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DST > SEC Filings for DST > Form 10-Q on 7-May-2013All Recent SEC Filings

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Form 10-Q for DST SYSTEMS INC


7-May-2013

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, 2012.

INTRODUCTION

DST Systems, Inc. (the "Company" or "DST") provides sophisticated information processing solutions and services. In addition to technology products and services, DST also provides integrated print and electronic statement and billing solutions. DST's data centers provide technology infrastructure support for asset management, insurance and healthcare companies around the globe. These business units are reported as two operating segments, Financial Services and Customer Communications. In addition, investments in the Company's real estate subsidiaries and affiliates, equity securities, private equity investments 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 a variety of solutions principally to the asset management, brokerage, retirement, insurance and healthcare industries.
The Company has developed a number of proprietary systems that are integrated into its solutions including the following:
Shareowner recordkeeping and distribution support systems for U.S. and international mutual fund companies, broker/dealers and financial advisors,

Investment management systems offered to U.S. and international investment managers and fund accountants,

Defined?contribution participant recordkeeping system for the U.S. retirement plan market,

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

Business process management and customer contact system offered to a broad variety of industries.


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The Financial Services Segment distributes its services and products on a direct basis and through subsidiaries and joint venture affiliates in the United States ("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. Customer Communications
The Company's Customer Communications Segment helps businesses deploy customer communications while improving operational performance across critical business functions such as sales, marketing, customer service, technology, finance, operations, and compliance. The Segment's product offering combines data insights and analysis with business decision-making tools and multi-channel execution and delivery designed to help businesses acquire, grow, retain, and win-back customers. By delivering information in the desired combination of print, digital and archival formats, the Company helps its clients deliver better customer experiences at each point of interaction.
The Customer Communication's North America business has four operating facilities located in the U.S. 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 U.S. The North America business is substantially a provider of print and digital delivery services for client bills and statements related to transaction events. Customer Communications also has several operating facilities in the U.K. and is among the largest direct communications manufacturers in that country. The U.K. business is oriented to data-driven marketing communications and direct mail campaigns. Investments and Other
The Investments and Other Segment is comprised of the Company's real estate subsidiaries and joint ventures, investments in equity securities, private equity investments and other 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 North America, 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 also holds investments in available-for-sale equity securities, including 8.8 million shares of State Street Corporation "State Street" as of March 31, 2013 with a market value of $518.8 million based on closing exchange value.

Seasonality

Generally, the Company does not have significant seasonal fluctuations in its business operations. Processing and Customer Communications volumes for mutual fund customers are usually highest during the three months ended March 31 due primarily to processing year-end transactions and printing and mailing of year-end statements and tax forms during January. The Company has historically added operating equipment in the last half of the year in preparation for processing year-end transactions, which has the effect of increasing costs for the second half of the year. Revenues and operating results from individual license sales depend heavily on the timing and size of the contract.


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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
                                                       March 31,
                                                    2013         2012
Revenues
Operating revenues
Financial Services                              $   320.3      $ 311.1
Customer Communications                             175.2        165.4
Investments and Other                                14.2         14.4
Elimination Adjustments                             (14.5 )      (15.0 )
                                                    495.2        475.9
% change from prior year period                       4.1 %

Out-of-pocket reimbursements
Financial Services                                   13.3         14.5
Customer Communications                             175.9        164.7
Investments and Other                                              0.1
Elimination Adjustments                              (2.0 )       (2.0 )
                                                    187.2        177.3
% change from prior year period                       5.6 %

Total revenues                                  $   682.4      $ 653.2
% change from prior year period                       4.5 %

Income from operations
Financial Services                              $    54.5      $  52.1
Customer Communications                              19.2          7.2
Investments and Other                                 2.9          2.8
Elimination Adjustments                              (2.0 )       (2.0 )
                                                     74.6         60.1

Interest expense                                     (9.6 )      (11.7 )
Other income, net                                    73.2         29.7
Equity in earnings of unconsolidated affiliates       5.6          5.3
Income before income taxes                          143.8         83.4
Income taxes                                         50.6         28.1
Net income                                      $    93.2      $  55.3

Basic earnings per share                        $    2.10      $  1.24
Diluted earnings per share                      $    2.04      $  1.22
Non-GAAP diluted earnings per share             $    0.99      $  1.05
Cash dividends per share of common stock        $    0.30      $  0.40


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Consolidated revenues

Consolidated total revenues (including out-of-pocket ("OOP") reimbursements) for the three months ended March 31, 2013 were $682.4 million, an increase of $29.2 million or 4.5% compared to the three months ended March 31, 2012. Consolidated operating revenues for the three months ended March 31, 2013 increased $19.3 million or 4.1% as compared to the same periods in 2012. The increase in consolidated operating revenues during the three months ended March 31, 2013 was attributable to an increase of $9.2 million in the Financial Services Segment and $9.8 million in the Customer Communications Segment. The increase in Financial Services operating revenues for the three months ended March 31, 2013 is primarily from a $6.0 million contract termination payment received from the partial termination of a retirement business client during first quarter 2013. Increased operating revenues from DST HealthCare, DST Retirement Solutions, ALPS and DST Brokerage Solutions were partially offset by lower operating revenues from mutual fund registered shareowner account processing and AWD software license and professional services. The increase in Customer Communications operating revenues for the three months ended March 31, 2013 is primarily from new client volumes in North America, partially offset by decreased revenues in the United Kingdom.

Consolidated OOP reimbursements for the three months ended March 31, 2013 increased $9.9 million or 5.6% as compared to the same periods in 2012. OOP reimbursements for Customer Communications increased $11.2 million or 6.8% for the three months ended March 31, 2013, as compared to the same periods in 2012. The increase in Customer Communications OOP reimbursements is attributable to higher volumes from new clients. The decrease in Financial Services OOP reimbursements during the three months ended March 31, 2013 is primarily due to lower mutual fund registered shareowner account processing.

Income from operations

Consolidated income from operations for the three months ended March 31, 2013, was $74.6 million, an increase of $14.5 million or 24.1% as compared to the same period in 2012. The increase in operating income during the three months ended March 31, 2013 was attributable to an increase of $2.4 million or 4.6% in Financial Services, $12.0 million in Customer Communications, and $0.1 million in Investments and Other.

Increased Financial Services operating revenues were partially offset by increased employee and other costs associated with acquiring and supporting new business, a $2.5 million incremental loss accrual related to a regulatory inquiry regarding the processing of pharmacy claims and from lower software license income. Customer Communications income from operations increased $12.0 million during the three months ended March 31, 2013 primarily due to new client revenue in North America and lower costs from facility consolidations and reduced headcount in the U.K. The increase in Investments and Other operating income for the three months ended March 31, 2013 primarily results from lower depreciation expense and operating costs.

Interest expense

Interest expense for the three months ended March 31, 2013 was $9.6 million, a decrease of $2.1 million, as compared to the three months ended March 31, 2012, principally from lower weighted average debt balances outstanding and lower weighted average interest rates.


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Other income, net

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

                                                                 Three Months Ended
                                                                     March 31,
                                                                  2013          2012
Net realized gains from sale of available-for-sale securities $    68.7       $ 15.4
Net gain on private equity funds and other investments              3.8          2.4
Other than temporary impairments                                   (0.2 )       (0.3 )
Dividend income                                                     3.3          5.7
Interest income                                                     1.1          1.0
Foreign currency gain (loss)                                       (6.6 )        1.1
Miscellaneous items                                                 3.1          4.4
Other income, net                                             $    73.2       $ 29.7

The Company recorded net gains from the sale of available-for-sale securities of $68.7 million during the three months ended March 31, 2013, an increase of $53.3 million as compared to the same period in 2012. Included in the $68.7 million of net gains from the sale of available-for-sale securities for the three months ended March 31, 2013 is a $24.1 million gain from the sale of approximately 0.5 million shares of State Street Corporation.

The Company recognized a net gain of $3.8 million on private equity funds and other investments for the three months ended March 31, 2013, as compared to a net gain of $2.4 million for the three months ended March 31, 2012.

The Company receives dividend income from certain investments held. Dividend income was $3.3 million for the three months ended March 31, 2013, as compared to $5.7 million for the three months ended March 31, 2012. The decline in dividend income for the three months ended March 31, 2013 as compared to March 31, 2012 is primarily due to the sale of the Company's shares in Computershare Ltd in 2012.

The Company had unrealized losses on foreign currency translation of $6.6 million during the three months ended March 31, 2013 as compared to unrealized gains on foreign currency translation of $1.1 million during the three months ended March 31, 2012. The majority of the 2013 foreign currency loss was caused by negative movements in the U.K. pound versus the U.S. dollar on an intercompany loan that is expected to be repaid over the next five years.

Miscellaneous items include unrealized gains and losses on marketable securities designated as trading securities, amortization of deferred non-operating gains and other non-operating items. Miscellaneous items resulted in a gain of $3.1 million for the three months ended March 31, 2013 compared to a gain of $4.4 million for the three months ended March 31, 2012. The decrease in miscellaneous items is primarily attributable to lower unrealized gains on trading securities and other non-operational losses incurred.

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
                    March 31,
                  2013           2012
BFDS       $     1.8            $ 3.2
IFDS, U.K.       0.8              1.6
IFDS, L.P.       1.1             (0.1 )
Other            1.9              0.6
           $     5.6            $ 5.3


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DST's equity in earnings of unconsolidated affiliates increased $0.3 million for the three months ended March 31, 2013.

DST's equity in BFDS earnings decreased $1.4 million as compared to the three months ended March 31, 2012 primarily from lower revenues associated with reduced levels of accounts serviced. BFDS derives investment earnings related to cash balances maintained on behalf of customers. Average daily client cash balances invested by BFDS were $1.4 billion during the three months ended March 31, 2013, as compared to $1.2 billion during the three months ended March 31, 2012. Average interest rates earned on the balances increased from 0.10% during the three months ended March 31, 2012 to 0.14% during the three months ended March 31, 2013.

DST's equity in earnings of IFDS, U.K. decreased $0.8 million during the three months ended March 31, 2013, as compared to the same period in 2012. The decline in IFDS U.K. earnings is attributable to costs for new product development initiatives and costs associated with client conversion activities. Shareowner accounts serviced by IFDS U.K. were 9.5 million at March 31, 2013, an increase of 0.1 million accounts or 1.1% from December 31, 2012 and an increase of 1.3 million accounts or 15.9% from March 31, 2012. The increase in accounts is attributable to organic account growth during the three months ended March 31, 2013. As previously announced, IFDS U.K. is in the process of converting new shareowner processing clients with approximately 0.2 million accounts which are scheduled to convert by June 30, 2013. New product development and client conversion costs are expected to continue to affect IFDS U.K. earnings.

DST's equity in earnings of IFDS L.P. (which includes IFDS Canada, Ireland and Luxembourg) increased $1.2 million during the three months ended March 31, 2013, as compared to the same period in 2012. The increase in IFDS L.P. earnings during the three months ended March 31, 2013 was primarily attributable to higher revenues from a new client in Canada that converted 1.1 million accounts in fourth quarter 2012, partially offset by increased operating costs to support the new client and decreased earnings from a Canadian real estate partnership that was sold in December 2012. Shareowner accounts serviced by IFDS Canada were 11.5 million at March 31, 2013, an increase of 0.2 million accounts or 1.8% from December 31, 2012 and an increase of 1.1 million accounts or 10.6% from March 31, 2012. The increase in accounts from December 31, 2012 is attributable to organic account growth.

DST's equity in earnings of other unconsolidated affiliates increased $1.3 million during the three months ended March 31, 2013, as compared to the same periods in 2012, primarily from improved performance at DST's real estate and other affiliates.

Income taxes

The Company records income tax expense during interim periods based on its best estimate of the full year's tax rate. Certain items are given discrete period treatment and, as a result, the tax effects of such items are reported in full in the relevant interim period. The Company's tax rate was 35.2% for the three months ended March 31, 2013, compared to 33.7% for the three months ended March 31, 2012. A change in the proportional mix of domestic and international income caused an increase in the tax rate in 2013 as compared to 2012. The increase was partially offset by $2.0 million of federal research and experimentation credits recorded during the three months ended March 31, 2013. The Company had previously filed federal income tax claims for research and experimentation credits. During first quarter 2013, the Company and the IRS reached a resolution in regards to the 2008 and 2009 refund claims. This income tax credit relates to the resolved claim years and certain post-audit periods that are still subject to examination.

Excluding the effect of discrete period items, the Company expects its tax rate to be approximately 36.1% for full year 2013, but the rate for the remainder of the year is estimated to vary on a quarterly basis between 35.5% and 38.5% depending on the amount and timing of estimated 2013 sources of taxable income (e.g. domestic consolidated, international, and/or joint venture). The full year 2013 tax rate can be affected as a result of variances among the estimates and amounts of full year sources of taxable income (e.g., domestic consolidated, joint venture and/or international), the realization of tax credits (e.g., historic rehabilitation, research and experimentation, foreign tax and state incentive), adjustments which may arise from the resolution of tax matters under review and the Company's assessment of its liability for uncertain tax positions.

Comprehensive income

The Company recorded comprehensive income of $127.1 million for the three months ended March 31, 2013 compared to comprehensive income of $102.9 million for the three months ended March 31, 2012. Comprehensive income includes net income of $93.2 million for the three months ended March 31, 2013 compared to $55.3 million for the three months ended


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March 31, 2012, and other comprehensive income of $33.9 million for the three months ended March 31, 2013 compared to other comprehensive income of $47.6 million for the three months ended March 31, 2012, respectively. Other comprehensive income consists of unrealized gains (losses) on available-for-sale securities, reclassifications for net gains and losses included in net income, unrealized gain (loss) on cash flow hedges, the Company's proportional share of unconsolidated affiliates interest rate swaps, foreign currency translation adjustments and deferred income taxes applicable to these items. The principal difference between net income and comprehensive income is the net change in unrealized gains (losses) on available-for-sale securities.

Business Segment Comparisons
FINANCIAL SERVICES SEGMENT

Revenues

Financial Services Segment total revenues for the three months ended March 31, 2013 were $333.6 million, an increase of $8.0 million or 2.5% as compared to the same period in 2012. Financial Services Segment operating revenues for the three months ended March 31, 2013 were $320.3 million, an increase of $9.2 million or 3.0% as compared to the same period in 2012. The increase in Financial Services operating revenues for the three months ended March 31, 2013 is primarily from a $6.0 million contract termination payment received from the partial termination of a retirement business client during first quarter 2013. The partial contract termination payment occurred from the Company's client not completing the contractual conversion of certain defined contribution participants to DST's retirement platform as a result of a business acquisition impacting the Company's client. Additionally, increased operating revenues from DST HealthCare, DST Retirement Solutions, ALPS and DST Brokerage Solutions were partially offset by lower operating revenues from mutual fund registered shareowner account processing and AWD software license and professional services.

U.S. operating revenues for the three months ended March 31, 2013 were $285.8 million, an increase of $10.6 million or 3.9% as compared to the same periods in 2012. U.S. operating revenues for the three months ended March 31, 2013 increased primarily from the partial contract termination payment received and increased operating revenues at DST HealthCare, DST Retirement Solutions, ALPS and DST Brokerage Solutions partially offset by lower operating revenues from mutual fund registered shareowner account processing.

International operating revenues for the three months ended March 31, 2013 were $34.5 million, a decrease of $1.4 million or 3.9% as compared to the same period in 2012. International operating revenues for the three months ended March 31, 2013 decreased primarily from the decline in international AWD software license and professional services and from changes in foreign currency exchange rates between the U.S. Dollar and other foreign currencies.

Financial Services Segment OOP reimbursement revenues for the three months ended March 31, 2013 were $13.3 million, a decrease of $1.2 million or 8.3% as compared to the same period in 2012. The decrease during the three months ended March 31, 2013 is primarily due to lower mutual fund registered shareowner account processing.


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The following table summarizes changes in registered accounts and subaccounts serviced (in millions):

                                                 Three Months Ended
                                                      March 31,
                                                  2013         2012
Registered Accounts
Beginning balance                                 75.7          85.1
New client conversions                             0.3           0.5
Subaccounting conversions to DST platforms        (0.7 )        (1.7 )
Subaccounting conversions to non-DST platforms    (0.7 )        (1.4 )
Organic growth                                     0.4           0.3
Ending balance                                    75.0          82.8

Subaccounts
. . .
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