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DST > SEC Filings for DST > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for DST SYSTEMS INC

Form 10-Q for DST SYSTEMS INC


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The discussions set forth in this Quarterly Report on Form 10-Q contain statements concerning potential future events. Such forward-looking statements are based upon assumptions by the Company's management, as of the date of this Quarterly Report, including assumptions about risks and uncertainties faced by the Company. In addition, management may make forward-looking statements orally or in other writings, including, but not limited to, in press releases, in the annual report and in the Company's other filings with the Securities and Exchange Commission ("SEC"). Forward-looking statements include, but are not limited to, (i) all statements, other than statements of historical fact, that address activities, events or developments that we expect or anticipate will or may occur in the future or that depend on future events, or (ii) statements about our future business plans and strategy and other statements that describe the Company's outlook, objectives, plans, intentions or goals, and any discussion of future operating or financial performance. Whenever used, words such as "may," "will," "would," "should," "potential,", "strategy," "anticipates," "estimates," "expects," "project," "predict," "intends," "plans," "believes," "targets" and other terms of similar meaning are intended to identify such forward-looking statements. Forward-looking statements are uncertain and to some extent unpredictable, and involve known and unknown risks, uncertainties, and other important factors that could cause actual results to differ materially from those expressed or implied in, or reasonably inferred from, such forward-looking statements. If any of management's assumptions prove incorrect or should unanticipated circumstances arise, the Company's actual results could materially differ from those anticipated by such forward looking statements. The differences could be caused by a number of factors or combination of factors including, but not limited to, those factors referred to below in Part II, Item 1A, "Risk Factors." Readers are strongly encouraged to consider those factors when evaluating any forward looking statements concerning the Company. The Company's reports filed with or furnished to the SEC on Form 8-K, Form 10-K, Form 10-Q and other forms and any amendments to those reports, may be obtained by contacting the SEC's Public Reference Branch at 1-800-SEC-0330 or by accessing the forms electronically, free of charge, through the SEC's Internet website at http://www.sec.gov or through the Company's Internet website, as soon as reasonably practicable after filing with the SEC, at http://www.dstsystems.com. The Company undertakes no obligation to update any forward-looking statements in this Quarterly Report on Form 10-Q to reflect new information, future events or developments, or otherwise.

The information contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto included in this Form 10-Q and the audited Consolidated Financial Statements and Notes thereto in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

INTRODUCTION

DST Systems, Inc. (the "Company" or "DST") provides sophisticated information processing and software services and products to the financial services industry (primarily mutual funds, broker/dealers and investment managers), telecommunications, video and utilities industries, the healthcare industry and other service industries.

The Company's operating business units are reported as two operating Segments (Financial Services and Output Solutions). In addition, investments in the Company's real estate subsidiaries and joint ventures, equity securities, private equity funds, and certain financial interests have been aggregated into the Investments and Other Segment.

A summary of each of the Company's Segments follows:

Financial Services

The Company's Financial Services Segment provides technology based solutions using its own proprietary software systems. The principal industries serviced include mutual fund/investment management, brokerage, retirement, life and property/casualty insurance and healthcare payer industries. The Company's proprietary software systems include shareowner recordkeeping and distribution support systems for United States ("U.S.") and international mutual fund companies, broker/dealers and financial advisors; a defined-contribution participant recordkeeping system for the U.S. retirement plan market; investment management systems offered to U.S. and international investment managers and fund accountants; a business process management and customer contact system offered to


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a broad variety of industries; medical and pharmacy claims administration processing systems and services offered to providers of healthcare plans, third party administrators, medical practice groups and pharmacy benefit managers; and an electronic file system offered to mutual fund companies, insurance companies and professional service (legal, accounting and others) firms. In certain cases, multiple products are integrated into a single solution.

The Financial Services Segment distributes its services and products on a direct basis and through subsidiaries and joint venture affiliates in the U.S., United Kingdom ("U.K."), Canada, Europe, Australia, South Africa, Asia-Pacific and the Middle East and, to a lesser degree, distributes such services and products through various strategic alliances.

Output Solutions

The Company's Output Solutions Segment prints, mails and electronically delivers transactional, marketing and compliance documents. The Segment's single source, customer communications solutions include customized statement and bill production; postal optimization; electronic presentment, payment and distribution solutions; fulfillment; direct marketing; and data-driven personalization services. These capabilities enable the Output Solutions Segment to provide services to industries that place a premium on high-quality, highly relevant customer communications.

The Output Solutions North America business has operating facilities located in the United States and Canada, and is among the largest users of continuous, high-speed, full-color inkjet printing systems and among the largest First-class mailers in the United States. The North America business provides digital print, direct marketing and fulfillment services, in addition to electronic solutions. The acquisition of Newkirk Products, Inc. in 2011 expanded the North America business to include participant enrollment and compliance communications related to retirement, insurance, mutual funds and healthcare plans. The business also provides significant cross-sell opportunities and leverage in DST's retirement and healthcare-related businesses.

The Output Solutions Segment in North America distributes its products directly to clients and through relationships in which its services are combined with or offered concurrently through providers of data processing services. The Output Solutions Segment's products in North America are also distributed or bundled with product offerings to clients of the Financial Services Segment.

Output United Kingdom ("Output U.K." and formerly known as Innovative Output Solutions Limited or "IOS") has several operating facilities in the United Kingdom and is among the largest direct communications manufacturers in that country. The acquisition of Lateral Group Limited in 2011 expanded the U.K. business to include data analytics and enhanced data-driven marketing services.

Investments and Other

The Investments and Other Segment is comprised of investments in the Company's real estate subsidiaries and joint ventures, equity securities, private equity funds, and certain financial interests. The assets held by the Investments and Other Segment are primarily passive in nature. The Company owns and operates real estate mostly in the U.S. and U.K., primarily for lease to the Company's other business segments. The Company is a partner in certain real estate joint ventures that lease office space to the Company, certain of its unconsolidated affiliates and unrelated third parties. The Investments and Other Segment holds investments in available-for-sale equity securities with a market value of approximately $606.1 million at September 30, 2012, including approximately 10.1 million shares of State Street Corporation ("State Street") and 1.9 million shares of Euronet Worldwide, Inc., with a market value of $423.0 million and $35.4 million respectively, based on closing exchange values at September 30, 2012.


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The following table summarizes the square footage of U.S. real estate facilities wholly-owned by DST or owned through unconsolidated affiliates of DST as of September 30, 2012 (in millions):

                                           DST      Joint
                                         wholly-   venture-
                                         owned*     owned*

Occupied by DST and related affiliates       1.9        0.5

Occupied by third parties                    0.9        2.4

Total                                        2.8        2.9

* Amounts exclude square footage of wholly-owned data centers and related property and a joint venture-owned 1,000 room convention hotel.

DST considers its data centers and surrounding property to be specialized operational assets and does not consider them to be real estate assets. Therefore, its data centers are not included in its real estate operations, but rather the Financial Services Segment.


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RESULTS OF OPERATIONS



The following table summarizes the Company's operating results (in millions,
except per share amounts):



                                        Three Months Ended           Nine Months Ended
                                          September 30,                September 30,
                                       2012           2011           2012          2011
Revenues
Operating revenues
Financial Services                  $     304.6    $     277.0    $    923.2    $    842.3
Output Solutions                          159.6          157.2         483.7         447.8
Investments and Other                      15.1           14.3          44.6          42.1
Elimination Adjustments                   (15.3 )        (15.4 )       (46.1 )       (45.5 )
                                          464.0          433.1       1,405.4       1,286.7
% change from prior year period             7.1 %                        9.2 %

Out-of-pocket reimbursements
Financial Services                         12.9            9.5          40.5          30.3
Output Solutions                          156.9          150.1         477.7         451.2
Investments and Other                       0.1            0.1           0.2           1.5
Elimination Adjustments                    (1.9 )         (1.4 )        (5.8 )        (4.4 )
                                          168.0          158.3         512.6         478.6
% change from prior year period             6.1 %                        7.1 %

Total revenues                      $     632.0    $     591.4    $  1,918.0    $  1,765.3
% change from prior year period             6.9 %                        8.7 %

Income from operations
Financial Services                  $      52.0    $      59.6    $    152.9    $    186.7
Output Solutions                           10.6            1.9          22.4          16.3
Investments and Other                     (13.6 )          1.7         (11.3 )         6.7
Elimination Adjustments                    (1.9 )         (2.0 )        (5.9 )        (5.9 )
                                           47.1           61.2         158.1         203.8

Interest expense                          (10.6 )        (10.9 )       (34.0 )       (34.6 )
Other income (expense), net                72.4           (4.5 )       296.3          27.3
Equity in earnings of
unconsolidated affiliates                   3.1            1.7           9.8          17.3
Income before income taxes and
non-controlling interest                  112.0           47.5         430.2         213.8
Income taxes                               26.1           14.0         144.1          72.8
Net income                                 85.9           33.5         286.1         141.0
Net loss attributable to
non-controlling interest                                   1.8                         2.9
Net income attibutable to DST
Systems, Inc.                       $      85.9    $      35.3    $    286.1    $    143.9

Basic earnings per share            $      1.90    $      0.77    $     6.38    $     3.11
Diluted earnings per share          $      1.87    $      0.76    $     6.27    $     3.07
Non-GAAP diluted earnings per
share                               $      0.96    $      0.90    $     2.78    $     3.02
Cash dividends per share of
common stock                        $              $      0.35    $     0.40    $     0.70


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Consolidated revenues

Consolidated total revenues (including out-of-pocket ("OOP") reimbursements) for the three and nine months ended September 30, 2012 were $632.0 million and $1,918.0 million, respectively, an increase of $40.6 million or 6.9% and $152.7 million or 8.7% compared to the three and nine months ended September 30, 2011. Consolidated operating revenues for the three and nine months ended September 30, 2012 increased $30.9 million or 7.1% and $118.7 or 9.2%, respectively, as compared to the same periods in 2011. The increase in consolidated operating revenues during the three months ended September 30, 2012 was attributable to an increase of $27.6 million in the Financial Services Segment and $2.4 million in the Output Solutions Segment. The increase in Financial Services operating revenues for the three months ended September 30, 2012 is primarily from DST's acquisition of ALPS Holdings, Inc. ("ALPS") on October 31, 2011, which contributed $25.3 million of operating revenues for the three months ended September 30, 2012. Increased revenues from DST HealthCare were offset by decreased revenues from mutual fund shareowner processing. The increase in Output Solutions operating revenues for the three months ended September 30, 2012 reflects new client volumes in North America and the acquisition of Lateral Group Limited ("Lateral") in August 2011, partially offset by decreased revenues in the United Kingdom.

The increase in consolidated operating revenues during the nine months ended September 30, 2012 was attributable to an increase of $80.9 million in the Financial Services Segment and $35.9 million in the Output Solutions Segment. The increase in Financial Services operating revenues for the nine months ended September 30, 2012 is primarily attributable to DST's acquisition of ALPS, which contributed $72.7 million of operating revenues for the nine months ended September 30, 2012. The increase in Output Solutions operating revenues for the nine months ended September 30, 2012 reflects the acquisition of Lateral and Newkirk Products, Inc. ("Newkirk"), which was acquired in May 2011.

Consolidated OOP reimbursements for the three and nine months ended September 30, 2012 increased $9.7 million or 6.1% and $34.0 million or 7.1%, respectively, as compared to the same periods in 2011. OOP reimbursements for Output Solutions increased $6.8 million or 4.5% and $26.5 million or 5.9% for the three and nine months ended September 30, 2012, respectively, as compared to the same periods in 2011. The increase in Output Solutions OOP reimbursements is attributable to higher volumes from new clients and volumes from Lateral and Newkirk. The increase in Financial Services OOP reimbursements during the three and nine months ended September 30, 2012 is from the inclusion of ALPS.

Income from operations

Consolidated income from operations for the three and nine months ended September 30, 2012, was $47.1 million and $158.1 million, respectively, a decrease of $14.1 million or 23.0% and $45.7 million or 22.4% as compared to the same periods in 2011. The decrease in operating income during the three months ended September 30, 2012 was attributable to a decrease of $7.6 million or 12.8% in Financial Services and $15.3 million in Investments and Other, partially offset by an increase in Output Solutions.

Financial Services income from operations decreased $7.6 million during the three months ended September 30, 2012, primarily from a $9.9 million increase in deferred compensation costs (the effect of which is offset as unrealized appreciation on trading securities in Other income (expense), net). The decrease in Financial Services income from operations is also attributable to lower contributions from mutual fund shareowner account processing, partially offset by contributions from the inclusion of ALPS and increased earnings from the DST Healthcare business. Output Solutions income from operations increased $8.7 million during the three months ended September 30, 2012 primarily due to new client revenue at Output North America and lower compensation and benefit costs at Output U.K. due to reduced headcount. The decrease in Investments and Other operating income for the three months ended September 30, 2012 primarily results from $5.8 million in real estate impairments and a charitable contribution of marketable securities of $11.0 million, which were partially offset by higher operating revenues.


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Discontinuing development of insurance processing solution for insurance market

After a thorough evaluation, DST has ceased the development of a processing solution for the North America insurance market, which was being built around the Percana software licensed from IFDS Ireland, the Company's joint venture with State Street Corporation. DST is discontinuing the development of the solution due to the Company's current outlook for market demand and estimated costs to complete development. This decision does not impact IFDS Ireland or the Company's European solution being provided through IFDS.

As a result of this decision, DST recorded $9.1 million of costs associated with the discontinuation of the insurance solution during the three months ended June 30, 2012. These costs were comprised of asset impairment charges of $5.8 million (principally software costs, both internal and third party, associated with the development of the solution), employee termination expenses of $1.9 million and other operating costs of $1.4 million.

The $45.7 million decrease in operating income during the nine months ended September 30, 2012 was attributable to a decrease of $33.8 million or 18.1% in Financial Services and $18.0 million in Investments and Other. Excluding $9.1 million of insurance solution discontinuation costs described above, Financial Services income from operations decreased $24.7 million during the nine months ended September 30, 2012. On this basis, the decrease in Financial Services income from operations is from lower contributions from mutual fund shareowner account processing, higher costs associated with new business initiatives (retirement, brokerage and insurance), higher employee termination costs, increased depreciation and amortization due to intangible asset amortization expense from 2011 acquisitions and higher employee compensation plan costs associated with higher earnings in 2012, partially offset by a $7.1 million increase in deferred compensation costs (the effect of which is offset as unrealized appreciation on trading securities in Other income (expense), net), contributions from the inclusion of ALPS, increased earnings from the DST Healthcare business and higher AWD software license revenues. Output Solutions income from operations increased $6.1 million during the nine months ended September 30, 2012 primarily due to new client revenue at Output North America and lower compensation and benefit costs at Output U.K. due to reduced headcount partially offset by higher operating costs to support new clients and conversion activities and higher intangible asset amortization expense related to 2011 acquisitions. The decrease in Investments and Other operating income for the nine months ended September 30, 2012 primarily results from real estate impairments of $7.6 million and a charitable contribution of marketable securities of $11.0 million, which were partially offset by higher operating revenues.

Interest expense

Interest expense for the three and nine months ended September 30, 2012 was $10.6 million and $34.0 million, respectively, a decrease of $0.3 million and $0.6 million, as compared to the three and nine months ended September 30, 2011, principally from lower weighted average debt balances outstanding and lower weighted average interest rates.


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Other income (expense), net

The components of Other income (expense), net are as follows (in millions):

                                              Three Months Ended         Nine Months Ended
                                                September 30,              September 30,
                                              2012          2011         2012          2011

Net realized gains from sale of
available-for-sale securities              $     58.3    $      0.4   $      81.0    $    18.8
Net gain (loss) on private equity funds
and other investments                             2.5          (2.7 )         6.7         (1.6 )
Other than temporary impairments /
unrealized losses on available-for-sale
securities                                       (0.4 )        (2.2 )        (2.3 )       (2.3 )
Net gain (loss) on the disposition of
senior convertible debentures                                  (0.3 )                     (1.2 )
Dividend income                                   4.7           5.2          14.1         13.4
Private company investment dividend                                          47.3
Gain on sale of private company
investment                                                                  138.7
Interest income                                   1.2           1.3           3.1          2.9
Miscellaneous items                               6.1          (6.2 )         7.7         (2.7 )
Other income (expense), net                $     72.4    $     (4.5 ) $     296.3    $    27.3

Included in the $58.3 million of net gains from the sale of available-for-sale securities for the three months ended September 30, 2012 is a $42.0 million gain from the sale of approximately 11.9 million shares of Computershare Ltd. and an $8.9 million gain from the charitable contribution of 250,000 common shares of State Street Corporation. Included in the $81.0 million of net gains from the sale of available-for-sale securities for the nine months ended September 30, 2012 is a $53.6 million gain from the sale of approximately 15.0 million shares of Computershare Ltd. and the charitable contribution of State Street shares.

The Company recognized a net gain of $2.5 million and $6.7 million on private equity funds and other investments for the three and nine months ended September 30, 2012, as compared to a net expense of $2.7 million and $1.6 million for the three and nine months ended September 30, 2011.

The Company records investment impairment charges for available-for-sale securities with gross unrealized holding losses resulting from a decline in value that is other than temporary. During the three and nine months ended September 30, 2012, the Company recorded $0.4 million and $2.3 million, respectively, of impairments that were other than temporary.

The Company recorded a net loss during the three and nine months ended September 30, 2011 of $0.3 million and $1.2 million, respectively, associated with the repurchase and extinguishment of senior convertible debentures.

The Company receives dividend income from certain investments held. Dividend income was $4.7 million and $14.1 million for the three and nine months ended September 30, 2012, respectively, as compared to $5.2 million and $13.4 million for the three and nine months ended September 30, 2011, respectively. The decline in dividend income for the three months ended September 30, 2012 as compared to September 30, 2011 is primarily due to the reduction in ownership of Computershare Ltd. For the nine months ended September 30, 2012, the increase in dividend income is the result of an increase in dividends from State Street Corporation as it increased its quarterly dividend per share to $0.24, an increase of $0.06 per share or approximately $0.6 million and $1.8 million as compared to the three and nine months ended September 30, 2011, partially offset by the reduction in ownership of Computershare Ltd.

In May 2012, the Company received a cash dividend of $47.3 million and realized a gain of $138.7 million on the sale of a portion of its shares in a privately held company investment.


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Interest income was $1.2 million and $3.1 million for the three and nine months ended September 30, 2012, respectively, as compared to $1.3 million and $2.9 million for the three and nine months ended September 30, 2011.

Miscellaneous items include unrealized gains and losses on marketable securities designated as trading securities, foreign currency gains and losses, amortization of deferred non-operating gains and other non-operating items. Miscellaneous items resulted in a gain of $6.1 million and $7.7 million for the three and nine months ended September 30, 2012, respectively, compared to a loss of $6.2 million and $2.7 million for the three and nine months ended September 30, 2011. The $12.3 million and $10.4 million increases in miscellaneous items for the three and nine months ended September 30, 2012, respectively, are primarily from unrealized appreciation on trading securities (the effect of which is offset by an increase in costs and expenses within the Financial Services Segment) and higher unrealized foreign currency exchange gains in 2012.

Equity in earnings of unconsolidated affiliates

Equity in earnings (losses) of unconsolidated affiliates, net of income taxes provided by the unconsolidated affiliates, is as follows (in millions):

               Three Months Ended        Nine Months Ended
                 September 30,             September 30,
               2012         2011        2012          2011

BFDS         $     2.1    $     0.1   $     7.6    $      6.4
IFDS, U.K.        (1.1 )        2.3         0.7           9.8
IFDS, L.P.         0.3          1.1         1.4           3.2
Other              1.8         (1.8 )       0.1          (2.1 )
             $     3.1    $     1.7   $     9.8    $     17.3

DST's equity in earnings of unconsolidated affiliates increased $1.4 million for . . .

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