10-Q 1 a11-25720_110q.htm 10-Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2011

 

or

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                to               

 

Commission File Number 1-14036

 

DST SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

43-1581814

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

 

 

333 West 11th Street, Kansas City, Missouri

 

64105

(Address of principal executive offices)

 

(Zip Code)

 

(816) 435-1000

(Registrant’s telephone number, including area code)

 

No Changes

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the 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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o
(do not check if a smaller reporting company)

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Number of shares outstanding of the Company’s common stock as of October 31, 2011:

Common Stock $0.01 par value — 44,071,146

 

 

 



Table of Contents

 

DST Systems, Inc.

Form 10-Q

September 30, 2011

Table of Contents

 

 

 

Page(s)

 

 

 

PART I. FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements (unaudited)

 

 

 

 

 

 

 

Introductory Comments

 

3

 

 

 

 

 

Condensed Consolidated Balance Sheet —
September 30, 2011 and December 31, 2010

 

4

 

 

 

 

 

Condensed Consolidated Statement of Income —
Three and nine months ended September 30, 2011 and 2010

 

5

 

 

 

 

 

Condensed Consolidated Statement of Cash Flows —
Nine months ended September 30, 2011 and 2010

 

6

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

7-24

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

25-62

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

62-63

 

 

 

 

Item 4.

Controls and Procedures

 

63

 

 

 

 

Item 4T.

Controls and Procedures

 

63

 

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

63

 

 

 

 

Item 1A.

Risk Factors

 

63-70

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

71

 

 

 

 

Item 3.

Defaults Upon Senior Securities

 

71

 

 

 

 

Item 4.

(Removed and Reserved)

 

71

 

 

 

 

Item 5.

Other Information

 

71

 

 

 

 

Item 6.

Exhibits

 

72

 

The brand, service or product names or marks referred to in this Report are trademarks or service marks, registered or otherwise, of DST Systems, Inc. or its subsidiaries or affiliates or of vendors to the Company.

 

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Table of Contents

 

DST Systems, Inc.

Form 10-Q

September 30, 2011

 

PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

Introductory Comments

 

The Condensed Consolidated Financial Statements of DST Systems, Inc. (“DST” or the “Company”) included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission.  Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to enable a reasonable understanding of the information presented.  These Condensed Consolidated Financial Statements should be read in conjunction with the Company’s audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

 

The results of operations for the three and nine months ended September 30, 2011 are not necessarily indicative of the results to be expected for the full year 2011.

 

3



Table of Contents

 

DST Systems, Inc.

Condensed Consolidated Balance Sheet

(in millions, except per share amounts)

(unaudited)

 

 

 

September 30,
2011

 

December 31,
2010

 

ASSETS

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

89.8

 

$

139.8

 

Funds held on behalf of clients

 

254.5

 

406.6

 

Client funding receivable

 

44.2

 

68.1

 

Accounts receivable

 

311.5

 

308.0

 

Deferred income taxes

 

10.5

 

12.1

 

Other assets

 

68.1

 

62.6

 

 

 

778.6

 

997.2

 

 

 

 

 

 

 

Investments

 

945.1

 

1,139.1

 

Unconsolidated affiliates

 

367.4

 

355.5

 

Properties

 

527.8

 

516.8

 

Intangible assets

 

79.4

 

49.5

 

Goodwill

 

299.8

 

230.2

 

Other assets

 

46.3

 

51.1

 

Total assets

 

$

3,044.4

 

$

3,339.4

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Current liabilities

 

 

 

 

 

Current portion of debt

 

$

312.4

 

$

286.1

 

Client funds obligations

 

298.7

 

474.7

 

Accounts payable

 

84.5

 

65.1

 

Accrued compensation and benefits

 

110.8

 

121.7

 

Deferred revenues and gains

 

50.7

 

58.9

 

Other liabilities

 

122.7

 

98.4

 

 

 

979.8

 

1,104.9

 

 

 

 

 

 

 

Long-term debt

 

962.3

 

923.3

 

Income taxes payable

 

60.2

 

53.3

 

Deferred income taxes

 

248.3

 

336.5

 

Other liabilities

 

71.4

 

75.8

 

Total liabilities

 

2,322.0

 

2,493.8

 

Commitments and contingencies (Note 11)

 

 

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

DST Systems, Inc. stockholders’ equity

 

 

 

 

 

Preferred stock, $0.01 par; 10 million shares authorized and unissued

 

 

 

 

 

Common stock, $0.01 par; 400 million shares authorized, 95.3 million shares issued

 

1.0

 

1.0

 

Additional paid-in capital

 

247.0

 

247.7

 

Retained earnings

 

3,151.8

 

3,039.8

 

Treasury stock (51.2 million and 49.1 million shares, respectively), at cost

 

(2,899.6

)

(2,815.4

)

Accumulated other comprehensive income

 

203.9

 

351.3

 

Total DST Systems, Inc. stockholders’ equity

 

704.1

 

824.4

 

Non-controlling interest

 

18.3

 

21.2

 

Total equity

 

722.4

 

845.6

 

Total liabilities and equity

 

$

3,044.4

 

$

3,339.4

 

 

The accompanying notes are an integral part of these financial statements.

 

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Table of Contents

 

DST Systems, Inc.

Condensed Consolidated Statement of Income

(in millions, except per share amounts)

(unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

 

$

433.1

 

$

413.7

 

$

1,286.7

 

$

1,288.7

 

Out-of-pocket reimbursements

 

158.3

 

153.5

 

478.6

 

459.1

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

591.4

 

567.2

 

1,765.3

 

1,747.8

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

496.5

 

459.3

 

1,466.4

 

1,363.4

 

Depreciation and amortization

 

33.7

 

33.5

 

95.1

 

99.4

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

61.2

 

74.4

 

203.8

 

285.0

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

(10.9

)

(12.1

)

(34.6

)

(33.7

)

Other income (expense), net

 

(4.5

)

9.4

 

27.3

 

67.8

 

Equity in earnings of unconsolidated affiliates

 

1.7

 

8.9

 

17.3

 

27.0

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes and non-controlling interest

 

47.5

 

80.6

 

213.8

 

346.1

 

Income taxes

 

14.0

 

26.4

 

72.8

 

121.0

 

 

 

 

 

 

 

 

 

 

 

Net income

 

33.5

 

54.2

 

141.0

 

225.1

 

Net loss attributable to non-controlling interest

 

1.8

 

0.1

 

2.9

 

0.1

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to DST Systems, Inc.

 

$

35.3

 

$

54.3

 

$

143.9

 

$

225.2

 

 

 

 

 

 

 

 

 

 

 

Average common shares outstanding

 

45.8

 

46.6

 

46.2

 

47.2

 

Average diluted shares outstanding

 

46.4

 

46.9

 

46.9

 

47.5

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.77

 

$

1.17

 

$

3.11

 

$

4.77

 

Diluted earnings per share

 

$

0.76

 

$

1.16

 

$

3.07

 

$

4.74

 

Cash dividends per share of common stock

 

$

0.35

 

$

 

 

$

0.70

 

$

0.30

 

 

The accompanying notes are an integral part of these financial statements.

 

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Table of Contents

 

DST Systems, Inc.

Condensed Consolidated Statement of Cash Flows

(in millions)

(unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2011

 

2010

 

Cash flows — operating activities:

 

 

 

 

 

Net income

 

$

141.0

 

$

225.1

 

Depreciation and amortization

 

95.1

 

99.4

 

Net gains on investments

 

(14.0

)

(41.4

)

Amortization of share based compensation

 

15.2

 

15.0

 

Equity in earnings of unconsolidated affiliates

 

(17.3

)

(27.0

)

Dividends from unconsolidated affiliates

 

6.5

 

2.5

 

Deferred income taxes

 

(2.5

)

16.1

 

Changes in accounts receivable

 

18.1

 

(117.1

)

Changes in accounts payable and accrued liabilities

 

16.1

 

 

 

Changes in accrued compensation and benefits

 

(12.1

)

10.4

 

Changes in income taxes payable

 

16.2

 

16.3

 

Other, net

 

(9.5

)

12.4

 

Total adjustments to net income

 

111.8

 

(13.4

)

Net

 

252.8

 

211.7

 

Cash flows — investing activities:

 

 

 

 

 

Capital expenditures

 

(60.8

)

(74.8

)

Investments in securities

 

(343.0

)

(208.7

)

Proceeds from sales/maturities of investments

 

288.8

 

182.2

 

Net (increase) decrease in restricted cash and cash equivalents held to satisfy client funds obligations

 

165.0

 

(74.6

)

Acquisition of businesses, net of cash acquired

 

(111.6

)

(6.3

)

Other, net

 

3.3

 

11.0

 

Net

 

(58.3

)

(171.2

)

Cash flows — financing activities:

 

 

 

 

 

Proceeds from issuance of common stock

 

45.2

 

10.6

 

Principal payments on debt

 

(20.1

)

(27.8

)

Repurchases of senior convertible debentures

 

(12.5

)

(443.6

)

Net proceeds from issuance of senior notes and mortgages

 

9.3

 

370.0

 

Net proceeds from accounts receivable securitization program

 

 

 

125.0

 

Net borrowings (payments) on revolving credit facilities

 

53.5

 

(35.0

)

Payment of debt issuance costs

 

(1.9

)

(8.2

)

Net increase (decrease) in client funds obligations

 

(152.1

)

81.5

 

Common stock repurchased

 

(151.1

)

(129.9

)

Payment of cash dividends

 

(16.2

)

(14.3

)

Excess tax benefits from share based compensation

 

1.4

 

0.3

 

Net

 

(244.5

)

(71.4

)

Net decrease in cash and cash equivalents

 

(50.0

)

(30.9

)

Cash and cash equivalents, beginning of period

 

139.8

 

106.2

 

Cash and cash equivalents, end of period

 

$

89.8

 

$

75.3

 

 

The accompanying notes are an integral part of these financial statements.

 

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Table of Contents

 

DST Systems, Inc.

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

1.  Summary of Accounting Policies

 

The Condensed Consolidated Financial Statements of DST Systems, Inc. (“DST” or the “Company”) included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”).  Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to enable a reasonable understanding of the information presented.  The Condensed Consolidated Balance Sheet as of December 31, 2010 has been derived from the audited Consolidated Balance Sheet at that date, but does not include all of the information and notes required by GAAP for complete financial statements.  These Condensed Consolidated Financial Statements should be read in conjunction with the Company’s audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

 

In the opinion of management, the accompanying unaudited Condensed Consolidated Financial Statements contain all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the consolidated financial position of the Company and its subsidiaries at September 30, 2011, and the results of operations for the three and nine months ended September 30, 2011 and 2010 and cash flows for the nine months ended September 30, 2011 and 2010.

 

Certain amounts in the 2010 financial statements have been reclassified to conform to the 2011 presentation.

 

The results of operations for the three and nine months ended September 30, 2011 are not necessarily indicative of the results to be expected for the full year 2011.

 

Revenue Recognition

 

On January 1, 2011, the Company adopted new authoritative accounting guidance related to revenue recognition for multiple element arrangements.  The guidance eliminates the use of the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method.  The Company adopted this guidance on a prospective basis and applied it to relevant revenue arrangements originating or materially modified on or after January 1, 2011.  The adoption of this new authoritative accounting guidance did not have a significant impact to the Company’s results during the nine months ended September 30, 2011.

 

Revenue arrangements entered into prior to January 1, 2011 will continue to follow the former revenue recognition policy for multiple element arrangements.  Specifically, in cases where there is objective and reliable evidence of the fair value of the undelivered item(s) in an arrangement but no such evidence for the delivered item(s), the residual method is used to allocate the arrangement consideration. For units of accounting which include more than one deliverable, the Company generally defers all revenue for the unit of accounting until the period over which the last undelivered item is delivered.

 

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Table of Contents

 

2.  Business Combinations

 

DST has made a number of acquisitions as part of its strategy to increase its product capabilities and expand its presence in the markets it currently serves as well as to adjacent markets.  During the nine months ended September 30, 2011, DST announced the following:

 

Finix Business Strategies, LLC and Finix Converge, LLC

 

On April 29, 2011, DST acquired, through a newly formed subsidiary, DST Brokerage Solutions, LLC, the assets of Finix Business Strategies, LLC (“Finix”), a financial services consulting firm with extensive brokerage and technology expertise.   DST Brokerage Solutions also acquired the assets of Finix Converge, LLC (“Converge”), a technology firm that develops and distributes an enterprise social networking and media platform to enable firms to connect and collaborate with their constituents more effectively online.  By combining Finix Business Strategies’ extensive knowledge and brokerage expertise with DST’s breadth and depth of technology and services, DST plans to address broker-dealers’ unique challenges through an expanded suite of products and solutions.  DST Brokerage Solutions, LLC is part of the Financial Services Segment.

 

Subserveo Inc.

 

On June 20, 2011, DST acquired Subserveo Inc. (“Subserveo”), a provider of automated compliance and surveillance solutions to broker-dealers and investment advisors throughout the U.S. and Canada.  Subserveo’s solutions perform daily analysis of transactions, orders and account holdings and provide detailed compliance alerts and case management.  Subserveo is operated as part of DST Brokerage Solutions.

 

Finix, Converge and Subserveo along with DST TASS, the Company’s subsidiary that provides full service subaccounting services, are operated as a single business unit.  This business unit will be DST’s channel to provide products to the broker/dealer market and will manage the distribution of the Company’s AWD, Vision Professional and print/mail products to that market.

 

IntelliSource Healthcare Solutions

 

On July 1, 2011, DST acquired, through its wholly-owned subsidiary, DST Health Solutions, LLC, the assets of IntelliSource Healthcare Solutions (“IntelliSource”), whose principal product is CareConnect which provides an automated care management system.  The addition of the IntelliSource suite of solutions broadens DST Health Solutions’ product offering for integrated care management, providing DST Health Solutions’ health plan clients access to an array of valuable solutions — including integrated care management, workflow and analytics — that will enable them to collaboratively facilitate proactive care and optimize resources at all levels of the healthcare system.  DST will integrate CareConnect into its proprietary claims offerings.

 

Newkirk Products, Inc.

 

On May 2, 2011, DST acquired the outstanding stock of Newkirk Products, Inc. (“Newkirk”), an industry leader in the development and deployment of communications, education, and investment information for clients in the retirement planning, managed care, and wealth management industries.  Newkirk will be operated as a unit of the Output Solutions Segment and its results will be reported in that segment from the date of acquisition.  DST believes the acquisition of Newkirk broadens the solution set available to multiple DST business units.  Newkirk’s innovative on-demand publishing and marketing solutions complement DST Output’s breadth of transactional and digital fulfillment solutions, making it easier for companies to craft effective customer communications across print, mobile, and electronic channels.  It also enables clients of DST Retirement Solutions to access a more fully integrated offering that leverages Newkirk’s capabilities geared to the needs of plan sponsors and participants, including communication and education materials, financial planning tools and plan documents.  The acquisition of Newkirk also extends DST Output’s capabilities in the healthcare industry enabling the Company to produce pre-enrollment communications, including information designed to help a participant personalize their health care plan.

 

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Table of Contents

 

Lateral Group Limited

 

On August 5, 2011, DST’s Innovative Output Solutions (“IOS”) subsidiary acquired the outstanding stock of Lateral Group Limited (“Lateral”), a U.K. company engaged in integrated, data driven, multi-channel marketing.  The acquisition of Lateral complements the existing IOS business in terms of services offered and business outlook.  In addition, this acquisition allows IOS to extend and develop its service/product offerings by further integrating communications through print, data and e-solutions and by providing additional solutions such as data insight and online marketing to the IOS client base.

 

The Company has not yet finalized its accounting for the acquired net assets of Finix, Converge, Subserveo, IntelliSource, Newkirk and Lateral; when finalized, it is possible that amounts appearing in the table below of net assets acquired will be adjusted.  The Subserveo, Newkirk and Lateral acquisitions are each subject to customary post-closing working capital adjustments, which could result in an adjustment to the respective purchase price.  Goodwill of $68.7 million from these acquisitions is comprised of the assembled workforce and other assets of the acquired businesses.  The Company does not believe that any of the above mentioned business combinations are material to DST’s consolidated financial statements.  Notwithstanding, the Company has provided aggregated disclosures of these transactions to assist users of the financial statements in understanding the impact to DST of the business combinations.  The following table summarizes the consideration (the Financial Services Segment spent $43.1 million on acquisitions while the Output Solutions Segment spent $71.7 million during the nine months ended September 30, 2011) and the preliminary allocation of the fair values of the acquisitions during the nine months ended September 30, 2011 to the fair values of the assets acquired and liabilities at the respective acquisition dates mentioned above (in millions):

 

Consideration

 

 

 

Cash paid

 

$

114.8

 

 

 

 

 

Recognized amounts of identifiable assets acquired and liabilities assumed

 

 

 

Cash and cash equivalents

 

$

3.2

 

Accounts receivable

 

22.2

 

Other current assets

 

6.9

 

Properties (includes $12.9 million of proprietary software)

 

31.2

 

Intangible assets

 

34.5

 

Goodwill

 

68.7

 

Other assets

 

0.4

 

Total assets

 

167.1

 

 

 

 

 

Other current liabilities

 

20.5

 

Deferred income tax liabilities

 

11.4

 

Debt

 

20.2

 

Other liabilities

 

0.2

 

Total liabilities

 

52.3

 

 

 

 

 

Net assets acquired

 

$

114.8

 

 

Assuming the acquisitions of Finix, Converge, Subserveo, IntelliSource, Newkirk, Lateral and dsicmm Group (as described in the Company’s 2010 Annual Report on Form 10-K) had occurred January 1, 2010, the Company’s total revenues would have been approximately $1,830.9 million and $1,942.0 million for the nine months ended September 30, 2011 and 2010, respectively. Consolidated pro forma net income and diluted earnings per share would not have been materially different from the reported amounts for the nine months ended September 30, 2011 and 2010. The unaudited pro forma amounts are not indicative of what actual consolidated results of operations might have been if the acquisitions had been effective at the beginning of 2010.

 

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ALPS Holdings, Inc.

 

On October 31, 2011, DST closed the previously announced acquisition of ALPS Holdings, Inc. (“ALPS”), a provider of a comprehensive suite of asset servicing, asset management, and asset gathering solutions to open-end mutual funds, closed-end funds (“CEFs”), exchange-traded funds (“ETFs”) and alternative investment funds.  The acquisition broadens the range of products and services DST will offer to the investment management and brokerage industries in the following areas: 1) ALPS’ comprehensive solution set allows DST to service market segments DST was previously unable to service; 2) ALPS positions DST to service hedge funds and ETFs; and 3) ALPS expands DST’s offerings beyond transfer agency.  On a pro-forma basis, the transaction is expected to be accretive to earnings.  ALPS’s financial results will be consolidated with those of DST beginning October 31, 2011, and will be reported as part of DST’s Financial Services Segment.  At closing, DST paid $250.0 million funded from cash, existing credit facilities and a new term loan credit facility.

 

3.  Client Funds/Obligations

 

The Company had $254.5 million and $406.6 million of funds held on behalf of clients at September 30, 2011 and December 31, 2010, respectively.  Included in these amounts were $23.8 million and $11.3 million of fixed-income marketable securities at September 30, 2011 and December 31, 2010, respectively, which have been classified as available-for-sale investments.  There were no significant unrealized gains or losses associated with these fixed-income securities at September 30, 2011 and December 31, 2010.  During the nine months ended September 30, 2011 and 2010, the Company received $77.0 million and $32.7 million, respectively, of proceeds from the sales/maturities of investments in available-for-sale securities held to satisfy client funds obligations.  Gross realized gains and gross realized losses associated with the sales/maturities of these available-for-sale securities held to satisfy client funds obligations were not significant during both the three and nine months ended September 30, 2011 and 2010.

 

4.  Investments

 

Investments are as follows (in millions):

 

 

 

2011

 

Carrying Value

 

 

 

Ownership
Percentage

 

September 30,
2011

 

December 31,
2010

 

Available-for-sale securities:

 

 

 

 

 

 

 

State Street Corporation

 

2%

 

$

332.2

 

$

478.7

 

Computershare Ltd.

 

3%

 

108.3

 

165.5

 

Euronet Worldwide

 

4%

 

29.7

 

32.9

 

Other available-for-sale securities

 

 

 

196.6

 

228.7

 

 

 

 

 

666.8

 

905.8

 

Other:

 

 

 

 

 

 

 

Trading securities

 

 

 

42.1

 

50.3

 

Held-to-maturity

 

 

 

15.4

 

11.3

 

Cost method, private equity and other investments

 

 

 

220.8

 

171.7

 

 

 

 

 

278.3

 

233.3

 

Total investments

 

 

 

$

945.1

 

$

1,139.1

 

 

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Table of Contents

 

Certain information related to the Company’s available-for-sale securities is as follows (in millions):

 

 

 

September 30,
2011

 

December 31,
2010

 

 

 

 

 

 

 

Book cost basis

 

$

334.2

 

$

327.4

 

Gross unrealized gains

 

326.8

 

555.7

 

Gross unrealized losses

 

(12.5

)

(0.6

)

Unrealized gain - foreign currency exchange rates

 

18.3

 

23.3

 

Market value

 

$

666.8

 

$

905.8

 

 

During the nine months ended September 30, 2011 and 2010, the Company received $201.2 million and $146.8 million, respectively, from the sale of investments in available-for-sale securities.  Gross realized gains of $3.0 million and $2.4 million and gross realized losses of $2.6 million and $1.2 million were recorded during the three months ended September 30, 2011 and 2010, respectively, from available-for-sale securities.  Gross realized gains of $22.1 million and $44.1 million and gross realized losses of $3.3 million and $2.3 million were recorded during the nine months ended September 30, 2011 and 2010, respectively, from available-for-sale securities.  In addition, the Company recorded unrealized losses on available-for-sale securities of $2.2 million and $2.3 million for the three and nine months ended September 30, 2011 compared to $0.3 million and $0.7 million for the three and nine months ended September 30, 2010, respectively, related to other than temporary investment impairments.  Included in the proceeds received from the sale of investments in available-for-sale securities for the nine months ended September 30, 2010 is $52.4 million of proceeds resulting from the sale of 4.8 million shares of Computershare Ltd., which resulted in a gain of $28.8 million.

 

The following table summarizes the fair value and gross unrealized losses of the Company’s investments by the length of time that the securities have been in a continuous loss position, at September 30, 2011 (in millions):

 

 

 

Less than 12 months

 

Greater than 12 months

 

Total

 

 

 

Fair Value

 

Unrealized
Losses

 

Fair Value

 

Unrealized
Losses

 

Fair Value

 

Unrealized
Losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

$

75.5

 

$

12.5

 

$

 

 

$

 

 

$

75.5

 

$

12.5

 

 

In addition to recording other than temporary investment impairments on available-for-sale securities, the Company records lower of cost or market valuation adjustments on private equity fund investments and other cost method investments when impairment conditions are present.  During the three and nine months ended September 30, 2011, the Company recorded $0.1 million and $1.1 million, respectively, of impairments on other investments compared to the nine months ended September 30, 2010 when the Company recorded $0.8 million.  There were no impairments on private equity and other investments for the three months ended September 30, 2010.  The impairments recorded related primarily to investments in the Financial Services Segment and the Investments and Other Segment.  A decline in a security’s net realizable value that is other than temporary is treated as a loss based on quoted or derived market value and is reflected in Other Income, net in the Condensed Consolidated Statement of Income.

 

Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s current carrying value, thereby possibly requiring an impairment charge in the future.  Such a charge could have a material effect on the Company’s financial position.

 

The Company is a limited partner in various private equity funds.  At September 30, 2011 and December 31, 2010, the Company’s carrying value of these private equity fund investments was approximately $196.6 million and $148.9 million, respectively.  At September 30, 2011, the Company had future capital commitments related to these private equity fund investments of approximately $58.0 million.

 

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5.  Unconsolidated Affiliates

 

Unconsolidated affiliates are as follows (in millions):

 

 

 

2011

 

Carrying Value

 

 

 

Ownership
Percentage

 

September 30,
2011

 

December 31,
2010

 

Unconsolidated affiliates:

 

 

 

 

 

 

 

Boston Financial Data Services, Inc.

 

50%

 

$

175.6

 

$

169.2

 

International Financial Data Services, U.K.

 

50%

 

88.2

 

78.8

 

International Financial Data Services, L.P.

 

50%

 

48.6

 

44.4

 

Unconsolidated real estate affiliates

 

 

 

38.9

 

50.4

 

Other unconsolidated affiliates

 

 

 

16.1

 

12.7

 

Total

 

 

 

$

367.4

 

$

355.5

 

 

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

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Boston Financial Data Services, Inc.

 

$

0.1

 

$

4.0

 

$

6.4

 

$

11.7

 

International Financial Data Services, U.K.

 

2.3

 

3.1

 

9.8

 

9.6

 

International Financial Data Services, L.P.

 

1.1

 

1.5

 

3.2

 

5.5

 

Other unconsolidated affiliates

 

(1.8

)

0.3

 

(2.1

)

0.2

 

 

 

$

1.7

 

$

8.9

 

$

17.3

 

$

27.0

 

 

6.  Fair Value Measurements

 

Authoritative accounting guidance on fair value measurements establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value.  These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

 

As of September 30, 2011 and December 31, 2010, the Company held certain investment assets that are required to be measured at fair value on a recurring basis.  These investments include the Company’s available-for-sale equity securities and trading securities whereby fair value is determined using quoted prices in active markets.  Accordingly, the fair value measurements of these investments have been classified as Level 1 in the table below.  In addition, the Company has investments in available-for-sale fixed income securities, pooled funds and interest rate swaps that are required to be reported at fair value.  Fair value for the available-for-sale fixed income securities and for the interest rate swaps was determined using inputs from quoted prices for similar assets and liabilities in active markets that are directly or indirectly observable.  Fair value for investments in pooled funds is determined using net asset value.  Accordingly, the Company’s investments in available-for-sale fixed income securities, pooled funds and interest rate swaps have been classified as Level 2 in the table below.

 

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The following tables present assets and liabilities measured at fair value on a recurring basis (in millions):

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

 

 

 

 

Quoted prices

 

 

 

 

 

 

 

 

 

in Active

 

Significant

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

 

 

Identical

 

Observable

 

Unobservable

 

 

 

 

 

Assets

 

Inputs

 

Inputs

 

 

 

September 30, 2011

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

$

691.8

 

$

691.8

 

$

 

 

$

 

 

 

 

 

 

 

 

 

 

 

 

Investments in pooled funds

 

43.9

 

 

 

43.9

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

40.9

 

 

 

40.9

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap liability

 

(4.9

)

 

 

(4.9

)

 

 

Total

 

$

771.7

 

$

691.8

 

$

79.9

 

$

 

 

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

 

 

 

 

Quoted prices

 

 

 

 

 

 

 

 

 

in Active

 

Significant

 

 

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

 

 

Identical

 

Observable

 

Unobservable

 

 

 

 

 

Assets

 

Inputs

 

Inputs

 

 

 

December 31, 2010

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

$

920.9

 

$

920.9

 

$

 

 

$

 

 

 

 

 

 

 

 

 

 

 

 

Investments in pooled funds

 

16.9

 

 

 

16.9

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

46.5

 

 

 

46.5

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap liability

 

(5.0

)

 

 

(5.0

)

 

 

Total

 

$

979.3

 

$

920.9

 

$

58.4

 

$

 

 

 

At September 30, 2011 and December 31, 2010, one of DST’s unconsolidated affiliates had an interest rate swap with a fair market value liability of $73.3 million and $47.7 million, respectively.  The unconsolidated affiliate used inputs from quoted prices for similar assets and liabilities in active markets that are directly or indirectly observable relating to the measurement of the interest rate swap.  The fair value measurement of the interest rate swap has been classified as Level 2 by the unconsolidated affiliate.  The above table presents only assets and liabilities measured at fair value for which the Company controls, and accordingly excludes items held by unconsolidated affiliates.

 

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7.  Intangible Assets and Goodwill

 

Intangible Assets

 

The following table summarizes intangible assets (in millions):

 

 

 

September 30, 2011

 

December 31, 2010

 

 

 

Carrying

 

Accumulated

 

Carrying

 

Accumulated

 

 

 

Amount

 

Amortization

 

Amount

 

Amortization

 

 

 

 

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

 

 

Customer relationships

 

$

94.6

 

$

20.2

 

$

63.6

 

$

16.4

 

Other

 

9.5

 

4.5

 

6.0

 

3.7

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

104.1

 

$

24.7

 

$

69.6

 

$

20.1

 

 

Amortization of intangible assets for the three and nine months ended September 30, 2011 was approximately $2.0 million and $4.6 million compared to $1.7 million and $4.2 million for the three and nine months ended September 30, 2010.  The Company estimates amortization expense for intangible assets recorded as of September 30, 2011 (which excludes ALPS and acquired software included in Properties on the Balance Sheet) will be $2.0 million for the remainder of 2011, $7.9 million for 2012, $7.6 million for 2013, $7.4 million for 2014, $7.2 million for 2015 and $47.3 million thereafter.

 

Goodwill

 

The following table summarizes the changes in the carrying amount of goodwill for the nine months ended September 30, 2011, by Segment (in millions):

 

 

 

December 31,
2010

 

Acquisitions

 

Disposals

 

Other

 

September 30,
2011

 

Financial Services 

 

$

178.0

 

$

30.7

 

$

 

 

$

 

 

$

208.7

 

Output Solutions

 

52.2

 

38.0

 

 

 

0.9

 

91.1

 

Total

 

$

230.2

 

$

68.7

 

$

 

 

$

0.9

 

$

299.8

 

 

The business acquisitions described in Note 2 increased the Company’s goodwill by $68.7 million during the nine months ended September 30, 2011, of which approximately $33.1 million is expected to be deductible for income tax purposes.

 

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8.  Debt

 

The Company is obligated under notes and other indebtedness as follows (in millions):

 

 

 

September 30,
2011

 

December 31,
2010

 

Accounts receivable securitization program

 

$

125.0

 

$

125.0

 

Secured promissory notes

 

16.9

 

3.5

 

Equipment credit facilities

 

11.7

 

7.5

 

Real estate credit agreement

 

106.1

 

108.5

 

Series C convertible senior debentures

 

86.5

 

94.1

 

Revolving credit facilities

 

360.2

 

330.2

 

Senior notes

 

370.0

 

370.0

 

Related party credit agreements

 

147.6

 

120.0

 

Other indebtedness

 

50.7

 

50.6

 

 

 

1,274.7

 

1,209.4

 

Less current portion of debt

 

312.4

 

286.1

 

Long-term debt

 

$

962.3

 

$

923.3

 

 

Accounts Receivable Securitization Program

 

DST securitizes certain of its domestic accounts receivable through an accounts receivable securitization program with a third-party, multi-seller, asset-backed commercial paper conduit administered by a bank.  The maximum amount that can be outstanding under this program is $150 million.  On May 19, 2011, the Company renewed its accounts receivable securitization program.  In connection with the renewal, the maturity date became May 17, 2012, and the interest rate spreads were decreased to reflect then-current market conditions.

 

At both September 30, 2011 and December 31, 2010, the outstanding amount of undivided interests in the receivables held by the conduit was $125.0 million.  During the nine months ended September 30, 2010, the Company’s accounts receivable increased by $125.0 million resulting in a cash outflow being reported in the operating section of the cash flow statement and the current portion of debt associated with the accounts receivable securitization program increased by $125.0 million resulting in a cash inflow being reported in the financing section of the statement of cash flows.  During the nine months ended September 30, 2011 and 2010, total proceeds from the accounts receivable securitization program were approximately $659.0 million and $625.0 million and total repayments were approximately $659.0 million and $500.0 million, respectively, which comprises the net cash flow in the financing section of the cash flow statement.

 

Secured Promissory Notes

 

During July 2011, IOS entered into a real estate mortgage in the amount of $9.3 million and denominated in British Pounds, which is secured by real estate in Bristol UK.  The loan requires quarterly principal payments and matures in July 2018.  At September 30, 2011, the outstanding balance was $8.5 million.

 

Revolving Credit Facilities

 

On June 30, 2011, DST amended its revolving syndicated bank facility.  The amendment extended the maturity date to July 1, 2015 and lowered the interest rate spreads and facility fees to reflect then-current market conditions.  In addition, the aggregate commitments under the facility were increased from $600 million to $630 million.

 

Related Party Credit Agreements

 

In 2011, DST’s Innovative Output Solutions Limited (“IOS”) subsidiary entered into a loan agreement denominated in British Pounds with International Financial Data Services Limited (“IFDS UK”).  The agreement

 

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Table of Contents

 

provides for unsecured revolving borrowings by IOS and matures on December 31, 2015.  IFDS UK may demand a prepayment of the loan by IOS at any time upon completion of a notice period.  The interest rate applicable to the loan is based on the base rate of the Bank of England plus an applicable margin of 3.0% and is payable monthly.  The amount outstanding under this loan at September 30, 2011 was $7.6 million.

 

Other Indebtedness

 

Other indebtedness is comprised of debt obligations assumed by the Company in connection with prior business acquisitions, including the acquisition of dsicmm Group Limited in 2010 and Lateral Group Limited in 2011.  Certain of the dsicmm credit agreements contain provisions that require dsicmm to maintain certain interest, leverage and other financial ratios.  In the event of non-compliance with the provisions of these credit agreements, an event of default may occur, which could result in the loan becoming immediately due and payable.

 

Other indebtedness also includes a borrowing arrangement denominated in British Pounds between IOS and a bank that is secured by accounts receivable of IOS.  The amounts outstanding under this facility were $13.9 million and $16.2 million at September 30, 2011 and December 31, 2010, respectively.  During the nine months ended September 30, 2011, proceeds received from this loan were $149.2 million and total repayments were $151.4 million, which have been included in net payments on revolving credit facilities in the Condensed Consolidated Statement of Cash Flows.

 

Term Loan Credit Facility

 

On October 28, 2011, the Company entered into a $125.0 million unsecured term loan credit facility with a bank.  Subsequent to entering the facility, the Company borrowed $125.0 million to partially fund the acquisition of ALPS which was completed on October 31, 2011.  The interest rates applicable to loans under the credit facility are generally based on LIBOR or prime rates plus applicable margins as defined in the facility.  The maturity date is the earlier of October 28, 2013 and the springing maturity date, as defined, which could cause the maturity date to become September 13, 2013 if the Company’s real estate credit agreement is not repaid or refinanced.  The facility contains customary restrictive covenants as well as customary events of default.  Based on the terms of the credit facility, the Company may be required to prepay the loan if certain events occur.  Amounts prepaid may not be reborrowed.

 

9.  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 29.5% and 34.1% for the three and nine months ended September 30, 2011, respectively, compared to 32.7% and 35.0% for the three and nine months ended September 30, 2010.  The Company’s tax rate for the three and nine months ended September 30, 2011 was different from the statutory federal income tax rate of 35% primarily because of foreign tax credits and benefits from dividends received deductions, partially offset by state income taxes and valuation allowances against international operating losses.  The nine months ended September 30, 2010 included a benefit from a dividend received deduction on approximately 50% of an $8.3 million cash dividend received from a private equity investment.

 

The full year 2011 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.

 

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Table of Contents

 

10.  Equity

 

Earnings per share

 

The computation of basic and diluted earnings per share is as follows (in millions, except per share amounts):

 

 

 

Three Months
Ended September 30,

 

Nine Months
Ended September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to DST Systems, Inc.

 

$

35.3

 

$

54.3

 

$

143.9

 

$

225.2

 

 

 

 

 

 

 

 

 

 

 

Average common shares outstanding

 

45.8

 

46.6

 

46.2

 

47.2

 

 

 

 

 

 

 

 

 

 

 

Incremental shares from restricted stock units and assumed conversions of stock options and debentures

 

0.6

 

0.3

 

0.7

 

0.3

 

 

 

 

 

 

 

 

 

 

 

Average diluted shares outstanding

 

46.4

 

46.9

 

46.9

 

47.5

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.77

 

$

1.17

 

$

3.11

 

$

4.77

 

Diluted earnings per share

 

$

0.76

 

$

1.16

 

$

3.07

 

$

4.74

 

 

The Company had approximately 44.2 million and 46.2 million shares outstanding at September 30, 2011 and 2010, respectively.  Shares from options to purchase common stock, excluded from the diluted earnings per share calculation because they were anti-dilutive, totaled 0.7 million and 0.9 million for the three and nine months ended September 30, 2011, respectively, compared to 3.8 million and 4.0 million for the three and nine months ended September 30, 2010.  The Company’s convertible senior debentures would have a potentially dilutive effect on the Company’s stock if converted in the future.  At September 30, 2011, outstanding Series C debentures would be convertible into 1.7 million shares of common stock, subject to adjustment.  The Company intends to settle any conversions with cash for the principal amount of the bonds and accrued and unpaid interest and issue common stock for any conversion value amount over the principal and accrued and unpaid interest amount.  Related to the debentures, the calculation of diluted earnings per share includes an incremental amount of shares assumed to be issued for the conversion spread when the Company’s average daily stock price exceeds the average accreted bond price per share.  For the three and nine months ended September 30, 2011, there was an insignificant amount of dilution related to the Company’s average share price exceeding the average accreted bond price per share.  For the three and nine months ended September 30, 2010, there was no additional dilution because the Company’s average share price was less than the average accreted bond price per share.

 

Share Based Compensation

 

The Company has a share based compensation plan covering its employees.  During the nine months ended September 30, 2011, the Company issued approximately 0.4 million restricted stock units (“RSU’s”).  A portion of these RSU grants contain performance features and are expected to vest over a three to five year period.  At September 30, 2011, the Company had outstanding 0.8 million unvested RSU’s, 0.1 million unvested restricted shares and 3.5 million stock options (of which 0.9 million are not yet exercisable).

 

Grants of RSU’s are valued at the date of grant based on the value of DST’s common stock.  The grant date fair value of the RSU’s granted during the nine months ended September 30, 2011 was approximately $19.2 million.  Certain of these RSU’s contain separate service and performance vesting requirements, while other grants contain performance vesting requirements with service required through the date of certification of performance.  The grant date fair value of the awards is generally being amortized over three to five year periods based on the estimated achievement of the required performance features of the awards.  The Company will continue to monitor and evaluate its assumptions pertaining to the achievement of the performance features over the performance period.  Unvested RSU’s may be forfeited upon termination of employment with the Company

 

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depending on the circumstances of the termination.  Holders of RSU’s participate in cash dividends, if any, (paid in the form of additional RSU’s and subject to the same vesting terms as the underlying RSU’s), but do not have full stockholders rights, including voting rights, prior to vesting.

 

At September 30, 2011, the Company had $29.5 million of total unrecognized compensation expense (included in Additional paid-in-capital on the Condensed Consolidated Balance Sheet) related to its share based compensation arrangements, net of estimated forfeitures.  The Company estimates that the amortized compensation expense attributable to the stock option, restricted stock and restricted stock unit grants will be approximately $4.2 million for the remainder of 2011, $12.4 million for 2012, $5.4 million for 2013, $1.8 million for 2014 and $0.2 million for 2015, based on awards currently outstanding.  Future amortization is not projected on approximately $5.5 million of unrecognized compensation expense as the related awards are not currently expected to achieve their required performance conditions and therefore are not expected to vest.

 

Other comprehensive income (loss)

 

Components of other comprehensive income (loss) consist of the following (in millions):

 

 

 

Three Months Ended
September 30,

 

Nine Months
Ended September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to DST Systems, Inc.

 

$

35.3

 

$

54.3

 

$

143.9

 

$

225.2

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) on investments:

 

 

 

 

 

 

 

 

 

Unrealized holding gain (losses) arising during the period

 

(191.9

)

63.0

 

(224.4

)

(72.2

)

Proportional share of unconsolidated affiliate interest rate swap

 

 

 

0.3

 

2.0

 

2.7

 

Unrealized gain (loss) on interest rate swaps

 

 

 

(1.3

)

0.1

 

(4.5

)

Less reclassification adjustments for net gains or losses included in net income

 

1.8

 

(0.9

)

(16.5

)

(41.1

)

Foreign currency translation adjustments

 

(15.1

)

23.8

 

(3.6

)

0.1

 

Deferred income taxes

 

78.1

 

(29.4

)

95.0

 

43.4

 

Other comprehensive loss

 

(127.1

)

55.5

 

(147.4

)

(71.6

)

Comprehensive income (loss)

 

$

(91.8

)

$

109.8

 

$

(3.5

)

$

153.6

 

 

One of DST’s unconsolidated affiliates had an interest rate swap liability with a fair market value of $73.3 million and $47.7 million at September 30, 2011 and December 31, 2010, respectively.  DST’s 50% proportionate share of this interest rate swap liability was $36.7 million and $23.9 million at September 30, 2011 and December 31, 2010, respectively.  The Company records in investments and accumulated other comprehensive income its proportionate share of this liability in an amount not to exceed the carrying value of its investment in this unconsolidated affiliate, which resulted in no liability recorded at September 30, 2011 and $2.0 million recorded at December 31, 2010.

 

Stock repurchases

 

On May 10, 2011, DST’s Board of Directors authorized the repurchase of an additional 2.0 million shares under the existing share repurchase authorization plan, which allows for the repurchase of common stock in open market and private transactions through December 31, 2012.  The Company repurchased 2.8 million shares of DST common stock for $129.5 million or approximately $45.92 per share during the nine months ended September 30, 2011.  At September 30, 2011, there were approximately 0.2 million shares remaining to be repurchased under the Company’s existing share repurchase authorization plan.  An additional 130,000 shares of DST common stock were repurchased in late September 2011, but settled in early October 2011 for $5.9 million or $45.45 per share.

 

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After completion of these purchases, the Company had approximately 50,000 shares remaining under its existing share repurchase authorization.

 

In November 2011, DST’s Board of Directors announced an increase to its share repurchase authorization by 2.0 million shares.  The new share repurchase program will become effective January 1, 2012 and expire on December 31, 2013.  When the new repurchase authorization is combined with remaining shares from the existing authorization, the Company will have approximately 2,050,000 shares available to repurchase.

 

Dividends

 

On February 24, 2011, DST’s Board of Directors declared a cash dividend of $0.35 per share which was paid on April 8, 2011, to shareholders of record as of the close of business on March 18, 2011.  The aggregate amount of the dividend was approximately $16.2 million.

 

On September 20, 2011, DST’s Board of Directors declared a cash dividend of $0.35 per share which was paid on November 4, 2011, to shareholders of record as of the close of business on October 14, 2011.  The aggregate amount of the dividend was approximately $15.7 million.

 

Non-controlling interest

 

As a result of the acquisition of dsicmm on July 30, 2010, the Company’s IOS subsidiary has a non-controlling investor group which owns approximately 29.5% of IOS.  The amount included in equity at December 31, 2010 associated with the non-controlling interest was $21.2 million.  During the nine months ended September 30, 2011, the net loss primarily attributable to the IOS non-controlling interest was $2.9 million resulting in a balance of $18.3 million at September 30, 2011.

 

11.  Commitments and Contingencies

 

The Company and its subsidiaries are involved in various legal proceedings arising in the normal course of their businesses. While the ultimate outcome of these legal proceedings cannot be predicted with certainty, it is the opinion of management, after consultation with legal counsel, that the final outcome in such proceedings, in the aggregate, would not have a material adverse effect on the consolidated financial condition, results of operations and cash flow of the Company.

 

The Company has letters of credit of $7.8 million outstanding at both September 30, 2011 and December 31, 2010.  Letters of credit are secured by the Company’s debt facility.

 

The Company has entered into agreements with certain officers whereby upon defined circumstances constituting a change in control of the Company, certain benefit entitlements are automatically funded and such officers are entitled to specific cash payments upon termination of employment.

 

The Company has established trusts to provide for the funding of corporate commitments and entitlements of Company officers, directors, employees and others in the event of a change in control of the Company. Assets held in such trusts at September 30, 2011 and December 31, 2010 were not significant.

 

The Company has entered into an agreement to guarantee 50% of the obligations of a 50% owned joint venture as a tenant under a real estate lease for an office building. The initial term of the lease is 10 years and 7 months, commencing March 1, 2007 and expiring September 30, 2017, with two five-year options to extend. The base rent for the initial term is $4.8 million per year, plus all operating expenses for the building.

 

The Company entered into an agreement to guarantee up to $3.0 million plus any enforcement costs related to a $32.0 million mortgage loan to a 50% owned real estate joint venture.  The $32.0 million loan matures on June 30, 2013.  At September 30, 2011 and December 31, 2010, total borrowings on the loan were $29.9 million and $30.5 million, respectively, and the Company’s guarantee totaled $1.5 million for both September 30, 2011 and December 31, 2010.

 

The Company’s 50% owned joint ventures are generally governed by shareholder or partnership agreements.  The agreements generally entitle the Company to elect one-half of the directors to the board in the case of corporations

 

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and to have 50% voting/managing interest in the case of partnerships.  The agreements generally provide that the Company or the other party, if it desires to terminate the agreement, may establish a price payable in cash, or a promise to pay cash, for all of the other’s ownership in the joint venture and submit a binding offer, in writing, to the other party to sell to the other party all of its ownership interests in the joint venture or to purchase all ownership interests owned by the other party at such offering price.  The party receiving the offer generally has a specified period of time to either accept the offer to sell its interest, or to elect to purchase the offering party’s interest, in either case at the established offering price.  The Company cannot estimate the potential aggregate offering price that it could be required to receive for its interest in the case of a sale, or to pay for the other party’s interest in the case of a purchase; however, the amount could be material.

 

Guarantees

 

In addition to the guarantees entered into as mentioned above, the Company has also guaranteed certain obligations of certain joint ventures under service agreements entered into by the joint ventures and their customers. The amount of such obligations is not stated in the agreements. Depending on the negotiated terms of the guaranty and/or the underlying service agreement, the Company’s liability under the guaranty may be subject to time and materiality limitations, monetary caps and other conditions and defenses.

 

In certain instances in which the Company licenses proprietary systems to customers, the Company gives certain warranties and infringement indemnities to the licensee, the terms of which vary depending on the negotiated terms of each respective license agreement, but which generally warrant that such systems will perform in accordance with their specifications. The amount of such obligations is not stated in the license agreements. The Company’s liability for breach of such warranties may be subject to time and materiality limitations, monetary caps and other conditions and defenses.

 

From time to time, the Company enters into agreements with unaffiliated parties containing indemnification provisions, the terms of which vary depending on the negotiated terms of each respective agreement. The amount of such obligations is not stated in the agreements. The Company’s liability under such indemnification provisions may be subject to time and materiality limitations, monetary caps and other conditions and defenses. Such indemnity obligations include the following:

 

The Company has entered into purchase and service agreements with its vendors, and consulting agreements with providers of consulting services to the Company, pursuant to which the Company has agreed to indemnify certain of such vendors and consultants, respectively, against third party claims arising from the Company’s use of the vendor’s product or the services of the vendor or consultant.

 

In connection with the acquisition or disposition of subsidiaries, operating units and business assets by the Company, the Company has entered into agreements containing indemnification provisions, the terms of which vary depending on the negotiated terms of each respective agreement, but which are generally described as follows: (i) in connection with acquisitions made by the Company, the Company has agreed to indemnify the seller against third party claims made against the seller relating to the subject subsidiary, operating unit or asset and arising after the closing of the transaction, and (ii) in connection with dispositions made by the Company, the Company has agreed to indemnify the buyer against damages incurred by the buyer due to the buyer’s reliance on representations and warranties relating to the subject subsidiary, operating unit or business assets in the disposition agreement if such representations or warranties were untrue when made, or due to any breach of the representations, warranties, agreements or covenants contained in the agreement.

 

The Company has entered into agreements with certain third parties, including banks and escrow agents that provide software escrow, fiduciary and other services to the Company or to its benefit plans or customers. Under such agreements, the Company has agreed to indemnify such service providers for third party claims relating to the carrying out of their respective duties under such agreements.

 

The Company has entered into agreements with lenders providing financing to the Company pursuant to which the Company agrees to indemnify such lenders for third party claims arising from or relating to such financings. In connection with real estate mortgage financing, the Company has entered into environmental indemnity

 

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agreements in which the Company has agreed to indemnify the lenders for any damage sustained by the lenders relating to any environmental contamination on the subject properties.

 

In connection with the acquisition or disposition of real estate by the Company, the Company has entered into real estate contracts containing indemnification provisions, the terms of which vary depending on the negotiated terms of each respective contract, but which are generally described as follows: (i) in connection with acquisitions by the Company, the Company has agreed to indemnify the seller against third party claims made against the seller arising from the Company’s on-site inspections, tests and investigations of the subject property made by the Company as part of its due diligence and against third party claims relating to the operations on the subject property after the closing of the transaction, and (ii) in connection with dispositions by the Company, the Company has agreed to indemnify the buyer for damages incurred by the buyer due to the buyer’s reliance on representations and warranties relating to the subject property made by the Company in the real estate contract if such representations or warranties were untrue when made and against third party claims relating to operations on the subject property prior to the closing of the transaction.

 

In connection with the leasing of real estate by the Company, as landlord and as tenant, the Company has entered into occupancy leases containing indemnification provisions, the terms of which vary depending on the negotiated terms of each respective lease, but which are generally described as follows: (i) in connection with leases in which the Company is the tenant, the Company has agreed to indemnify the landlord against third party claims relating to the Company’s occupancy of the subject property, including claims arising from loss of life, bodily injury and/or damage to property thereon, and (ii) in connection with leases in which the Company is the landlord, the Company has agreed to indemnify the tenant against third party claims to the extent occasioned wholly or in part by any negligent act or omission of the Company or arising from loss of life, bodily injury and/or damage to property in or upon any of the common areas or other areas under the Company’s control.

 

At September 30, 2011 and December 31, 2010, the Company had not accrued any liability on the aforementioned guarantees or indemnifications as they relate to future performance criteria or indirect guarantees of indebtedness of others in accordance with accounting and reporting guidance on guarantees, including indirect guarantees of indebtedness of others.

 

12.  Authoritative Accounting Guidance

 

Testing Goodwill for Impairment

 

In September 2011, the Financial Accounting Standards Board (“FASB”) issued new authoritative guidance related to testing goodwill for impairment, intended to simplify how entities test goodwill for impairment.  The guidance permits an entity to first assess qualitative factors to determine whether it is more than likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test.  The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent.  The guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  Early adoption is permitted under certain conditions.  The Company has not yet determined the impact that the adoption of this new accounting guidance may have on the consolidated financial statements.

 

Fair Value Measurement and Disclosure

 

In May 2011, the FASB issued new authoritative guidance related to fair value measurement and disclosure requirements.  The guidance is intended to improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and International Financial Reporting Standards.  The guidance is effective for annual periods beginning after December 15, 2011.  The Company has not yet determined the impact that the adoption of this new accounting guidance may have on the consolidated financial statements.

 

Earnings per Share Proposed Accounting Standard

 

In August 2008, the FASB issued a revised exposure draft, that would amend current earnings per share accounting guidance to clarify guidance for mandatorily convertible instruments, the treasury stock method,

 

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contingently issuable shares, and contracts that may be settled in cash or shares.  The final authoritative accounting guidance has yet to be issued.  In April 2009, the FASB decided to pause the earnings per share project.

 

The proposed guidance, which is designed for convergence with international accounting standards, would require the use of the “if-converted” method from the date of issuance of the convertible debentures.  The proposed guidance would remove the ability of a company to support the presumption that the convertible securities will be satisfied in cash and not converted into shares of common stock.  Accordingly, the Company’s stated intention to settle conversions of its convertible debentures with cash for the principal and accrued and unpaid interest and issue common stock for any conversion value amount over the principal and accrued and unpaid interest amounts would no longer be accepted under the current guidance, if amended as proposed.  Retrospective application would be required for all changes, except that retrospective application would be prohibited for contracts that were either settled in cash prior to adoption or modified prior to adoption to require cash settlement.  For DST, adoption of this accounting guidance, as proposed, will require retroactive restatement of the Company’s diluted earnings per share calculations subsequent to the issuance of the convertible debentures.  The revised exposure draft also contains other EPS computational changes (e.g., treasury stock method considerations) that may have an effect on the Company’s diluted earnings per share calculation.  DST is continuing to monitor the FASB’s progress towards finalizing this proposed accounting guidance.

 

The proposed change in accounting principle would affect the calculation of diluted earnings per share during the period the debentures are outstanding, but would not affect DST’s ability to ultimately settle the convertible debentures in cash, shares or any combination thereof.

 

13.  Segment Information

 

The Company’s operating business units offer sophisticated information processing and software services and products.  These business units are reported as two operating segments (Financial Services and Output Solutions).  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 an Investments and Other Segment.

 

Information concerning total assets by reporting segment is as follows (in millions):

 

 

 

September 30,
2011

 

December 31,
2010

 

 

 

 

 

 

 

Financial Services

 

$

1,535.6

 

$

1,639.9

 

Output Solutions

 

477.8

 

457.6

 

Investments and Other

 

1,100.2

 

1,329.1

 

Elimination Adjustments

 

(69.2

)

(87.2

)

 

 

$

3,044.4

 

$

3,339.4

 

 

The Company evaluates the performance of its Segments based on income before income taxes, interest expense and non-controlling interest.  Intersegment revenues are reflected at rates prescribed by the Company and may not be reflective of market rates.

 

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Summarized financial information concerning the Company’s Segments is shown in the following tables (in millions):

 

 

 

Three Months Ended September 30, 2011

 

 

 

Financial
Services

 

Output
Solutions

 

Investments
/ Other

 

Eliminations
Adjustments

 

Consolidated
Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

 

$

274.6

 

$

155.4

 

$

3.1

 

$

 

 

$

433.1

 

Intersegment operating revenues

 

2.4

 

1.8

 

11.2

 

(15.4

)

 

 

Out-of-pocket reimbursements

 

9.5

 

150.1

 

0.1

 

(1.4

)

158.3

 

Total revenues

 

286.5

 

307.3

 

14.4

 

(16.8

)

591.4

 

 

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

208.0

 

292.6

 

10.0

 

(14.1

)

496.5

 

Depreciation and amortization

 

18.9

 

12.8

 

2.7

 

(0.7

)

33.7

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

59.6

 

1.9

 

1.7

 

(2.0

)

61.2

 

Other income (expense), net

 

(1.6

)

(0.1

)

(2.8

)

 

 

(4.5

)

Equity in earnings (losses) of unconsolidated affiliates

 

1.8

 

0.1

 

(0.2

)

 

 

1.7

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) before interest, income taxes and non-controlling interest

 

$

59.8

 

$

1.9

 

$

(1.3

)

$

(2.0

)

$

58.4

 

 

 

 

Three Months Ended September 30, 2010

 

 

 

Financial
Services

 

Output
Solutions

 

Investments
/ Other

 

Eliminations
Adjustments

 

Consolidated
Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

 

$

287.3

 

$

123.4

 

$

3.0

 

$

 

 

$

413.7

 

Intersegment operating revenues

 

3.1

 

2.0

 

11.6

 

(16.7

)

 

 

Out-of-pocket reimbursements

 

11.5

 

143.3

 

0.1

 

(1.4

)

153.5

 

Total revenues

 

301.9

 

268.7

 

14.7

 

(18.1

)

567.2

 

 

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

209.6

 

255.5

 

9.7

 

(15.5

)

459.3

 

Depreciation and amortization

 

19.5

 

12.2

 

2.5

 

(0.7

)

33.5

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

72.8

 

1.0

 

2.5

 

(1.9

)

74.4

 

Other income (expense), net

 

(8.1

)

 

 

17.5

 

 

 

9.4

 

Equity in earnings of unconsolidated affiliates

 

8.8

 

 

 

0.1

 

 

 

8.9

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) before interest, income taxes and non-controlling interest

 

$

73.5

 

$

1.0

 

$

20.1

 

$

(1.9

)

$

92.7

 

 

Earnings before interest, income taxes and non-controlling interest in the segment reporting information above less interest expense of $10.9 million and $12.1 million for the three months ended September 30, 2011 and 2010, respectively, is equal to the Company’s income before income taxes and non-controlling interest on a consolidated basis for the corresponding periods.

 

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Nine Months Ended September 30, 2011

 

 

 

Financial
Services

 

Output
Solutions

 

Investments
/ Other

 

Eliminations
Adjustments

 

Consolidated
Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

 

$

835.6

 

$

442.0

 

$

9.1

 

$

 

 

$

1,286.7

 

Intersegment operating revenues

 

6.7

 

5.8

 

33.0

 

(45.5

)

 

 

Out-of-pocket reimbursements

 

30.3

 

451.2

 

1.5

 

(4.4

)

478.6

 

Total revenues

 

872.6

 

899.0

 

43.6

 

(49.9

)

1,765.3

 

 

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

631.1

 

848.3

 

29.0

 

(42.0

)

1,466.4

 

Depreciation and amortization

 

54.8

 

34.4

 

7.9

 

(2.0

)

95.1

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

186.7

 

16.3

 

6.7

 

(5.9

)

203.8

 

Other income, net

 

1.7

 

0.2

 

25.4

 

 

 

27.3

 

Equity in earnings (losses) of unconsolidated affiliates

 

17.1

 

0.5

 

(0.3

)

 

 

17.3

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) before interest, income taxes and non-controlling interest

 

$

205.5

 

$

17.0

 

$

31.8

 

$

(5.9

)

$

248.4

 

 

 

 

Nine Months Ended September 30, 2010

 

 

 

Financial
Services

 

Output
Solutions

 

Investments
/ Other

 

Eliminations
Adjustments

 

Consolidated
Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

 

$

855.7

 

$

423.6

 

$

9.4

 

$

 

 

$

1,288.7

 

Intersegment operating revenues

 

8.3

 

5.9

 

34.6

 

(48.8

)

 

 

Out-of-pocket reimbursements

 

35.2

 

428.0

 

0.3

 

(4.4

)

459.1

 

Total revenues

 

899.2

 

857.5

 

44.3

 

(53.2

)

1,747.8

 

 

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

637.9

 

742.7

 

28.2

 

(45.4

)

1,363.4

 

Depreciation and amortization

 

58.7

 

35.2

 

7.5

 

(2.0

)

99.4

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

202.6

 

79.6

 

8.6

 

(5.8

)

285.0

 

Other income (expense), net

 

(0.8

)

0.1

 

68.5

 

 

 

67.8

 

Equity in earnings of unconsolidated affiliates

 

26.5

 

 

 

0.5

 

 

 

27.0

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) before interest, income taxes and non-controlling interest

 

$

228.3

 

$

79.7

 

$

77.6

 

$

(5.8

)

$

379.8

 

 

Earnings before interest, income taxes and non-controlling interest in the segment reporting information above less interest expense of $34.6 million and $33.7 million for the nine months ended September 30, 2011 and 2010, respectively, is equal to the Company’s income before income taxes and non-controlling interest on a consolidated basis for the corresponding periods.

 

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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 to shareholders and in the Company’s other filings with the Securities and Exchange Commission (“SEC”).  Readers can identify these forward-looking statements by the use of such verbs as expects, anticipates, believes or similar verbs or conjugations of such verbs.  If any of management’s assumptions prove incorrect or should unanticipated circumstances arise, the Company’s actual results could materially differ from those anticipated by such forward-looking statements.  The differences could be caused by a number of factors or combination of factors including, but not limited to, those factors referred to below in Part II, Item 1A, “Risk Factors.”  Readers are strongly encouraged to consider the factors referred to in such section and any amendments or modifications thereof 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 to reflect future events or developments.

 

The information contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto included in this Form 10-Q and the audited Consolidated Financial Statements and Notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

 

INTRODUCTION

 

The business units of DST Systems, Inc. (“DST” or “the Company”) offer sophisticated information processing and software services and products. These business units are reported as two operating segments, Financial Services and Output Solutions.  In addition, investments in the Company’s real estate subsidiaries and affiliates, 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 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 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.

 

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.

 

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Output Solutions

 

The Company’s Output Solutions Segment provides single source, integrated print and electronic statement and billing output solutions, including customized statement and bill production, direct marketing and personalization services, fulfillment, postal optimization, and electronic presentment, payment and distribution solutions.  These capabilities enable the Output Solutions Segment to provide services to industries that place a premium on customer communications that require high quality, accurate and timely statement and billing output processing.

 

The Output Solutions Segment 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 electronic delivery services for client bills and statements related to transaction events.  The acquisitions of Newkirk Products, Inc. in 2011 and Capital Fulfillment Group in 2010 expand 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 both DST’s retirement and insurance solutions businesses.

 

Innovative Output Solutions Limited (“IOS”) has several operating facilities in the United Kingdom and is among the largest direct communications manufacturers in that country.  The United Kingdom business is oriented to data driven marketing communications and direct mail campaigns with transaction printing accounting for less than 20% of revenues.

 

The Output Solutions Segment’s research and development efforts have resulted in two mail and postal processing initiatives, Smart Commingling and Intelligent Mail barcode, in compliance with United States Postal Services requirements.  In addition, the Digital Press Technology (“DPT”) high-speed color printing and inserting platform enables the Output Solutions Segment to produce high-speed transactional printing combined with dynamic color printing.  The Company believes DPT is a technologically-differentiated service offering that enables it to provide better and more efficient products and services to clients.

 

The Output Solutions Segment in North America distributes its product 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.

 

Investments and Other

 

The Investments and Other Segment is comprised of the Company’s real estate subsidiaries and affiliates 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 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 $610.9 million at September 30, 2011, including approximately 10.3 million shares of State Street Corporation (“State Street”), 15.0 million shares of Computershare Ltd. (“Computershare”) and 1.9 million shares of Euronet Worldwide, Inc., with a market value of $332.2 million, $108.3 million and $29.7 million, respectively, based on closing exchange values at September 30, 2011.

 

DST is a 100% owner of approximately 3.3 million square feet of real estate facilities in the U.S. of which 1.9 million square feet are occupied by DST and related affiliates, and approximately 1.4 million square feet of facilities are occupied by third parties.  Through joint ventures, DST has an interest in approximately 2.9 million square feet of U.S. commercial real estate facilities of which 500,000 square feet are occupied by DST and related affiliates and 2.4 million square feet are occupied by third parties, including a 1.1 million square foot facility developed for and occupied by the Internal Revenue Service under a long term lease arrangement.  An additional

 

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1.1 million square feet of joint venture property is a 1,000 room convention hotel.  The joint venture properties are principally located in Kansas City.

 

DST considers its data centers 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.

 

Recent Developments in the Company’s Business

 

Formation of DST Insurance Solutions, LLC

 

As previously announced, IFDS Ireland, a subsidiary of IFDS L.P., a joint venture of DST and State Street Corporation, acquired Percana Ltd., an outsourcing services and software provider to the global life and pensions industry headquartered in Dublin.  Percana has proprietary software for the processing of life and annuity products.  Percana licenses its software and also provides policy processing administration services and hosting.  As part of a strategy to provide these services on a broader basis, Percana products will be offered through IFDS U.K. in the United Kingdom and continental Europe.  To address the North American market, DST will license the software from the joint venture and offer a remote service (“ASP”) and, in partnership with BFDS, a full service (“BPO”) product.  DST has formed DST Insurance Solutions, LLC (“DSTIS”) to support this effort and will be responsible for the costs to adapt the product to the North American market.  DSTIS has been established to bring a contemporary, flexible solution to the insurance industry that is well-suited for the rapid introduction of new products and to provide processing solutions to DST’s client base as products are introduced to meet the customer needs for payout (retirement) products as investors transition from the accumulation phase of investment.

 

Business Combinations

 

DST has made a number of acquisitions in 2011 as part of its strategy to increase its product capabilities and expand its presence in the markets it currently serves and in adjacent markets.

 

ALPS Holdings, Inc.

 

On October 31, 2011, DST completed the previously announced acquisition of ALPS Holdings, Inc. (“ALPS”), a provider of a comprehensive suite of asset servicing and asset gathering solutions to open-end mutual funds, closed-end funds (“CEFs”), exchange-traded funds (“ETFs”) and alternative investment funds.

 

ALPS’ solutions fall into two major areas:  asset servicing and asset gathering.  Asset servicing clients include:

·                  Open-end mutual funds

·                  Exchange traded funds

·                  Closed-end mutual funds

·                  Hedge funds

 

ALPS’ fund servicing platform offers:

·                  Fund administration

·                  Tax administration

·                  Fund accounting

·                  Transfer agency

·                  Legal and compliance

·                  Creative services

·                  Medallion distribution

·                  Hedge fund administration

 

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ALPS’ asset gathering solutions include:

·                  Marketing and wholesaling services

·                  Closed-end fund IPO launch platform providing product sales, road show and marketing support

 

ALPS has approximately 340 employees and recorded $65.4 million of revenues for the nine months ended September 30, 2011.  ALPS has demonstrated a strong track record of growth.  Revenue growth for the year ended September 30, 2011 was 24.4%. As of December 31, 2010, ALPS managed more than $3.275 billion in assets and provided servicing to more than $291 billion in client assets.  DST plans to operate ALPS as a stand-alone entity.

 

The acquisition broadens the range of products and services DST will offer to the investment management and brokerage industries in the following areas: 1) ALPS’ comprehensive solution set allows DST to service market segments DST was previously unable to service; 2) ALPS positions DST to service hedge funds and ETFs; and 3) ALPS expands DST’s offerings beyond transfer agency.  ALPS’s financial results will be consolidated with those of DST beginning October 31, 2011, and will be reported as part of DST’s Financial Services Segment.  At closing, DST paid $250.0 million funded from cash, existing credit facilities and a new term loan credit facility.

 

DST expects to realize $5.0 million of annualized synergies in the first 24 months through rationalization of technology and service infrastructures.  Prior to the realization of synergies and costs associated with rationalization, DST estimates that ALPS will break even in fourth quarter 2011.  DST expects the addition of ALPS to be accretive to 2012 earnings before taking into account anticipated synergies from the transaction.  The Company now estimates that ALPS will contribute approximately $0.22 per share in 2012 on a GAAP basis, prior to synergies and costs associated with the transaction, compared to DST’s prior estimate of $0.06 per share.  The increase is the result of an updated estimate of the amortization of ALPS intangible assets.  Excluding the net income effect of non-cash charges, DST projects ALPS to contribute approximately $0.31 per share in 2012.  These projections include an estimate of intangible asset amortization expense, which was based on a preliminary estimate of the purchase price allocation to the fair value of net assets acquired.  When the purchase price allocation is finalized, the actual amount of intangible asset amortization expense may be different from the Company’s current estimate.

 

Finix Business Strategies, LLC, Finix Converge, LLC and Subserveo Inc.

 

On April 29, 2011, DST acquired, through a newly formed subsidiary, DST Brokerage Solutions, LLC, the assets of Finix Business Strategies, LLC (“Finix”), a financial services consulting firm with extensive brokerage and technology expertise.   DST Brokerage Solutions also acquired the assets of Finix Converge, LLC (“Converge”), a technology firm that develops and distributes an enterprise social networking and media platform to enable firms to connect and collaborate with their constituents more effectively online.  By combining Finix Business Strategies’ extensive knowledge and brokerage expertise with DST’s breadth and depth of technology and services, DST plans to address broker-dealers’ unique challenges through an expanded suite of products and solutions.  DST Brokerage Solutions, LLC is part of the Financial Services Segment.

 

On June 20, 2011, DST acquired Subserveo Inc. (“Subserveo”), a provider of automated compliance and surveillance solutions to broker-dealers and investment advisors throughout the U.S. and Canada.  Subserveo’s solutions perform daily analysis of transactions, orders and account holdings and provide detailed compliance alerts and case management.  Subserveo is operated as part of DST Brokerage Solutions.

 

Finix, Converge and Subserveo along with DST TASS, the Company’s subsidiary that provides full service subaccounting services, are operated as a single business unit.  This business unit will be DST’s channel to provide products to the broker/dealer market and will manage the distribution of the Company’s AWD, Vision Professional and print/mail products to that market.  Finix, Converge and Subserveo are development stage companies.  DST anticipates additional investment in these companies and DST’s retirement and insurance processing businesses will be required for them to reach their full potential.

 

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IntelliSource Healthcare Solutions

 

On July 1, 2011, DST acquired, through its wholly-owned subsidiary, DST Health Solutions, LLC, the assets of IntelliSource Healthcare Solutions (“IntelliSource”), whose principal product is CareConnect which provides an automated care management system.  The addition of the IntelliSource suite of solutions broadens DST Health Solutions’ product offering for integrated care management, providing DST Health Solutions’ health plan clients access to an array of valuable solutions — including integrated care management, workflow and analytics — that will enable them to collaboratively facilitate proactive care and optimize resources at all levels of the healthcare system.  DST will integrate CareConnect into its proprietary claims offerings.

 

Newkirk Products, Inc.

 

On May 2, 2011, DST acquired the outstanding stock of Newkirk Products, Inc. (“Newkirk”), an industry leader in the development and deployment of communications, education, and investment information for clients in the retirement planning, managed care, and wealth management industries.  Newkirk will be operated as a unit of the Output Solutions Segment and its results will be reported in that segment from the date of acquisition.  DST believes the acquisition of Newkirk broadens the solution set available to multiple DST business units.  Newkirk’s innovative on-demand publishing and marketing solutions complement DST Output’s breadth of transactional and digital fulfillment solutions, making it easier for companies to craft effective customer communications across print, mobile, and electronic channels.  It also enables clients of DST Retirement Solutions to access a more fully integrated offering that leverages Newkirk’s capabilities geared to the needs of plan sponsors and participants, including communication and education materials, financial planning tools and plan documents.  The acquisition of Newkirk also extends DST Output’s capabilities in the healthcare industry enabling the Company to produce pre-enrollment communications, including information designed to help a participant personalize their health care plan.

 

Lateral Group Limited

 

On August 5, 2011, DST’s Innovative Output Solutions (“IOS”) subsidiary completed the acquisition of the outstanding stock of Lateral Group Limited (“Lateral”), a U.K. company engaged in integrated, data driven, multi-channel marketing.  The acquisition of Lateral complements the existing IOS business in terms of services offered and business outlook.  In addition, this acquisition allows IOS to extend and develop its service/product offerings by further integrating communications through print, data and e-solutions and by providing additional solutions such as data insight and online marketing to the IOS client base.

 

Following the closing of the ALPS transaction, DST has invested approximately $360.0 million in acquisitions during the ten months ended October 31, 2011, from which the Company expects to record approximately $270.0 million of operating revenue in 2012. DST views investment management, brokerage, retirement, insurance and healthcare as key vertical markets for the Company and plans to market and enhance its comprehensive solution sets for each of these vertical markets.

 

Amortization expense recorded during the three months ended September 30, 2011 from intangible assets (principally customer relationship assets and proprietary software) acquired in connection with 2011 business combinations was approximately $1.0 million comprised of $0.4 million in Financial Services and $0.6 million in Output Solutions.  Amortization expense for fourth quarter 2011 from the full year 2011 acquisitions, including ALPS, is projected to be $2.2 million ($1.4 million in Financial Services and $0.8 million in Output Solutions).  For 2012, amortization expense from the full year 2011 acquisitions is projected to be $11.0 million ($8.0 million in Financial Services and $3.0 million in Output Solutions).

 

Review by DST’s Independent Advisors

 

On August 5, 2011, DST’s Board of Directors announced that it was engaging independent advisors to review the Company’s business plan, assets and investment portfolio.  On November 2, 2011, after a comprehensive review of the Company’s business plan and strategy, DST’s Board of Directors announced that it unanimously determined that continuing to execute on the Company’s business plan and strategy is in the best interests of DST

 

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and its shareholders.  In Management’s Discussion and Analysis of Financial Condition and Results of Operations that follows, DST discusses the operating performance of Company and its continued focus on five key industry verticals of asset management, brokerage, retirement, insurance and healthcare, as well as the development and delivery of customer communications through both print and electronic media.

 

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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
September 30,

 

Nine Months Ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Revenues

 

 

 

 

 

 

 

 

 

Operating revenues

 

 

 

 

 

 

 

 

 

Financial Services

 

$

277.0

 

$

290.4

 

$

842.3

 

$

864.0

 

Output Solutions

 

157.2

 

125.4

 

447.8

 

429.5

 

Investments and Other

 

14.3

 

14.6

 

42.1

 

44.0

 

Elimination Adjustments

 

(15.4

)

(16.7

)

(45.5

)

(48.8

)

 

 

433.1

 

413.7

 

1,286.7

 

1,288.7

 

% change from prior year period

 

4.7

%

 

 

(0.2

)%

 

 

 

 

 

 

 

 

 

 

 

 

Out-of-pocket reimbursements

 

 

 

 

 

 

 

 

 

Financial Services

 

9.5

 

11.5

 

30.3

 

35.2

 

Output Solutions

 

150.1

 

143.3

 

451.2

 

428.0

 

Investments and Other

 

0.1

 

0.1

 

1.5

 

0.3

 

Elimination Adjustments

 

(1.4

)

(1.4

)

(4.4

)

(4.4

)

 

 

158.3

 

153.5

 

478.6

 

459.1

 

% change from prior year period

 

3.1

%

 

 

4.2

%

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

591.4

 

$

567.2

 

$

1,765.3

 

$

1,747.8

 

% change from prior year period

 

4.3

%

 

 

1.0

%

 

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

 

 

 

 

 

 

 

 

Financial Services

 

$

59.6

 

$

72.8

 

$

186.7

 

$

202.6

 

Output Solutions

 

1.9

 

1.0

 

16.3

 

79.6

 

Investments and Other

 

1.7

 

2.5

 

6.7

 

8.6

 

Elimination Adjustments