
year, and directors may only be removed by the affirmative vote of 80% or more
of all classes of voting stock. Also, pursuant to our Stock Incentive Plan, all
stock options granted to employees automatically vest and become exercisable
upon certain triggering events leading up to a change of control. These factors
may have the effect of delaying or preventing a change of control.
The market price of our common stock may be volatile.
There may be significant volatility in the market price of our common
stock. The stock market has from time to time experienced significant price and
volume fluctuations that may be unrelated to the operating performance of
particular companies. Factors such as the following will vary from period to
period:
- actual or anticipated operating results;
- growth rates;
- changes in estimates by analysts;
- industry conditions;
- competitors' announcements;
- regulatory actions; and
- general economic conditions.
As a result of these and other factors, our operating results from time to time
may be below the expectations of public market analysts and investors. Any such
event would likely have a material adverse effect on the market price of the
common stock.
Government regulation of our customers could negatively affect us.
Currently, our business is not subject to direct government
regulation; however, our existing and potential customers are subject to
extensive regulation in many jurisdictions. Regulatory changes which affect our
existing
-27-
28
and potential customers could have a material adverse effect on our business,
operating results and financial condition.
Additional shares will become eligible for sale in the future.
The market price of our common stock could drop as a result of sales
of large numbers of shares in the market, or the perception that such sales
could occur. Several of our principal stockholders hold a significant portion
of the outstanding common stock.
We have approximately 59 million shares of common stock outstanding.
Approximately 45 million of these shares are freely transferable without
restriction or further registration under the Securities Act of 1933, except
for any shares purchased by our "affiliates," as defined in Rule 144 under the
Securities Act. Approximately 14 million of the shares of common stock
outstanding are "restricted securities" as defined in Rule 144. These shares
may be sold in the future without registration under the Securities Act to the
extent permitted by Rule 144 or an exemption under the Securities Act. In
addition, we have registered under the Securities Act 16 million shares of
common stock issuable under our Long-Term Incentive Plan.
Certain of our stockholders are entitled to demand and piggyback
registration rights with respect to the shares that they own. Once registered,
such shares generally will be eligible for immediate sale in the public market.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A significant portion of the Company's operations consist of software
license sales and software implementation, support and project consulting
services in foreign countries, primarily in Europe (including Eastern Europe),
Asia and Latin America. As a result, the Company's financial results could be
significantly affected by factors such as changes in foreign currency exchange
rates when the Company is paid in foreign currencies and weak economic
conditions in the foreign markets in which the Company licenses and implements
its software products. The Company's operating results are affected by changes
in exchange rates between the U.S. Dollar and the Euro, German Deutsche Mark,
Swiss Franc, and Malaysian Ringitt. When the U.S. Dollar strengthens against
these foreign currencies, the value of our non-functional currency revenues
decreases. When the U.S. Dollar weakens, the value of our functional currency
revenues increases. Overall, the Company is a net receiver of currencies other
than the U.S. Dollar and, as such, the Company benefits from a weaker U.S.
Dollar and is adversely affected by a stronger U.S. Dollar relative to major
currencies worldwide. However, the Company believes that its exposure to foreign
currency exchange rate risk at December 31, 1999 was not material.
The Company does not engage in trading of market-risk sensitive
instruments. The Company also does not purchase for investment, hedging or for
purposes "other than trading", instruments that are likely to expose it to
market risk, whether interest rate, foreign currency exchange, commodity price
or equity price risk. The Company has issued no debt instruments, entered into
no forward or futures contracts, purchased no options and entered into no swaps.
The Company's interest income and expense are most sensitive to changes
in the general level of U.S. interest rates. In this regard, changes in the U.S.
interest rates affect the interest earned on the Company's cash equivalents and
short-term investments. To mitigate the impact of fluctuations in U.S. interest
rates, the Company generally maintains the majority of its investments in fixed
rate debt instruments. Because the Company has no outstanding balances in its
loans or credit facilities, it is not exposed to interest rate risk in
connection with its operating expenses.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and financial statement schedules in Part
IV, Item 14 of this annual report are incorporated by reference into this
Item 8.
-28-
29
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
-29-
30
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Pursuant to General Instruction G(3) of Form 10-K, information
concerning the directors and executive officers of LHS will be set forth in the
Company's 2000 Proxy Statement or will be set forth in an amendment to this
Annual Report on Form 10-K which will be filed no later than 120 days after
December 31, 1999. Such information to the extent not included herein is
incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION.
Pursuant to General Instruction G (3) of Form 10-K, information
concerning executive compensation will be set forth in the Company's 2000 Proxy
Statement or will be set forth in an amendment to this Annual Report on Form
10-K which will be filed no later than 120 days after December 31, 1999. Such
information to the extent not included herein is incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Pursuant to General Instruction G (3) of Form 10-K, information
concerning security ownership of certain beneficial owners and management, will
be set forth in the Company's 2000 Proxy Statement or will be set forth in an
amendment to this Annual Report on Form 10-K which will be filed no later than
120 days after December 31, 1999. Such information to the extent not included
herein is incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to General Instruction G (3) of Form 10-K, information
concerning certain relationships and related transactions, will be set forth
in the Company's 2000 Proxy Statement or will be set forth in an amendment to
this Annual Report on Form 10-K which will be filed no later than 120 days
after December 31, 1999. Such information to the extent not included herein
is incorporated by reference.
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A)1. CONSOLIDATED FINANCIAL STATEMENTS
The following consolidated financial statements of LHS Group Inc. are
filed herewith, beginning on page F-1 through page F-23.
- Report of Independent Accountants
- Consolidated Balance Sheets as of December 31, 1999, and 1998
- Consolidated Statements of Income for the years ended December
31, 1999, 1998, and 1997
- Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1999, 1998, and 1997
- Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998, and 1997
- Notes to Consolidated Financial Statements
-30-
31
2. CONSOLIDATED FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statement schedule of LHS Group
Inc. is set forth on page 33 hereof:
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
All other schedules to the consolidated financial statements are
omitted as they are not required under the related instructions or are
inapplicable, or because the required information is included in the
consolidated financial statements or related notes thereto.
3. EXHIBITS
The following exhibits either (i) are filed herewith or (ii) have
previously been filed with the Securities and Exchange Commission and are
incorporated herein by reference to such prior filings. Previously filed
registration statements or reports which are incorporated herein by reference
are so identified. The Company will furnish any exhibit upon request to Scott
A. Wharton, Corporate Secretary, Six Concourse Parkway, Suite 2700, Atlanta,
Georgia 30328. There is a charge of $.50 per page to cover expenses of copying
and mailing.
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
-----------------------
2.1 Agreement and Plan of Merger by and between LHS Group Inc., Priority
Call Management, Inc. and Patriot Acquisition Corp. dated as of April
20, 1999 (Incorporated by reference from Exhibit 2.1 to the
Registrant's Registration Statement on Form S-4 (File No. 333-77557)).
2.2 Plan and Agreement of Merger, dated as of March 14, 2000, among LHS
Group Inc., Sema Group plc and SG Acquisition Corporation (Incorporated
by reference to Exhibit 2.1 to the Company's Current Report on Form
8-K).
2.3 Stock Option Agreement, dated as of March 14, 2000, among LHS Group
Inc. and Sema Group plc (Incorporated by reference to Exhibit 2.2 to
the Company's Current Report on Form 8-K filed on March 14, 2000).
3.1 Certificate of Incorporation, as amended (Incorporated by reference to
Exhibit 4.1 to the Company's Registration Statement on Form S-8 (File
No. 333-57269)).
3.2 By-Laws, as amended (Incorporated by reference to Exhibit 3.2 to the
Company's Form 10-Q for the quarterly period ended June 30, 1999).
4 Specimen Common Stock Certificate. (Incorporated by reference to
Exhibit 4.1 to the Company's Registration Statement on Form S-1 (File
No. 333-22195)).
10.1 Registration Rights Agreement dated July 15, 1996 among the Company,
General Atlantic Partners 23, L.P., General Atlantic partners 31, L.P.,
GAP Coinvestment Partners, L.P. and the other stockholders named
therein. (Incorporated by reference to Exhibit 10.4 to the Company's
Registration Statement on Form S-1 (File No. 333-22195)).
*10.5 LHS Group Inc. 1998 Employee Stock Purchase Plan (Incorporated by
reference to Exhibit 99.1 to the Company's Registration Statement on
Form S-8 (File No. 333-57269)).
*10.6 LHS Group Inc. Amended and Restated Stock Incentive Plan (Incorporated
by reference to Exhibit 99.2 to the Company's Registration Statement on
Form S-8 (File No. 333-57269)).
-31-
32
*10.7 Employment Agreement dated March 19,1999, between Stefan Sieber and LHS
Group Inc. (Incorporated by reference to Exhibit 10.7 the Company's
Form 10-Q for the quarterly period ended June 30, 1999) .
*10.8 Employment Agreement dated June 23, 1999 between Peter J. Chambers and
LHS Group Inc. (Incorporated by reference to Exhibit 10.8 to the
Company's Form 10-Q for the quarterly period ended September 30, 1999).
*10.9 Employment Agreement dated July 16, 1999 between Reudiger Hellmich and
LHS Group Inc., and amended on October 6, 1999 (Incorporated by
reference to Exhibit 10.9 to the Company's Form 10-Q for the quarterly
period ended September 30, 1999).
*10.10 Employment Agreement dated September 5, 1999 between Gary D. Cuccio and
LHS Group Inc., and amended on October 6, 1999 (Incorporated by
reference to Exhibit 10.10 to the Company's Form 10-Q for the quarterly
period ended September 30, 1999).
21.1 List of Subsidiaries - filed herewith.
23.1 Consent of Ernst & Young LLP - filed herewith.
23.2 Consent of Arthur Andersen LLP - filed herewith.
27 Financial Data Schedule - filed herewith.
* Management contract or compensatory plan.
(B) REPORTS ON FORM 8-K
The Company filed on Current Report on Form 8-K on October 21, 1999 to
announce certain consolidated financial information for the quarter and nine
month period ended September 30, 1999.
-32-
33
SCHEDULE II
ADDITIONS
-----------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING OF COSTS AND OTHER END OF
DESCRIPTION PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
Year ended December 31, 1999
Allowance for doubtful accounts $ 3,716 $ 2,541 $(1,269)(1) $ 4,988
Valuation Allowance for Deferred Taxes $(2,423) $ 2,423
Year ended December 31, 1998
Allowance for doubtful accounts $ 1,516 $ 3,547 $(1,347)(1) $ 3,716
Valuation Allowance for Deferred Taxes $(2,763) $ 340 $(3,423)
Year ended December 31, 1997
Allowance for doubtful accounts $ 360 $ 1,168 $ (12) $ 1,516
Valuation Allowance for Deferred Taxes $(2,257) $(506) $(2,763)
(1) Uncollectible accounts written off, net of recoveries
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf on March 28, 2000 by the undersigned, thereunto duly organized.
LHS GROUP INC.
By: /s/ Gary D. Cuccio
------------------
Gary D. Cuccio
President, Chief Executive Officer and Director
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Gary D. Cucio, Peter Chambers, and Scott
A. Wharton, and each of them, with the power to act without the other, as his
true and lawful attorneys-in-fact and agents, with full power of substitution
and resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any and all amendments to this Report, and to file any of
the same, with all exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or his or their substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the registrant in the capacities indicated on March 28,
2000.
SIGNATURE TITLE
- --------- -----
/s/ Gary D. Cuccio President, Chief Executive Officer and Director
- ---------------------- (Principal Executive Officer)
Gary D. Cuccio
/s/ Peter Chambers Executive Vice President, Chief Financial Officer and Treasurer
- ---------------------- (Principal Financial and Accounting Officer)
Peter Chambers
/s/ Hartmut Lademacher Chairman
- ----------------------
Hartmut Lademacher
/s/ Ulf Bohla Director
- ----------------------
Ulf Bohla
/s/ William E. Ford Director
- ----------------------
William E. Ford
/s/ William O. Grabe Director
- ----------------------
William O. Grabe
/s/ George F. Schmitt Director
- ----------------------
George F. Schmitt
/s/ Vincenzo Damiani Director
- ----------------------
Vincenzo Damiani
-33-
34
Report of Independent Auditors
The Board of Directors
LHS Group Inc.
We have audited the accompanying consolidated balance sheets of LHS Group Inc.
(the "Company") as of December 31, 1999 and 1998, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the three
years in the period ended December 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
financial statements of Priority Call Management, Inc., which statements reflect
total assets constituting 10.3% at December 31, 1998 and revenues constituting
approximately 15.9% and 16.0%, for the years ended December 31, 1998 and 1997.
Those statements were audited by other auditors whose report has been furnished
to us, and our opinion, insofar as it relates to data included for Priority Call
Management, Inc., is based solely on the report of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits and the report of the other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of LHS Group Inc. at December 31, 1999 and
1998 and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1999, in conformity with accounting
principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
February 17, 2000
Atlanta, Georgia
F-1
35
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Priority Call Management, Inc.:
We have audited the accompanying consolidated balance sheets of
Priority Call Management, Inc. (a Massachusetts corporation) and subsidiary as
of December 31, 1997 and 1998, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
Priority Call Management, Inc. and subsidiary as of December 31, 1997 and 1998,
and the results of its operations and its cash flows for each of the three years
in the period ended December 31, 1998, in conformity with generally accepted
accounting principles.
/s/ Arthur Andersen LLP
Boston, Massachusetts
February 4, 1999
F-2
36
LHS Group Inc.
Consolidated Balance Sheets
DECEMBER 31
1999 1998
------------------------------
(In thousands of U.S. Dollars,
except share data)
ASSETS
Current assets:
Cash and cash equivalents ....................................... $ 86,888 $ 46,794
Short-term marketable debt securities ........................... 49,009 62,218
Trade accounts receivable, net of allowance for
doubtful accounts of $4,988 and $3,716 ........................ 91,910 68,189
Prepaid expenses and other current assets ....................... 10,482 8,251
Deferred income taxes ........................................... 3,658 --
-------------------------
Total current assets ............................................... 241,947 185,452
Furniture, fixtures and equipment:
Computer equipment .............................................. 11,316 15,076
Purchased computer software ..................................... 9,822 7,267
Furniture and fixtures .......................................... 16,390 8,005
Other ........................................................... 3,834 2,835
-------------------------
41,362 33,183
Allowance for depreciation and amortization ........................ (20,413) (14,050)
-------------------------
20,949 19,133
Deferred income taxes .............................................. -- 914
Long-term investments .............................................. 11,800 --
Intangible assets net of accumulated amortization of $1,256 and $495 2,962 3,949
Other .............................................................. 2,904 876
-------------------------
Total assets ....................................................... $ 280,562 $ 210,324
=========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................................ $ 9,255 $ 10,253
Accrued expenses and other liabilities .......................... 21,211 20,798
Deferred revenues ............................................... 15,929 7,712
Income taxes payable ............................................ 25,164 8,907
Deferred income taxes ........................................... -- 4,127
-------------------------
Total current liabilities .......................................... 71,559 51,797
Other long-term obligations ........................................ 985 2,772
Stockholders' equity:
Common stock ($.01 par value) 200,000,000 shares authorized;
58,363,175 and 56,726,234 shares issued and outstanding ...... 583 567
Additional paid-in capital ...................................... 150,922 125,628
Retained earnings ............................................... 68,626 30,193
Note Receivable ................................................. -- (525)
Accumulated other comprehensive income .......................... (12,113) (108)
-------------------------
Total stockholders' equity ......................................... 208,018 155,755
-------------------------
Total liabilities and stockholders' equity ......................... $ 280,562 $ 210,324
=========================
See accompanying notes.
F-3
37
LHS Group Inc.
Consolidated Statements of Income
YEAR ENDED DECEMBER 31
1999 1998 1997
-----------------------------------------------------
(In thousands of U.S. Dollars, except per share data)
Revenues:
License ................................................. $ 108,774 $ 78,560 $ 46,215
Service ................................................. 153,822 115,558 79,307
-----------------------------------------
Total ...................................................... 262,596 194,118 125,522
Cost of services ........................................... 89,383 74,793 56,643
-----------------------------------------
Gross margin ............................................... 173,213 119,325 68,879
Operating expenses:
Sales and marketing ..................................... 30,531 19,477 14,611
Research and development ................................ 57,270 39,721 22,116
General and administrative .............................. 24,314 20,828 16,622
Cost of purchased in-process research and development
related to computer software technology ............... -- 8,200 --
Merger charges .......................................... 4,320 -- --
-----------------------------------------
116,435 88,226 53,349
-----------------------------------------
Earnings before interest and taxes ......................... 56,778 31,099 15,530
Interest (income) expense, net ............................. (4,844) (4,619) (2,391)
-----------------------------------------
Earnings before income taxes ............................... 61,622 35,718 17,921
Income taxes ............................................... 23,189 17,033 7,470
-----------------------------------------
Net earnings ............................................... $ 38,433 $ 18,685 $ 10,451
=========================================
Net earnings per share:
Basic ................................................... $ 0.67 $ 0.33 $ 0.22
=========================================
Diluted ................................................. $ 0.65 $ 0.32 $ 0.20
=========================================
Shares used in per share calculation (Note 2)
Basic ................................................... 57,359 55,838 46,913
=========================================
Diluted ................................................. 59,206 59,159 53,376
=========================================
See accompanying notes.
F-4
38
LHS Group Inc.
Consolidated Statements of Stockholders' Equity
Accumulated
Preferred Stock Common Stock Additional Other
------------------------------------ Paid-in Note Retained Comprehensive Total
Shares Amount Shares Amount Capital Receivable Earnings Income Equity
-------------------------------------------------------------------------------------------------
(In thousands of U.S. Dollars,
except share data)
Balance December 31, 1996 (1) .. 225,000 $ 2 35,106,684 $ 351 $ 20,579 $ -- $ 1,057 $ (508) $ 21,481
Comprehensive income:
Net earnings ............... -- -- -- -- -- -- 10,451 -- 10,451
Translation adjustment ..... -- -- -- -- -- -- -- (4,402) (4,402)
---------
6,049
Issuance of common stock,
net of costs of issuance ... -- -- 9,730,000 97 70,533 -- -- -- 70,630
Conversion of preferred
stock into common ........... (225,000) (2) 9,000,000 90 (88) -- -- -- -
Exercise of stock options .... -- -- 700,710 7 1,850 -- -- -- 1,857
Tax benefit relating to
stock options -- -- -- -- 931 -- -- -- 931
-------------------------------------------------------------------------------------------------
Balance December 31, 1997 (1) .. -- -- 54,537,394 545 93,805 -- 11,508 (4,910) 100,948
Comprehensive income:
Net earnings ............... -- -- -- -- -- -- 18,685 -- 18,685
Translation adjustment ..... -- -- -- -- -- -- -- 4,802 4,802
---------
23,407
Issuance of common stock
in connection with business
acquisition ............... -- -- 117,885 1 7,022 -- -- -- 7,023
Exercise of stock options .... -- -- 2,070,955 21 14,544 (525) -- -- 14,040
Tax benefit relating to
stock options ..... -- -- -- -- 10,161 -- -- -- 10,161
Compensation expense related
to stock options ........... -- -- -- -- 96 -- -- -- 96
-------------------------------------------------------------------------------------------------
Balance December 31, 1998 (1) .. 56,726,234 567 125,628 (525) 30,193 (108) 155,755
Comprehensive income:
Net earnings ............... -- -- -- -- -- -- 38,433 -- 38,433
Translation adjustment ..... -- -- -- -- -- -- -- (12,005) (12,005)
---------
26,428
Repayment of Note Receivable . -- -- -- -- -- 525 -- -- 525
Exercise of stock options .... -- -- 1,636,941 16 13,294 -- -- -- 13,310
Tax benefit relating to
stock options ..... -- -- -- -- 12,000 -- -- -- 12,000
-------------------------------------------------------------------------------------------------
Balance December 31, 1999 ...... -- $ -- 58,363,175 $ 583 $ 150,922 $ -- $ 68,626 (12,113) $ 208,018
=================================================================================================
See accompanying notes.
F-5
39
LHS Group Inc.
Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31
1999 1998 1997
--------------------------------------
(In thousands of U.S. Dollars)
OPERATING ACTIVITIES
Net earnings ............................................... $ 38,433 $ 18,685 $ 10,451
Adjustments to reconcile net earnings to net cash
provided by (used in) operating activities:
Depreciation and amortization ......................... 9,597 5,625 2,955
Provision for deferred income taxes ................... (6,871) 1,229 3,754
Write-off of in-process research and development
related to computer software technology ............. -- 8,200 --
Changes in operating assets and liabilities:
Trade accounts receivable ........................... (28,025) (26,404) (11,313)
Prepaid expenses and other current assets ........... (8,671) (654) (1,600)
Accounts payable .................................... (714) 1,093 5,085
Accrued expenses and other liabilities .............. 6,627 243 7,621
Deferred revenues ................................... 8,746 1,933 (3,644)
Income taxes payable ................................ 23,170 11,548 1,666
--------------------------------------
Net cash provided by operating activities .................. 42,292 21,498 14,975
INVESTING ACTIVITIES
Additions of furniture, fixtures and equipment ............. (10,829) (11,258) (6,844)
Purchase of investments .................................... 2,631 (13,879) (49,560)
Acquisition of business, net of cash acquired .............. -- (2,955) --
Other ...................................................... (2,092) (395) (240)
--------------------------------------
Net cash used in investing activities ...................... (10,290) (28,487) (56,644)
FINANCING ACTIVITIES
Proceeds from issuance of common stock ..................... 13,325 14,039 72,487
Proceeds from bank borrowings .............................. -- 1,000 500
Repayment of bank borrowings ............................... (1,520) (327) (1,661)
Repayment to former shareholder ............................ -- -- (4,153)
Other ...................................................... (251) (670) (629)
--------------------------------------
Net cash provided by financing activities .................. 11,554 14,042 66,544
Effect of exchange rate differences on cash ................ (3,462) 5,580 (211)
--------------------------------------
Increase in cash and cash equivalents ...................... 40,094 12,633 24,664
Cash and cash equivalents at beginning of period ........... 46,794 34,161 9,497
--------------------------------------
Cash and cash equivalents at end of period ................. $ 86,888 $ 46,794 $ 34,161
======================================
ADDITIONAL CASH FLOW INFORMATION
Cash paid for interest ..................................... $ 348 $ 325 $ 198
======================================
Cash paid for income taxes ................................. $ 3,024 $ 1,386 $ 260
======================================
See accompanying notes.
F-6
40
LHS Group Inc.
Notes to Consolidated Financial Statements
December 31, 1999
(In Thousands of U.S. Dollars)
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of LHS Group Inc. and
its wholly-owned subsidiaries ("LHS Group" or the "Company"). Significant
intercompany accounts and transactions have been eliminated in preparing the
accompanying financial statements.
In June 1999, the Company acquired Priority Call Management, Inc. ("Priority
Call") in a transaction accounted for as a pooling of interests (see note 4
where discussed). The Company's consolidated financial statements and the notes
to the consolidated financial statements have been restated to include the
results of Priority Call for all periods presented.
Business Activity and Basis of Revenue Recognition
The Company provides scaleable client/server-based billing and customer care
solutions to carriers in the telecommunications industry. Solutions based on the
Company's software products enable carriers to offer flexible, customer-
tailored, cost-effective billing and customer care services in the wireless and
wireline telecommunications markets. LHS configures its proprietary software
tools to give each carrier a flexible and cost-effective billing solution
tailored to specific network technology and marketing needs.
The Company derives revenues from license fees and fees for its services.
License revenues consist of license fees for the Company's client/server-based
software and service revenues consist of fees for implementation and production
support services. The typical BSCS license is perpetual and non-refundable by
the Company.
The Company's customers often require significant customization of the software
products and, therefore, the license and service fees are recognized as long
term contracts in conformity with Accounting Research Bulletin ("ARB") No. 45
"Long Term Construction Type Contracts", Statement of Position ("SOP") 81-1
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts" and SOP 97-2 "Software Revenue Recognition". For long term contracts,
revenue is recognized using the percentage of completion method of accounting
based on hours worked on the project compared to the total hours expected to be
worked through completion. Revenue related to ongoing production support
services following the completion of the initial production launch of the
software is recognized as the work is performed. Revenue from maintenance
services are recognized ratably over the term of the maintenance contract.
Deferred revenue represents cash collections from customers in advance of the
performance of the work.
License revenues for one-time licenses without significant customization are
recognized upon delivery of the software to the customer unless the Company has
significant related obligations remaining or the collectibility of the
receivable is doubtful. When significant obligations remain after the software
product has been delivered or the collectibility of the receivable is doubtful,
revenue is not recognized until such obligations have been completed and the
collectibility of the software is no longer doubtful.
Additional license revenues are recognized and realized only when the Company is
notified that the number of customer subscribers supported by the software
exceeds the number of subscribers for which the customer is currently licensed.
Losses on long-term contracts are recognized in the period that the anticipated
loss is identified.
F-7
41
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Business Activity and Basis of Revenue Recognition (continued)
In accordance with the provisions of ARB No. 45, SOP 81 and SOP 97-2 trade
accounts receivable includes amounts earned by the Company but not yet billed to
the customer as stipulated based on milestones defined in certain contracts. At
December 31, 1999 and 1998, trade accounts receivable includes $13,540 and
$10,823 of unbilled receivables.
Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Marketable Securities
Management determines the appropriate classification of debt securities at the
time of purchase and reevaluates such designation as of each balance sheet date.
Debt securities are classified as held-to-maturity when the Company has the
positive intent and ability to hold the securities to maturity. Held-to-maturity
securities are stated at amortized cost, adjusted for amortization of premiums
and accretion of discounts to maturity. Such amortization is included in
interest income from investments. Interest on securities classified as
held-to-maturity is included in interest income from investments.
Marketable equity securities and debt securities not classified as
held-to-maturity are classified as available-for-sale. Available-for-sale
securities are carried at fair value, with the unrealized gains and losses, net
of tax, reported in a separate component of shareholder's equity. The amortized
cost of debt securities in this category is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization is included
in interest income from investments. Realized gains and losses and declines in
value judged to be other-than-temporary on available-for-sale securities are
included in interest income from investments. The cost of securities sold is
based on the specific identification method. Interest and dividends on
securities classified as available-for-sale are included in interest income from
investments.
Furniture, Fixtures, and Equipment
Furniture, fixtures and equipment are stated at cost. Depreciation and
amortization is provided over the estimated useful lives of the assets or the
term of the lease on a straight-line basis.
Depreciation and amortization expense for the years ended December 31, 1999,
1998, and 1997 was $8,836, $5,130 and $2,955 respectively.
Research and Development Costs
Research and development expenses consist primarily of salaries, benefits,
equipment and allocable overhead for software engineers, pre-production quality
assurance personnel, program managers and technical writers. Research and
development expenses relate to activities performed prior to commercial
production of a product. To date we have not capitalized any development costs
because our short development cycle has historically resulted in only
immaterial amounts of development costs that were eligible for capitalization.
F-8
42
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Translation of Foreign Currencies
All assets and liabilities are translated into U.S. Dollars using the exchange
rate in effect at the balance sheet date. All revenue, costs and expenses are
translated using an average exchange rate. The gains and losses of foreign
subsidiaries resulting from the change in exchange rates from year to year have
been reported separately as a component of stockholders' equity. The effect on
the statements of income of transaction gains and losses is insignificant for
all years presented.
Income Taxes
The Company accounts for income taxes under the liability method. Under the
liability method, deferred income taxes are recorded to reflect the net tax
effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting and the amounts used for income tax
purposes.
Intangible Assets
Intangible assets result from acquisitions accounted for under the purchase
method. (See Note 4.) Amortization of intangible assets is provided on the
straight-line basis over the respective estimated useful lives of the assets.
The Company periodically evaluates whether changes have occurred that would
require revision of the remaining estimated useful life of the assigned
intangible assets or render the intangible assets not recoverable. If such
circumstances arise, the Company would use an estimate of the undiscounted value
of expected future operating cash flows to determine whether the goodwill or
intangibles are impaired. To date, no such impairment losses have been recorded.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrated
credit risks consists primarily of cash and cash equivalents, short-term
marketable debt securities and trade receivables. The Company maintains cash and
cash equivalents with various financial institutions. The Company policy is
designed to limit exposure to any one institution. Due to the size and terms of
certain customer contracts and the industry in which the Company competes, trade
accounts receivable include amounts due from certain customers that are
considered significant in relation to total trade accounts receivable.
Fair Value of Financial Instruments
The carrying value of financial instruments such as cash, accounts receivable
and accounts payable approximate their fair value based on the short-term
maturities of these instruments. The carrying value of bank debt approximates
fair value based on quoted market prices for the same or similar issues as well
as the current rates offered to the Company. (See Note 3 for fair value
disclosures regarding marketable securities)
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
F-9
43
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
2. CAPITALIZATION
Initial Public Offering
In May, 1997, the Company sold 9,730,000 shares of its Common Stock in an
Initial Public Offering ("IPO") in which it received approximately $70,630 in
net proceeds. At the completion of the offering, 225,000 shares of the Company's
Series A Convertible Preferred Stock were converted into 9,000,000 shares of
Common Stock.
Common Stock
Effective May of 1998, the Company amended its certificate of incorporation to
increase the authorized Common Stock to 200,000,000 shares, and effected a 2-
for-1 Common Stock split. All common share and per common share amounts have
been adjusted for all periods to reflect the stock split.
Preferred Stock
The board of directors of the Company is authorized to issue up to 225,000
shares of preferred stock, par value $.01 per share, in one or more series and
to fix the powers, voting rights, designations and preferences of each series.
During 1995, the board of directors authorized for issuance 225,000 shares of
Preferred Stock ranking senior to common stock. The Preferred Stock ranked
senior to common stock and was entitled to dividends, if declared by the board
of directors, in an amount equal to the pro rata share that would have been
received had the Preferred Stock been converted to common stock. Upon
liquidation, holders of Preferred Stock, on an equal basis, are entitled to
receive the preference value of $88.89, plus accumulated and unpaid dividends,
if any, before any distribution or payment is made to the holders of common
stock. No dividends have been declared or paid on Preferred Stock.
The holders of Preferred Stock had the right to vote at special or annual
meetings of stockholders on all matters entitled to be voted on by holders of
common stock voting together as a single class with other shares entitled to
vote thereon. With respect to such vote, each share of Preferred Stock shall
entitle the holder to cast that number of votes per share as would be cast had
the Preferred Stock been converted to common stock at the Conversion Ratio.
At the time of the initial public offering in 1997, the holders of Preferred
Stock converted each share of Preferred Stock into 40 shares of common stock.
Per Share Data
Earnings per share was computed by dividing net earnings by the weighted average
number of shares of Common Stock outstanding. Retroactive effect has been given
to share and per share amounts for the stock split as noted above.
In February 1998, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 98 ("SAB 98"), which revised the guidance for earnings per share
calculations in an IPO. As a result of SAB 98, the Company restated its 1997
earnings per share calculation by excluding the effect of cheap stock, which was
included in the calculation of weighted shares outstanding for the period prior
to the public offering.
Diluted EPS for the years ended December 31, 1999, 1998 and 1997 includes the
effect of options to purchase 1,809,487, 3,195,622 and 3,070,616 shares of
common stock, respectively and 37,019, 56,235 and 65,626 shares of restricted
common stock, respectively. Diluted EPS in 1997 also includes the weighted
average effect of the conversion of Preferred Stock into Common Stock prior to
the IPO. The effect was to increase diluted weighted average shares outstanding
by 3,328,768 in 1997. Options to purchase 4,160,210 shares of common stock at
prices ranging from $31.28 to $65.37 were outstanding during 1999 and options to
purchase 627,000 shares of common stock at prices ranging from $51.00 to $66.12
were outstanding during 1998 and options to purchase 1,824,000 shares of common
stock at prices ranging from $20 to $30 per share were outstanding during 1997,
but were not included in the computations of diluted earnings per share because
the options' exercise price was greater than the average market price of the
common shares and, therefore, the effect would be antidilutive.
F-10
44
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
3. MARKETABLE SECURITIES
The following is a summary of investments in marketable debt securities that the
Company has classified as held-to-maturity securities:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ---------- ---------- ----------
DECEMBER 31, 1999
Obligations of U.S. Government agencies .... $ 1,499 $ -- $ (1) $ 1,498
U.S. Corporate Securities .................. 49,310 26 (324) 49,012
------- ----- -------- -------
$50,809 $ 26 $ (325) $50,510
======= ===== ======== =======
DECEMBER 31, 1998
Obligations of U.S. Government agencies .... $20,739 $ 28 $ (2) $20,765
U.S. Corporate Securities .................. 41,479 26 (26) 41,479
------- ----- -------- -------
$62,218 $ 54 $ (28) $62,244
======= ===== ======== =======
The amortized cost and estimated fair value of debt securities held to maturity
at December 31, 1999 by contractual maturity are shown below. All debt
securities held-to-maturity at December 31, 1998 were due in one year or less.
AMORTIZED ESTIMATED
COST FAIR VALUE
--------- ----------
DECEMBER 31, 1999
Due in one year or less .................... $49,009 $48,749
Due after one year ......................... 1,800 1,761
------- -------
$50,809 $50,510
======= =======
There was no difference in the cost and estimated fair value of investments in
marketable equity securities that the Company has classified as
available-for-sale securities.
F-11
45
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
4. ACQUISITIONS
In June 1999, the Company completed its merger with Priority Call, in which
Priority Call became a wholly owned subsidiary of LHS Group Inc. The Company
exchanged 4,105,120 shares of Common Stock for all the outstanding common
shares, preferred shares, and stock options or stock appreciation rights in
Priority Call. The Company recorded a charge of $4,320 in the second quarter
ended June 30, 1999 related to direct external costs incurred as a result of the
merger with Priority Call. Priority Call is a provider of network-based
solutions that enable telecommunications providers to offer subscribers a range
of enhanced services, including prepaid calling, credit/debit card calling,
enhanced messaging and one-number "follow-me" services.
The Priority Call acquisition was accounted for as a pooling of interests, and
accordingly, the Company's consolidated financial statements and notes thereto
have been restated to include the financial position and results of these
mergers for all periods presented. The following information shows revenue and
net income (loss) of the separate companies for the periods preceding the
combination (in thousands):
Year Ended December 31,
1998 1997
Revenues:
LHS $ 163,182 $ 105,411
Priority Call 30,936 20,111
--------- ---------
Combined $ 194,118 $ 125,522
========= =========
Net income (loss):
LHS $ 17,349 $ 11,208
Priority Call 1,336 (757)
--------- ---------
Combined $ 18,685 $ 10,451
========= =========
In June 1998, the Company acquired the stock of Infocellular, Inc.
("Infocellular") for $8,484, paid by the issuance of 117,885 shares of Common
Stock and $1,327 in cash. Infocellular, which operates as a wholly-owned
subsidiary of the Company, is engaged in the business of providing point of sale
and customer acquisition software and related services to telecommunication
service providers. The purchase price was allocated as follows:
Purchased in-process research and development related to
computer software technology............................. $ 8,200
Fully developed computer software technology................ 500
Current assets.............................................. 1,327
Furniture and fixtures...................................... 716
Other assets................................................ 127
Other intangible assets..................................... 500
Current liabilities......................................... (4,348)
Goodwill.................................................... 1,462
-------------
Total purchase price........................................ $ 8,484
=============
F-12
46
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
The acquisition was accounted for as a purchase and the results of
Infocellular's operations have been included in the consolidated financial
statements of LHS Group Inc. effective June 11, 1998. Goodwill recorded in
connection with this acquisition is being amortized over five years.
The valuations of core and developed technologies and in-process research and
development were based on the present value of estimated future cash flows over
the lesser of: (i) five years or (ii) the period in which the product is
expected to be integrated into an existing LHS product. The resulting values
were reviewed for reasonableness based on the time and cost spent on the effort,
the complexity of the development effort and, in the case of in-process
development projects, the stage to which it had progressed. For in-process
research and development, the valuation was reduced for the core technology
component of such product and the percentage of product development remaining at
the acquisition date. The resulting in-process research and development amount
of $8,200 is reflected as a charge in the 1998 statement of operations. No
income tax benefit was recognized on the write-off of the purchased in-process
research and development related to computer software technology because the
merger was structured as tax free to the selling shareholders and the write-off
of this asset and the amortization of the other intangibles will not be
deductible for federal income tax purposes.
The following table summarizes pro forma unaudited results of operations as if
the acquisition was concluded on January 1, 1997. The adjustments to the
historical data reflects the amortization of goodwill and intangibles. This
unaudited pro forma financial information is not necessarily indicative of what
the combined operations would have been if LHS had control of Infocellular for
the periods presented.
1998 1997
-------- --------
Revenues ............................... $195,832 $130,472
Earnings before interest and taxes ..... 37,571 4,590
Net Earnings ........................... 25,564 259
Per share:
Basic net earnings ................... $ 0.46 $ 0.01
Diluted net earnings ................. $ 0.43 $ 0.00
F-13
47
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
5. DEBT
The Company has a short-term credit facility with a bank under which it can
borrow up to $2,500 at 7.5% per annum. At December 31, 1998, the Company had
$2,300 of outstanding letters of credit. Outstanding letters of credit incur a
fee of 1.5% of the amount outstanding. No other borrowings were outstanding
under the facility at December 31, 1999 or 1998.
The Company's Priority Call subsidiary has a security agreement with a bank,
which allows the Company to borrow the lesser of (i) $2,000 or (ii) 80% of
eligible accounts receivable (working capital line) and up to $1,000 for
equipment purchases (equipment line). Borrowings under the working capital line
accrue interest at the bank's prime rate (8.5% at December 31, 1999) and
borrowings under the equipment line accrue interest at the bank's prime rate
plus 1/2%. Accounts receivable and inventory collateralize borrowings against
the working capital line. The equipment purchased collateralizes borrowings
against the equipment line. At December 31, 1998, the Company had a $1,000
advance against the equipment line and no borrowings against the working capital
line. Advances against the equipment note converted to a term note payable as of
December 31, 1998. The term note was repayable in 36 monthly installments of
principal and accrued interest. In addition, the Company had $520 outstanding
under prior agreements with the bank that is being repaid in monthly
installments through January 2001. No borrowings were outstanding under the
security agreement, term note or other agreements at December 31, 1999.
F-14
48
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
6. LEASES
LHS Group leases certain of its office buildings from a Company related through
common ownership under an operating lease agreement which expires in 2005. The
lease agreement requires monthly rental payments of $26 adjusted annually for
inflation. Rental expenses under all operating leases totaled $9,526, $6,034,
and $4,158 for the years ended December 31, 1999, 1998 and 1997, respectively.
Telecommunications equipment in the amount of $598 was acquired under capital
lease arrangements. Future minimum lease payments are as follows:
CAPITAL OPERATING
LEASES LEASES TOTAL
--------------------------------------
2000........................................... $ 192 $ 9,293 $ 9,485
2001........................................... 174 7,973 8,147
2002........................................... 3,664 3,664
2003........................................... 1,324 1,324
2004........................................... 1,086 1,086
------ ------- -------
Total future minimum lease payments ............ 366 $23,340 $23,706
======= =======
Less amounts representing interest ............. (34)
------
Present value of net minimum lease payments .... $ 332
======
F-15
49
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
7. INCOME TAXES
The Company and each of its consolidated subsidiaries file separate tax returns.
For financial reporting, the Company and consolidated subsidiaries calculate
their respective tax liabilities on a separate return basis which are combined
in the accompanying consolidated financial statements.
The provision for income taxes consists of the following:
YEAR ENDED DECEMBER 31
1999 1998 1997
-----------------------------------------
Currently payable income taxes:
U.S. federal ........................ $ 7,233 $ 3,061 $ 931
Foreign ............................. 15,054 12,729 3,620
Deferred income taxes (credit):
U.S. federal ........................ (1,248) (360) (390)
Foreign ............................. 2,150 1,601 3,309
-----------------------------------------
$ 23,189 $ 17,031 $ 7,470
=========================================
The net deferred income tax asset (liability) consists of the following:
DECEMBER 31
1999 1998
-----------------------
Deferred tax assets:
Net operating loss carryforwards ........ $ -- $ 119
Research and development tax credit ..... 1,715 1,616
Inventory Reserve ....................... 344 602
Depreciation Expense .................... 389 --
Accrued vacation and bonuses ............ 547 916
Tax on foreign differences .............. 3,443 86
Warranty expense ........................ 377 322
Allowance for doubtful accounts ......... 752 419
Allowance for current unbilled .......... 424 --
Accrued commission and contractor ....... 317 --
Other ................................... 729 1,647
Valuation allowance ..................... -- (2,423)
-----------------------
9,037 3,304
Deferred tax liabilities:
Unbilled receivables .................... (2,101) (1,075)
Depreciation expense .................... (7) (83)
Other ................................... (1,353) --
Tax on foreign differences .............. (1,918) (5,359)
-----------------------
(5,379) (6,517)
-----------------------
$ 3,658 $(3,213)
=======================
F-16
50
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
The reconciliation of income tax expense computed using the statutory tax rates
in the United States to the income tax expense recognized in the financial
statements is as follows:
YEAR ENDED DECEMBER 31
1999 1998 1997
--------------------------------------
Tax at statutory rates ...................... $21,315 $ 12,144 $6,094
Differences resulting from higher tax
rates in foreign countries ................. 976 2,564 1,119
Non-deductible write off of in-process
research and development ................... -- 2,778 --
Non-deductible write off of merger costs .... 898 -- --
Other ....................................... -- (455) 257
--------------------------------------
$23,189 $ 17,031 $7,470
======================================
During 1999, 1998 and 1997 the Company received $33,111, $66,500 and $10,387,
respectively, in tax deductions from the exercise of nonqualified employee stock
options of which $12,000, $10,161 and $931, respectively, was realized and
recognized as a reduction to taxes currently payable and an increase to equity.
At December 31, 1999 and 1998, the Company had tax net operating loss
carryforwards of $64,973 and $58,908 which is primarily the result of the tax
deductions from the exercises of the nonqualified stock options. The benefit of
the tax net operating loss carryforwards will be credited to additional
paid-in-capital when realized and is not reflected in deferred tax assets at
December 31, 1999.
F-17
51
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
8. RELATED PARTY TRANSACTIONS
The Company leases office space and housing space for certain of its employees
from partnerships consisting in part of one of the Company's directors. During
the years ended December, 31, 1999, 1998, and 1997, the Company made lease
payments totaling $314, $382, and $387, respectively, to the partnerships. The
Company periodically charters the use of an aircraft owned by a director of the
Company. During the years ended December 31, 1999 and 1998, the Company paid
approximately $172 and $103 for its use of the aircraft.
9. MAJOR CUSTOMERS
No customer accounted for more than 10% of revenues in 1999 and 1998 while in
1997, one customer accounted for 12% of revenues.
10. RETIREMENT PLANS
The Company maintains the LHS Communications Systems, Inc. 401(k) Plan ("LHS
Plan") and the Priority Call Management, Inc. 401(k) Profit Sharing Plan ("PCM
Plan"). Employees age 21 or older are eligible to participate in the quarter
following their date of hire and to elect to defer a percentage of his/her
salary. The Company has the discretion to make contributions to the 401(k)
plans. During 1999 and 1998, the Company made matching contributions to the LHS
Plan of $1,129 and $520, respectively. During 1999 and 1998, the Company made no
matching contributions to the PCM Plan.
F-18
52
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
11. EMPLOYEE STOCK PLANS
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
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
Based Compensation," ("SFAS 123") requires use of option valuation models that
were not developed for use in valuing employee stock options. Under APB 25,
when the exercise price of the Company's employee stock options equals the
market price of the underlying stock on the date of grant, no compensation
expense is recognized.
The Company has a nonqualified Stock Incentive Plan (the "Plan") under which
stock options, restricted stock and other stock-based awards may be granted to
certain officers, directors, key employees and non-employee directors. Awards
may be granted under the Plan for up to 16,000,000 shares of common stock. All
options are exercisable over a five year period with 25% vesting on the first
anniversary of the grant date and the remaining 75% vesting ratable over 48
months. The terms of the options are 10 years from the date of the grant at
which time all unexercised options expire and are again available for future
grant.
The company has an Employee Stock Purchase Plan ("ESPP"), established in 1998,
under which employees may subscribe to purchase shares of Common Stock through
payroll deductions of up to 15% of eligible compensation. The purchase price is
the lower of 85% of market value at the beginning or the end of the
participation period. The aggregate number of shares purchased by an employee
may not exceed 1000 shares and $25 of fair market value annually. A total of
500,000 shares are available for purchase under the plan. During the years ended
December 31, 1999 and 1998, options for 52,164 and 24,134 were exercised at a
weighted average price per share of $27.85 and $51.62, respectively.
Pro forma information regarding net earnings and earnings per share is required
by SFAS 123, which also requires that the information be determined as if the
Company has accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. In 1997, the
fair value for options granted was estimated at the date of grant using the
Black Scholes option pricing models with the following assumptions: volatility
of .778; average risk-free interest rate of 6.2%; no anticipated dividends; and
a weighted-average expected life of the option of 5.3 years. In 1998, the fair
value for options granted was estimated at the date of grant using the Black
Scholes option pricing models with the following assumptions: volatility of
.713; average risk-free interest rate of 5.50%; no anticipated dividends; and a
weighted-average expected life of the option of 5.2 years. In 1999, the fair
value for options granted was estimated at the date of grant using the Black
Scholes option pricing models with the following assumptions: volatility of
.644; average risk-free interest rate of 5.56%; no anticipated dividends; and a
weighted-average expected life of the option of 5.1 years.
Option valuation models require the input of highly subjective assumptions.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options. The weighted average
grant date fair value of options granted during the year 1997 using the minimum
value option pricing model was $28.65. The weighted average grant date fair
value of options granted during 1998 and 1999 using the Black-Scholes option
pricing model was $25.65 and $20.09, respectively.
For purposes of SFAS 123 pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period as follows:
1999 1998 1997
---------- --------- ---------
Pro forma net earnings ............ $ 21,160 $ 7,520 $ 7,792
Basic earnings per share .......... $ 0.37 $ 0.13 $ 0.17
Diluted earnings per share ........ $ 0.36 $ 0.12 $ 0.15
F-19
53
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
A summary of the Company's stock option activity, and related follows:
WEIGHTED
NUMBER OF AVERAGE PRICE
SHARES ISSUED PER SHARE
------------------------------------
Outstanding as of January 1, 1997........... 6,682,149 $ 3.01
Granted.................................. 2,412,776 19.67
Exercised................................ (700,710) 2.65
Cancelled................................ (673,053) 3.26
------------------------------------
Outstanding as of December 31, 1997......... 7,721,162 8.22
Granted.................................. 2,670,320 37.87
Exercised................................ (2,070,955) 7.03
Cancelled................................ (640,579) 8.76
------------------------------------
Outstanding as of December 31, 1998......... 7,679,948 18.71
Granted.................................. 5,228,218 33.52
Exercised................................ (1,636,941) 6.86
Cancelled................................ (2,435,875) 28.06
------------------------------------
Outstanding as of December 31, 1999......... 8,835,350 $ 27.35
====================================
Exercisable as of December 31, 1999......... 1,899,559 $ 17.83
====================================
Exercisable as of December 31, 1998......... 1,483019 $ 5.06
====================================
Information regarding stock options outstanding as of December 31, 1999 is as
follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ---------------------------------------------------------------------- -----------------------------
WEIGHTED
AVERAGE WEIGHTED- WEIGHTED-
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ---------------------------------------------------------------------- -----------------------------
$2.65 1,485,515 6.4 $ 2.65 739,788 $ 2.65
$ 4.25 - 5.84 275,688 5.9 5.56 220,970 5.49
$ 7.12 - 8.92 251,526 7.7 7.65 90,877 7.55
$11.04 - 14.87 76,390 8.2 14.01 24,418 14.21
$16.99 - 25.00 809,364 8.1 21.83 174,763 22.67
$25.63 - 38.31 4,151,166 9.2 30.80 436,512 34.02
$41.87 - 58.62 1,780,701 8.9 47.99 210,591 50.96
$65.37 - 65.37 5,000 8.5 65.37 1,640 65.37
- ------------------------------------------------------------------------------------------------------
$ 2.65 - 65.37 8,835,350 8.5 $ 27.35 1,899,559 $ 17.83
====================================================================== =============================
F-20
54
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
12. SEGMENT INFORMATION
In accordance with the requirements of SFAS 131, the following disclosure
represents the information used by management when evaluating the operating
performance of its operating segments. The information reviewed by management
includes the operating revenue from external customers and identifiable assets
for the Company's three geographic areas, the Americas, Europe and
Asia-Pacific:
1999 1998 1997
---------------------------------------
Revenues:
Americas........................... $ 113,814 $ 85,816 $ 58,569
Europe............................. 118,425 86,099 50,462
Asia-Pacific....................... 30,357 22,203 16,491
---------------------------------------
Total in financial statements......... $ 262,596 $ 194,118 125,522
=======================================
Long-lived assets:
Americas........................... $ 27,990 $ 16,688
Europe............................. 9,789 6,589
Asia-Pacific....................... 836 681
------------------------
Total in financial statements......... $ 38,615 $ 23,958
========================
F-21
55
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
13. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). The Company
reported comprehensive income in its statement of stockholders' equity. The
adoption of SFAS 130 resulted in revised and additional disclosures but had no
effect on the financial position, results of operations, or liquidity of the
Company.
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131"), which establishes standards for the way public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information
about operating segments in interim financial reports issued to shareholders.
Operating segments are components of an enterprise about which separate
financial information is available which is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in assessing
performance. SFAS 131 also establishes standards for related disclosures about
products and services, geographic areas, and major customers. The Company
adopted SFAS 131 in 1998, and the effect of the adoption was not material to
the consolidated financial statements. (see Note 12).
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities", which
requires the recognition of all derivatives as either assets or liabilities in
the balance sheet and the measurement of those instruments at fair value. The
accounting for changes in the fair value of a derivative depends on the planned
use of the derivative and the resulting designation. The Company is required to
implement the statement in the first quarter of the year 2001. The Company has
not used derivative instruments and believes the impact of adoption of this
statement will not have significant effect on the financial statements.
The American Institute of Certified Public Accountants issued SOP 97-2, SOP
98-4 and SOP 98-9 to clarify guidance on applying generally accepted accounting
principles to software transactions and to provide guidance on when revenue
should be recognized and in what amounts for licensing, selling, leasing, or
otherwise marketing computer software. The Company adopted this guidance during
1997. Such adoption had no effect on the Company's methods of recognizing
revenue.
On December 3, 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"). SAB 101 summarizes certain areas of
the Staff's views in applying generally accepted accounting principles to
revenue recognition in financial statements. The Company believes that its
current revenue recognition principles comply with SAB 101.
F-22
56
LHS Group Inc.
Notes to Consolidated Financial Statements (continued)
14. UNAUDITED QUARTERLY INFORMATION
QUARTER ENDED
------------------------------------------------------------------------
March 31, 1999 June 30, 1999 Sept. 30, 1999 Dec. 31, 1999
------------------------------------------------------------------------
Revenues ................................. $ 58,878 $ 66,021 $ 67,985 $ 69,711
Gross margin ............................. 37,242 42,298 45,499 48,174
Net earnings (loss) ...................... 8,249 6,154 11,738 12,292
Net earnings (loss) per share (diluted)
Basic ............................... $ .15 $ .11 $ .20 $ .21
Diluted ............................. $ .14 $ .10 $ .20 $ .21
QUARTER ENDED
------------------------------------------------------------------------
March 31, 1998 June 30, 1998 Sept. 30, 1998 Dec. 31, 1998
------------------------------------------------------------------------
Revenues ................................. $ 39,281 $ 44,087 $ 52,119 $ 58,631
Gross margin ............................. 23,461 26,854 32,191 36,819
Net earnings (loss) ...................... 4,500 (2,062) 7,293 8,954
Net earnings (loss) per share (diluted)
Basic ............................... $ .08 $ (0.04) $ .13 $ .16
Diluted ............................. $ .08 $ (0.04) $ .13 $ .15
15. SUBSEQUENT EVENT -- UNAUDITED
On March 15, 2000, Sema Group plc ("Sema") entered into a definitive agreement
with the Company to acquire all of the outstanding shares of LHS Group Inc. The
Company's stockholders will receive American Depository Shares representing 2.6
new Sema ordinary shares for each LHS share. The transaction is subject to
stockholder votes, regulatory approvals and other customary closing conditions.
F-23