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DST > SEC Filings for DST > Form 10-Q on 5-Nov-2013All Recent SEC Filings

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Form 10-Q for DST SYSTEMS INC


5-Nov-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. Through March 31, 2013, the Company presented these businesses as two operating segments, Financial Services and Customer Communications. Investments in the Company's real estate subsidiaries and affiliates, equity securities, private equity investments and certain financial interests have been aggregated into an Investments and Other Segment. Beginning in second quarter 2013, these business units are reported as three operating segments, Financial Services, Healthcare Services and Customer Communications. The new Healthcare Services Segment includes the operations of DST Healthcare (comprised of DST Health Solutions and Argus Health Systems) which were previously reported within the Financial Services Segment. The new segment presentation is reflective of how management now evaluates the strategic direction and financial results of the business and makes investment allocations. Prior periods have been revised to reflect the new reportable operating 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, and insurance 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,

• Defined­contribution participant recordkeeping system for the U.S. retirement plan market,


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

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

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. Healthcare Services
The Company's Healthcare Services Segment provides a variety of solutions to meet the information processing, quality of care and cost management needs while achieving compliance and improving operational efficiencies of U.S. healthcare organizations. The Company has proprietary systems that are integrated into its solutions including 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. 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 7.9 million shares of State Street Corporation as of September 30, 2013 with a market value of $518.2 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               Nine Months Ended
                                              September 30,                   September 30,
                                           2013            2012            2013           2012
Revenues
Operating revenues
Financial Services                    $     248.8      $    242.2      $    746.3     $    727.6
Healthcare Services                          80.7            71.2           242.7          221.9
Customer Communications                     160.5           159.6           498.5          483.7
Investments and Other                        14.6            15.1            43.3           44.6
Elimination Adjustments                     (24.4 )         (24.1 )         (70.3 )        (72.4 )
                                            480.2           464.0         1,460.5        1,405.4
% change from prior year period               3.5 %                           3.9 %

Out-of-pocket reimbursements
Financial Services                            8.8            11.7            31.9           36.6
Healthcare Services                           1.5             1.2             4.2            3.9
Customer Communications                     163.1           156.9           500.2          477.7
Investments and Other                         0.1             0.1             0.1            0.2
Elimination Adjustments                      (1.9 )          (1.9 )          (5.6 )         (5.8 )
                                            171.6           168.0           530.8          512.6
% change from prior year period               2.1 %                           3.6 %

Total revenues                        $     651.8      $    632.0      $  1,991.3     $  1,918.0
% change from prior year period               3.1 %                           3.8 %

Income (loss) from operations
Financial Services                    $      54.4      $     46.6      $    153.5     $    134.4
Healthcare Services                          11.4             5.4            29.9           18.5
Customer Communications                      15.5            10.6            43.0           22.4
Investments and Other                         7.2           (13.6 )          13.3          (11.3 )
Elimination Adjustments                      (2.2 )          (1.9 )          (6.1 )         (5.9 )
                                             86.3            47.1           233.6          158.1

Interest expense                             (8.4 )         (10.6 )         (27.3 )        (34.0 )
Other income, net                            73.4            72.4           175.0          296.3
Equity in earnings of unconsolidated
affiliates                                    3.8             3.1            18.9            9.8
Income before income taxes                  155.1           112.0           400.2          430.2
Income taxes                                 58.2            26.1           131.6          144.1
Net income                            $      96.9      $     85.9      $    268.6     $    286.1

Basic earnings per share              $      2.26      $     1.90      $     6.16     $     6.38
Diluted earnings per share            $      2.23      $     1.87      $     6.03     $     6.27
Non-GAAP diluted earnings per share   $      1.21      $     0.96      $     3.24     $     2.78
Cash dividends per share of common
stock                                 $      0.30      $        -      $     0.90     $     0.40


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Consolidated revenues

Consolidated total revenues (including out-of-pocket ("OOP") reimbursements) for the three and nine months ended September 30, 2013 were $651.8 million and $1,991.3 million, respectively, an increase of $19.8 million or 3.1% and $73.3 million or 3.8% compared to the three and nine months ended September 30, 2012. Consolidated operating revenues for the three and nine months ended September 30, 2013 increased $16.2 million or 3.5% and $55.1 million or 3.9% as compared to the same periods in 2012.

The increase in consolidated operating revenues during the three months ended September 30, 2013 was primarily attributable to increased operating revenues in the Healthcare Services and Financial Services Segments. The $9.5 million increase in Healthcare Services operating revenues for the three months ended September 30, 2013 is primarily from an increase in pharmacy claims paid as well as growth from existing and new clients on the DST Health Solutions' processing platform. The $6.6 million increase in Financial Services operating revenues for the three months ended September 30, 2013 is primarily from increased operating revenues from ALPS, DST Brokerage Solutions and DST Retirement Solutions, partially offset by lower operating revenues from mutual fund registered shareowner account processing due to lower registered accounts primarily as a result of subaccounting conversions. Customer Communications Segment operating revenues were relatively flat as compared to the three months ended September 30, 2012.

The increase in consolidated operating revenues during the nine months ended September 30, 2013 was primarily attributable to an increase of $20.8 million in the Healthcare Services Segment, $18.7 million in the Financial Services Segment and $14.8 million in the Customer Communications Segment. The increase in the Healthcare Services operating revenue for the nine months ended September 30, 2013 is attributable to higher pharmacy claims paid as well as growth from existing and new clients on the DST Health Solutions' processing platform. The increase in the Financial Services operating revenue for the nine months ended September 30, 2013 is primarily attributable to increased operating revenues from ALPS, DST Brokerage Solutions, and DST Retirement Solutions, which included a $6.0 million client termination payment received in first quarter 2013. The increased revenues in the Financial Services Segment were partially offset by lower operating revenues from mutual fund registered shareowner account processing due to lower registered accounts, primarily as a result of subaccounting conversions. The increase in the Customer Communications operating revenue is primarily from new client volumes in North America.

Consolidated OOP reimbursements for the three and nine months ended September 30, 2013 increased $3.6 million or 2.1% and $18.2 million or 3.6% as compared to the same periods in 2012. The increase in OOP reimbursements is primarily attributable to higher volumes from new clients in the Customer Communications Segment.

Income from operations

Consolidated income from operations for the three and nine months ended September 30, 2013 was $86.3 million and $233.6 million, respectively, an increase of $39.2 million or 83.2% and $75.5 million or 47.8% as compared to the same periods in 2012.

The increase in operating income during the three months ended September 30, 2013 was due to increases of $7.8 million in Financial Services, $6.0 million in Healthcare Services, $4.9 million in Customer Communications, and $20.8 million in the Investments and Other Segment. Financial Services income from operations increased as a result of higher revenues and lower operating costs. Operating costs declined as a result of cost containment activities, partially offset by increased costs at ALPS and DST Brokerage Solutions to support the higher revenues. The increase in Healthcare Services income from operations is due to higher revenues from claims processed, partially offset by increased costs and expenses from new client conversion activities, product development and increased staffing costs associated with supporting the increase in clients. Customer Communications Segment income from operations increased primarily from lower costs from facility consolidations and reduced headcount in the U.K., partially offset by increased personnel costs in North America. The increase in Investments and Other Segment income from operations is attributable to the non-recurrence of an $11.0 million charitable contribution and $5.8 million of real estate impairments that were recorded during the three months ended September 30, 2012.

The increase in income from operations during the nine months ended September 30, 2013 was primarily attributable to an increase of $19.1 million in Financial Services, an increase of $11.4 million in Healthcare Services, $20.6 million in Customer Communications, and $24.6 million in Investments and Other. The nine months ended September 30, 2012 included approximately $9.1 million of asset impairment and other costs for the Financial Services Segment associated with ceasing the development of an insurance processing solution for the insurance market. Excluding the $9.1 million of asset impairment and other costs associated with ceasing development of an insurance processing solution in 2012, Financial Services Segment income from operations increased $10.0 million as compared to the nine months ended September 30, 2012. On this basis,


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increased Financial Services operating revenues were partially offset by increased employee and other costs associated with acquiring and supporting new business, approximately $3.4 million of increased deferred compensation costs (the effect of which is offset in Other income, net) and $2.8 million of marketing and distribution costs associated with a new closed-end fund launch by ALPS in June 2013. The increase in Healthcare Services operating revenues during the nine months ended September 30, 2013 were partially offset by a $2.5 million incremental loss accrual related to a regulatory inquiry regarding the processing of pharmacy claims, as well as employee and other costs associated with acquiring and supporting new business. Customer Communications income from operations increased $20.6 million during the nine months ended September 30, 2013 primarily due to new client revenue in North America and lower costs from facility consolidations and reduced headcount in the U.K. Excluding $11.0 million of charitable contribution expense, $7.6 million of real estate impairments and $1.8 million of leased facility abandonment costs recorded during the nine months ended September 30, 2012, Investments and Other Segment income from operations increased $4.2 million during the nine months ended September 30, 2013. On this basis, the increase in Investments and Other income from operations is primarily from $3.8 million of net gains on sale of real estate.

Interest expense

Interest expense for the three and nine months ended September 30, 2013 was $8.4 million and $27.3 million, respectively, a decrease of $2.2 million and $6.7 million, as compared to the three and nine months ended September 30, 2012, from lower weighted average debt balances outstanding and lower weighted average interest rates.

Other income, net

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

                                           Three Months Ended              Nine Months Ended
                                             September 30,                   September 30,
                                          2013             2012           2013            2012
Net realized gains from sale of
available-for-sale securities        $      50.0       $     58.3     $     134.4     $     81.0
Net gain on private equity funds and
other investments                           16.3              2.5            27.8            6.7
Other than temporary impairments            (0.4 )           (0.4 )          (0.9 )         (2.3 )
Dividend income                              3.1              4.7            10.1           14.1
Private company investment dividend            -                -               -           47.3
Gain on sale of private company
investment                                     -                -               -          138.7
Interest income                              0.8              1.2             2.9            3.1
Foreign currency gain (loss)                 0.8              2.3            (6.4 )          3.3
Miscellaneous items                          2.8              3.8             7.1            4.4
Other income, net                    $      73.4       $     72.4     $     175.0     $    296.3

The Company recorded net gains from the sale of available-for-sale securities of $50.0 million and $134.4 million during the three and nine months ended September 30, 2013, compared to $58.3 million and $81.0 million for the same periods in 2012. Included in the $134.4 million of net gains from the sale of available-for-sale securities for the nine months ended September 30, 2013 is a $76.7 million gain from the sale of approximately 1.4 million shares of State Street Corporation.

The Company recognized a net gain of $16.3 million and $27.8 million on private equity funds and other investments for the three and nine months ended September 30, 2013, as compared to a net gain of $2.5 million and $6.7 million for the three and nine months ended September 30, 2012.

The Company receives dividend income from certain investments held. Dividend income was $3.1 million and $10.1 million for the three and nine months ended September 30, 2013, as compared to $4.7 million and $14.1 million for the three and nine months ended September 30, 2012. The decline in dividend income during the three months ended September 30, 2013 is attributable to lower dividends from State Street Corporation resulting from lower shares owned. The decline in dividend income for the nine months ended September 30, 2013 as compared to September 30, 2012 is primarily due to the sale of the Company's shares in Computershare Ltd. in 2012 and lower dividends from State Street Corporation resulting from lower shares owned.

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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The Company had an unrealized gain on foreign currency translation of $0.8 million during three months ended September 30, 2013 and an unrealized loss of $6.4 million during the nine months ended September 30, 2013 as compared to unrealized gains of $2.3 million and $3.3 million during the three and nine months ended September 30, 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. The Company began hedging against this exposure in May 2013 and, as a result, movements in the foreign currency rates in the future are no longer expected to result in a net foreign currency gain (loss) for this intercompany loan.

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 $2.8 million and $7.1 million for the three and nine months ended September 30, 2013 compared to a gain of $3.8 million and $4.4 million for the three and nine months ended September 30, 2012, respectively. The movements within miscellaneous items are primarily attributable to unrealized gains on trading securities (which are offset within Financial Services Segment Costs and expenses), partially offset by 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             Nine Months Ended
                  September 30,                  September 30,
                  2013           2012            2013           2012
BFDS       $     1.8            $ 2.1     $      6.1           $ 7.6
IFDS, U.K.       0.1             (1.1 )          6.4             0.7
IFDS, L.P.       0.9              0.3            2.5             1.4
Other            1.0              1.8            3.9             0.1
           $     3.8            $ 3.1     $     18.9           $ 9.8

DST's equity in earnings of unconsolidated affiliates increased $0.7 million and $9.1 million for the three and nine months ended September 30, 2013, respectively, as compared to the same periods in 2012. The increase in equity in earnings, during the nine months ended September 30, 2013, is primarily due to the recognition of a $7.4 million gain (DST's share) on sale of IFDS U.K.'s equity method investment in Cofunds, Ltd. IFDS U.K. received approximately $62.7 million of pretax proceeds from this transaction. The aggregate pretax gain of $7.4 million was recorded by IFDS U.K. ($6.3 million) and BFDS ($1.1 million), from a previously deferred gain.

DST's equity in BFDS earnings decreased $0.3 million as compared to the three months ended September 30, 2012 and decreased $1.5 million as compared to the nine months ended September 30, 2012. Absent the recognition of the Cofunds, Ltd. deferred gain of $1.1 million, DST's equity in BFDS earnings decreased $2.6 million during the nine months ended September 30, 2013, as compared to the same periods in the prior year. The decreases are primarily from lower revenues associated with reduced levels of accounts serviced and lower interest income. BFDS derives investment earnings related to cash balances maintained on behalf of customers. Average daily client cash balances invested by BFDS were $1.2 billion and $1.3 billion during the three and nine months ended September 30, 2013, as compared to $971.2 million and $1.0 billion during the three and nine months ended September 30, 2012. Average interest rates earned on the balances increased from 0.10% during the nine months ended September 30, 2012 to 0.17% during the nine months ended September 30, 2013.

DST's equity in earnings of IFDS, U.K. increased $1.2 million and $5.7 million during the three and nine months ended September 30, 2013, as compared to the same periods in 2012. Absent the $6.3 million Cofunds, Ltd. gain mentioned . . .

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