10-K 1 dst10k2017.htm 10-K Document
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United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
x    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
or
¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
to
Commission file number 1-14036
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DST Systems, Inc.
(Exact name of Registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
 
43-1581814
(I.R.S. Employer identification no.)
 
 
 
333 West 11th Street, Kansas City, Missouri
(Address of principal executive offices)
 
64105
(Zip code)
(816) 435-1000
Registrant’s telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each Exchange on which registered
Common Stock, $0.01 Per Share Par Value
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES x    NO ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ¨    NO x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x    NO ¨
Indicate by check mark 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 ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer ¨
 
Non-accelerated filer ¨
 (Do not check if a
smaller reporting company)
 
Smaller reporting company ¨
 
Emerging growth company¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨    NO x
Aggregate market value of the voting and non-voting stock held by non-affiliates of the Registrant as of June 30, 2017:
Common Stock, $0.01 par value—$3,746,186,932
Number of shares outstanding of the Registrant’s common stock as of January 31, 2018:
Common Stock, $0.01 par value—59,313,526
Documents incorporated by reference: None.




DST Systems, Inc.
2017 Form 10-K Annual Report
Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The brand, service or product names or marks referred to in this Annual Report are trademarks or services marks, registered or otherwise, of DST Systems, Inc., our consolidated subsidiaries or our joint ventures.

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PART I
Item 1.    Business
DST Systems, Inc. is a global provider of technology-based information processing and servicing solutions. References below to “DST,” “the Company,” “we,” “us” and “our” may refer to DST Systems, Inc. exclusively or to one or more of our consolidated subsidiaries. We provide business solutions through a unique blend of industry knowledge and experience, technological expertise and service excellence to clients in the asset management, brokerage, retirement, healthcare and other markets. The Company was formed in 1969. Through a reorganization in August 1995, we are a corporation organized in the State of Delaware.
NARRATIVE DESCRIPTION OF BUSINESS
DST uses our proprietary software applications to provide sophisticated information processing and servicing solutions through strategically unified data management and business process solutions to clients globally within the asset management, brokerage, retirement, healthcare and other markets. Our wholly-owned data centers provide the secure technology infrastructure necessary to support our solutions.
On January 11, 2018, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with SS&C Technologies Holdings, Inc. (“SS&C”) and Diamond Merger Sub, Inc., a Delaware corporation and an indirect wholly owned subsidiary of SS&C (“Merger Sub”), pursuant to which, among other things, Merger Sub will merge with and into DST, with DST surviving as a wholly owned subsidiary of SS&C (the “Merger”).
At the effective time of the Merger (the “Effective Time”), each share of common stock, par value $0.01 per share, of DST issued and outstanding immediately prior to the Effective Time (subject to certain exceptions as provided in the Merger Agreement) shall be converted into the right to receive $84.00 in cash, without interest, for a total enterprise value of approximately $5.4 billion, including assumption of debt. The transaction is currently expected to close before the end of the second quarter of 2018 and is subject to the satisfaction of certain customary conditions as set forth in the Merger Agreement; however, there can be no assurances as to the actual closing or the timing of the closing.
In March 2017, we acquired State Street Corporation’s (“State Street”) ownership interest in our joint ventures Boston Financial Data Services, Inc. (“BFDS”) and International Financial Data Services, U.K. (“IFDS U.K.”), as well as other investments and real estate held by International Financial Data Services, L.P. (“IFDS L.P.”). BFDS and IFDS U.K. were consolidated in our financial results from the date control of these entities was obtained.
We sold our North American Customer Communications business on July 1, 2016 and sold our United Kingdom (“U.K.”) Customer Communications business on May 4, 2017. We have classified the results of the Customer Communications businesses sold as discontinued operations in our consolidated financial statements for all periods presented.
Beginning in 2017, DST established a new reportable segment structure that reflects how management is now operating the business and making resource allocations following the acquisitions of the remaining interests in IFDS U.K. and BFDS, as well as the recent reductions in non-core investment assets. The Company’s operating business units are now reported as three operating segments (Domestic Financial Services, International Financial Services and Healthcare Services).  Prior periods have been revised to reflect the new reportable operating segments.
For the year ended December 31, 2017, DST’s operating revenues were $2,086.7 million. Segment operating revenues, as a percentage of consolidated operating revenues (excluding intersegment revenues), were 54.2%, 25.8%, and 20.0% contributed from the Domestic Financial Services, International Financial Services, and Healthcare Services segments, respectively.
DOMESTIC FINANCIAL SERVICES SEGMENT
Through the Domestic Financial Services segment, we provide investor, investment, advisor/intermediary and asset distribution services to companies within the United States (“U.S.”) financial services industry. Utilizing our proprietary software applications, we offer our clients information processing solutions to support direct and intermediary sales of mutual funds, alternative investments, securities brokerage accounts and retirement plans. This includes transaction processing; account opening and maintenance; reconciliation of trades, positions and cash; corporate actions; regulatory reporting and compliance functions; and tax reporting. We also support full reporting to investors for confirmations, statements and tax forms, web access, and electronic delivery of documents.
Services are provided either on a remote processing (“Remote”) or business process outsourcing (“BPO”) basis utilizing our proprietary software applications, including our TA 2000® and TRAC® systems. Our BPO service offerings are enhanced by

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AWD®, our proprietary workflow software, which is also licensed separately to third parties. In the U.S., we provide services to mutual funds, brokerage firms, retirement plans and alternative investment funds (such as real estate investment trusts “REITs”).
Accounts serviced under shareowner recordkeeping arrangements with the mutual fund and alternative investment sponsors are referred to as “registered accounts.” Registered accounts include both tax-advantaged and non tax-advantaged accounts on the books of the transfer agent. We also contract directly with broker/dealers to manage brokerage subaccounts.
Additionally, we deliver a comprehensive suite of asset servicing, distribution solutions and asset management for open-end mutual funds, closed-end funds, exchange-traded funds and alternative investment funds. Focusing on the needs of small- to medium-sized funds that require a broad set of customizable services, we provide compliance, creative services, medallion distribution, fund administration, fund accounting, legal, tax administration, transfer agency and asset management services.
Our distribution services range from consulting to active wholesaling and marketing, including closed-end funds IPO launch platform services. We also offer products designed to assist clients in meeting the expanding needs associated with distributing U.S. investment products through financial intermediaries.
We serve as the asset manager to proprietary open-end mutual funds, closed-end funds and exchange-traded funds through active management and through the utilization of sub-advisors and index providers. Additionally, we offer data analytics and consulting services in the U.S. to help our clients gain actionable insights into the needs and preferences of their customers.
We typically have multi-year agreements with our clients. Domestic Financial Services segment fees are primarily charged to the client based on the number of accounts, participants or transactions processed. For subaccounts, broker/dealers provide a portion of the services directly. As a result, our revenue per account is generally higher for registered accounts than for subaccounts. On a more limited basis, we also generate revenue through asset-based fee arrangements, subscriptions and/or seat licensing and from investment earnings related to cash balances maintained in our full service transfer agency bank accounts.
The Domestic Financial Services segment’s largest client accounted for 10.0% of the segment’s operating revenues in 2017 and the five largest Domestic Financial Services clients collectively accounted for 18.8% of the segment’s operating revenues in 2017.
Sources of new business for the Domestic Financial Services segment include: (i) existing clients, particularly with respect to complementary and new products and services, (ii) companies relying on their own in-house capabilities and not using outside vendors, (iii) companies using competitors’ systems, and (iv) new entrants into the markets we serve. We believe that competition in the markets in which the Domestic Financial Services segment operates is based largely on price, quality of service, features offered, the ability to handle rapidly changing volumes, response to security and compliance needs, product innovation, and responsiveness. Our competitors are primarily financial institutions and in-house systems. Our financial institution competitors may have an advantage because they may take into consideration the value of their clients’ funds on deposit or under management when pricing their services. We believe there is significant competition in our markets and our ability to compete effectively is dependent in part on access to capital.
INTERNATIONAL FINANCIAL SERVICES SEGMENT
We offer investor and policyholder administration and technology services on a Remote and BPO basis in the U.K. and, through our joint venture IFDS L.P., in Canada, Ireland and Luxembourg, utilizing our proprietary FAST platform and IFDS L.P.’s iFAST platform. Additionally, in Australia and the U.K., we provide solutions related to participant accounting and recordkeeping for wealth management, “wrap platforms” and retirement savings (“superannuation”) industries/markets through use of our wealth management platform (Bluedoor) and our life and pension administration system (Percana).
Our primary clients are mutual fund managers, insurers, and platform providers. International Financial Services fees are primarily charged to the client based on the number of accounts or transactions processed. We also realize revenues from fixed-fee license agreements that include provisions for ongoing support and maintenance and for additional license payments in the event that usage or members increase. Additionally, we derive professional service revenues from the fees for implementation services, custom programming and data center operations. We typically have multi-year agreements with our clients.
The International Financial Services segment’s largest client accounted for 24.4% of the segment’s operating revenues in 2017 and the five largest International Financial Services clients collectively accounted for 55.7% of the segment’s operating revenues in 2017.
Sources of new business for International Financial Services segment include: (i) existing clients, particularly with respect to complementary and new products and services, (ii) companies relying on their own in-house capabilities and not using outside vendors, (iii) companies using competitors’ systems, and (iv) new entrants into the markets we serve. We believe that

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competition in the markets in which the International Financial Services segment operates is based largely on price, quality of service, features offered, the ability to handle rapidly changing volumes, response to security and compliance needs, product innovation, and responsiveness. We believe there is significant competition in our markets and our ability to compete effectively is dependent in part on access to capital.
HEALTHCARE SERVICES SEGMENT
The Healthcare Services segment uses our proprietary software applications to provide healthcare organizations with pharmacy, healthcare administration, and health outcomes optimization solutions to satisfy their information processing, quality of care, cost management and payment integrity needs. Our healthcare solutions include claims adjudication, benefit management, care management, business intelligence and other ancillary services. The Healthcare Services segment’s five largest clients accounted for 48.7% of segment operating revenues in 2017, including 18.6% from its largest client.
Our healthcare services are marketed to health insurance companies, health plans and benefits administrators. Clients primarily consist of managed care organizations, preferred provider organizations, third-party administrators, dental, vision, and behavioral health organizations operating commercial and government sponsored programs such as the Health Insurance Exchanges that operate under the Patient Protection and Affordable Care Act, Medicare Advantage, Medicare Part D and Medicaid.
We compete with other third-party providers and companies that perform their services in-house with licensed or internally developed systems and processes. We believe that we compete effectively in the market due to our ongoing investment in our products and the development of new products to meet the evolving business requirements of our clients.
Our competitors’ healthcare administration and health outcomes optimization solutions are primarily based on complete replacement of a payer’s core system. We believe that a component application approach shifts the focus away from core application replacement to one in which clients have more alternatives for modernization of the business operation. With a component approach, health payer clients can still choose core application replacement if warranted, or adopt component applications that address only those areas of the business that offer the most opportunity of improvement for the client, resulting in protection of the client’s current IT investment and less disruption to its business operation.
Pharmacy Solutions
We use our proprietary software applications, supporting technology and enhanced clinical expertise to provide pharmacy health management solutions supporting commercial, Medicaid and Medicare Part D plans. These services include pharmacy claims administration, pharmacy network solutions, government programs administration, formulary and rebate management, trend control and quality compliance programs, member services, and discount drug card programs. RxNova, our proprietary claims processing system, is a highly scalable and comprehensive system for the administration of pharmacy benefits, prescription claims adjudication, eligibility, pharmacy management, and related activities. This benefit management solution provides substantial flexibility to accommodate varying provider requirements, allows point-of-sale monitoring, and provides control of pharmacy plan benefits with online benefit authorization.
We generally derive revenue from our pharmacy-solutions business on a transactional fee basis. Fees are earned on pharmacy claims processing and payments services, pharmacy and member call center services, formulary and rebate administration, administration or management of clinical programs, pharmacy network management, member and plan web services and management information and reporting. We also receive investment earnings on cash balances maintained in our bank accounts related to funds held to satisfy our client’s pharmacy claim obligations.
Healthcare Administration
We use our proprietary software applications to provide medical claim administration services and health plan compliance and revenue integrity services for payers and providers in the domestic healthcare industry.  Healthcare administration services are offered on a software license, Remote and BPO basis. Our solutions, combined with our health outcomes optimization solutions described below, are offered as stand-alone component solutions to complement health plans, existing operations or systems, or as an integrated core administration package of solutions.
Claims administration services include claims processing, benefit plan management, eligibility and enrollment management, provider contract administration, mail receipt and processing, imaging/data capture and retention, fulfillment, utilization management, and customer service. Health plan compliance and revenue integrity services include a retrospective review of medical records to accurately capture members’ health status through proper hierarchical condition categories.
Healthcare administration revenues are generally derived from fees charged on a per member/per month basis or transactional basis. We also realize revenue from fixed-fee license agreements that include provisions for ongoing support and maintenance and for additional license payments in the event that usage or members increase.

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Health Outcomes Optimization
We provide health outcomes optimization solutions through the use of our integrated care management and population health analytics applications and professional services for health plans and providers in the domestic healthcare industry.  Our Integrated Care Management solution is a real-time, intuitive, workflow-driven solution suite that assists clients to improve member outcomes and manage costs. Our population health technology provides organizations with the ability to measure and manage federal and state required quality management initiatives, provider network quality and efficiency, member health programs, and risk adjustment on an integrated system. In addition to our proprietary systems, we are the exclusive distributor of Johns Hopkins’ Adjusted Clinical Groups (“ACG”), a patient classification system developed by Johns Hopkins University. The ACG System is a software tool that provides health plans the ability to easily identify their at-risk population and stratify them into the optimal care management program.
Professional services include business and industry consulting, risk adjustment, compliance and regulatory consulting, behaviorally based interventions, healthcare quality incentive management, medical management (disease, care, and utilization), HEDIS, managed information technology, software engineering, operations process engineering and management consulting.
Health outcomes optimization revenues are generally derived from fees charged based on a per member/per month basis. We also realize revenue from fixed-fee license agreements that include provisions for ongoing support and maintenance and for additional license payments in the event that usage or members increase. Additionally, we derive professional service revenues from fees for implementation services, custom programming and data center operations.
SOFTWARE DEVELOPMENT AND MAINTENANCE
DST’s software development and maintenance efforts are focused on introducing new products and services, as well as enhancing our existing products and services. The software development, maintenance and enhancement costs, including capitalized software development costs, were $243.0 million, $217.3 million and $205.5 million for the years ended December 31, 2017, 2016 and 2015, respectively.
INTELLECTUAL PROPERTY
We hold U.S. patents, U.S. copyrights and trademarks covering various aspects of the information processing and computer software services and products provided by the Domestic Financial Services, International Financial Services and Healthcare Services segments. The duration of the patent term is generally 20 years from its earliest application filing date. The patent term is not renewable. The durations of the copyrights depend on a number of factors, such as who created the work and whether he or she was employed by us at the time. The trademark rights generally will continue for as long as we maintain usage of the trademarks. We believe our copyrights are adequate to protect our original works of authorship. We believe that although the patents, trademarks and copyrights related to the segments are valuable, our success primarily depends upon our product and service quality, marketing and service skills. Despite patent, trademark and copyright protection, we may be vulnerable to competitors who attempt to imitate our systems or processes. In addition, other companies and inventors may receive patents that contain claims applicable to our systems and processes.
EMPLOYEES
We had approximately 14,200 total employees at December 31, 2017, of which approximately 7,500 employees were located in the U.S. and approximately 6,700 employees were located internationally. Additionally, our joint ventures had approximately 1,500 employees in Canada, Ireland, Luxembourg and the U.S. at December 31, 2017. None of our employees are represented by a labor union or covered by a collective bargaining agreement, and we consider our employee relations to be good.
SEGMENT, GEOGRAPHIC AREA AND OTHER FINANCIAL INFORMATION
This discussion of the business of DST Systems, Inc. should be read in conjunction with, and is qualified by reference to, Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) under Item 7 herein. In addition, the information set forth under the headings “Forward Looking Statements,” “Introduction” and “Seasonality” in the MD&A and the segment and geographic information included in Item 8, Financial Statements and Supplementary Data - Note 17, “Segment and Geographic Information” are incorporated herein by reference in partial response to this Item 1.

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AVAILABLE INFORMATION
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports will be made available free of charge on or through our Internet website (www.dstsystems.com) as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). In addition, our corporate governance guidelines and the charters of the Audit Committee, the Corporate Governance/Nominating Committee, and Compensation Committee of the DST Board of Directors are available at investors.dstsystems.com/govdocs. These guidelines and charters are available in print to any stockholder who requests them. Written requests may be made to the DST Corporate Secretary, 333 West 11th Street, Kansas City, Missouri 64105, and oral requests may be made by calling the DST Corporate Secretary’s Office at (816) 435-8655. We do not intend for information contained on our website to be part of this Annual Report on Form 10-K. An individual may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E. Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
Item 1A.    Risk Factors
In addition to the other information set forth in this report, you should carefully consider the following factors, which could materially affect our business, financial condition, results of operations or cash flows in future periods. While we believe we have identified and discussed below the key risk factors affecting our business, there may be additional risks and uncertainties not currently known to us or that we currently deem to be immaterial that may adversely affect our business, financial condition, results of operations, cash flows or share price in the future.
Risks Related to Our Business
Trends or events affecting our clients or their industries could decrease the demand for our products and services and the loss of, reduction of business with, or less favorable terms with any of our significant clients could materially harm our business and results of operations.
We derive our revenues from the delivery of products and services to clients primarily in the mutual fund, brokerage, investment management, other financial service (e.g., insurance, banking and financial planning), healthcare and pharmacy industries. Demand for our products and services among companies in those industries could decline for many reasons. If demand for our products or services decreases or any of the industries we serve decline or fail or consolidate, reducing the number of potential clients, our business and our operating results could be adversely affected.
On a consolidated basis, for the year ended December 31, 2017, our five largest clients accounted for approximately 23.7% of our consolidated operating revenues. For the same period, the Healthcare Services segment’s five largest clients accounted for approximately 48.7% of our revenues in that segment, including 18.6% from its largest clients. Because of our significant client concentration, particularly in the Healthcare Services segment, our revenues could fluctuate significantly due to changes in economic conditions, the use of competitive products, or the loss of, reduction of business with, or less favorable terms with any of our significant clients, and a delay or default in payment by any significant client could materially harm our business and results of operations.
Events that adversely affect our clients’ businesses, rates of growth or numbers of clients they serve could decrease demand for our products and services and the number of transactions we process. Events that could adversely affect our clients’ businesses include decreased demand for our clients’ products and services, adverse conditions in our clients’ markets or adverse economic conditions generally. We may be unsuccessful in predicting the needs of changing industries and whether potential clients will accept our products or services. We also may invest in technology or infrastructure for specific clients and not realize additional revenue from such investments. If trends or events do not occur as we expect, our business could be negatively impacted.

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We depend on information technology, and any failures of or damage to, attack on or unauthorized access to our information technology systems or those of third parties on which we rely could result in significant costs and reputational damage. 
We have developed and maintained, and our businesses depend on, information technology, including elements both internal and external, to record and process a large volume of complex transactions and other data, including personally identifiable information regarding financial and health matters. In certain circumstances, vendors have access to such data in order to assist us with responsibilities, such as producing benefit plan identification cards, maintaining software we license on our own behalf or for resell to others, or helping clients comply with anti-money laundering regulations. Any interruptions, delays, breakdowns, or breach, including as a result of cybersecurity breaches or breaches of our environments and procedures or those of our vendors, could result in significant data losses or theft of our or our clients’ intellectual property, proprietary business information or personally identifiable information.  Several health care and financial services firms have been victims of computer systems hacking attacks, resulting in the disruption of services to clients, loss or misappropriation of sensitive or private data, and reputational harm. Rapid advances in technology, and the limits and costs of technology, skills and manpower, may prevent us from anticipating, identifying, preventing or addressing all potential security threats and breaches. A cybersecurity breach involving our systems or those of third parties on which we rely could negatively affect our reputation as a trusted product and service provider by adversely affecting the market’s perception of the security or reliability of our products or services. In addition, a system breach could result in other negative consequences, including remediation costs, disruption of internal operations, increased cybersecurity protection costs, lost revenues, regulatory penalties, and litigation. 
The demand for our products and services could decrease if we do not continually address our clients’ technology and capacity requirements.
Our clients use technology-based products and services in the complex and rapidly changing markets in which they operate. Our processes to support the design, set-up, quality assurance, and maintenance activities for the timely implementation of new client services, migration of existing clients onto new or different platforms, and ongoing servicing may not meet the needs of our business and clients. We must substantially invest in technology and systems to meet client requirements for technology and capacity. If we do not meet clients’ technology and capacity requirements in advance of our competitors or if the investments we make are not cost-effective or do not result in successful products or services, our business could be adversely affected.
The success of our information technology transformation initiative will depend on the timing, extent and cost of implementation; performance of third-parties; upgrade requirements; and availability and reliability of the various technologies required to provide such transformation.
We must continually invest in our information technology in order to continually meet our clients’ needs.  We are implementing a multi-year information technology transformation initiative intended to reduce operating costs, increase information security, upgrade infrastructure, expand automation, provide access to emerging technologies and position us to take advantage of market opportunities. If we fail to provide an enhanced client experience with this initiative, our ability to retain and attract clients and to maintain and grow revenues could be adversely affected.  Using new and sophisticated technology on a very large scale entails risks.  For example, deployment of new software may adversely affect the performance of existing services on our existing platforms and decrease the client experience.  If implementation of our information technology transformation initiative results in delayed services or costs of the initiative exceed expected amounts, our margins could be adversely affected and such effects could be material.  If the delivery of services expected to be deployed on modernized architecture were delayed due to technological constraints, performance of third-party suppliers, or other reasons, the cost of providing such services could become higher than expected, which could result in higher costs to clients, potentially resulting in decisions to purchase services from our competitors, which would adversely affect our revenues, profitability and cash flow from operations. 
We have made and may continue to make acquisitions and divestitures that involve numerous risks and uncertainties.
Our business strategy anticipates that we will supplement internal growth by pursuing acquisitions of complementary businesses. We may be unable to identify suitable businesses to acquire. We compete with other potential buyers for the acquisition of other complementary businesses. Information we obtain about an acquisition target may be limited and there can be no assurance that an acquisition will perform as expected or positively impact our financial performance. Potential acquisitions involve risk, including the risk we would be unable to effectively integrate the acquired technologies, operations and personnel into our business, and the risk that management’s attention and our capital would be diverted from other areas of our business. The anticipated benefits of our acquisitions may not materialize. Future acquisitions or dispositions could result in the issuance of capital stock, incurrence or assumption of debt, contingent liabilities or expenses, or write-offs of goodwill and other intangible assets, any of which could harm our financial condition. If we cannot complete acquisitions, our growth may be limited and our financial condition may be adversely affected.

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In addition, we have divested, and may in the future divest, businesses that are no longer a part of our ongoing strategic plan. These divestitures similarly require a significant investment of time and resources, may disrupt our business, distract management from other responsibilities and may result in continued responsibility for the divested business, including through indemnification, for a period of time following the transaction, which could adversely affect our financial results.
If our new investments and business initiatives are not successful, our financial condition and prospects could be adversely affected.
We have invested, and continue to invest heavily in our technology to improve existing products and services and add new products and services to address the needs of existing or new clients. Our investments may not lead to successful deployment or increases in the number of accounts or transactions. If we are not successful in creating value from our investments by increasing sales or reducing expenses, our financial condition and prospects could be harmed.
An increase in subaccounting services performed by brokerage firms has and will continue to adversely impact our revenues.
We service open-end and closed-end funds registered under the Investment Company Act of 1940, including mutual funds, exchange-traded funds, interval funds and exchange-listed closed-end funds, as well as private funds, collective investment trusts and other accounts under shareowner recordkeeping arrangements which we refer to as registered accounts. These arrangements are distinguished from broker subaccounts, which are serviced under contract with a broker/dealer. Our clients may adopt the broker subaccount structure. We offer subaccounting services to brokerage firms that perform shareowner subaccounting. As the recordkeeping functions in connection with subaccounting are more limited than traditional shareowner accounting, the fees charged are generally lower on a per unit basis. Brokerage firms that obtain agreements from our clients to use a broker subaccount structure cause accounts currently on our traditional recordkeeping system to convert to our subaccounting system, or to the subaccounting systems of other service providers, which generally results in lower revenues. While subaccounting conversions have generally been limited to our non tax-advantaged mutual fund accounts, such conversions have begun to extend to the tax-advantaged accounts (such as retirement and Section 529 accounts) we service, which could adversely affect our business and operating results.
Consolidation in or among our clients and potential clients could result in a reduction of clients or reduction in use of our products or services.
Mergers or acquisitions of or consolidations among our clients or between our clients and other entities could reduce the number of our clients and potential clients and result in the discontinuation or reduction in use of our products or services. This could adversely affect our revenues even if these events do not reduce the aggregate number of clients or the activities of the consolidated entities. Any of these developments could materially and adversely affect our business, financial condition, operating results and cash flows.
Our businesses are subject to substantial competition.
We are subject to intense competition from other established service providers in all industries we serve. Some of our competitors are able to bundle service offerings and offer more appealing pricing structures. Some of our clients, or the clients they serve, may develop, have developed or are developing the in-house capacity to perform the transaction processing and recordkeeping services they have paid us to perform. Additionally, some of our competitors and clients have greater financial and human resources and access to capital than we do.
In the financial and healthcare markets we serve, we compete based on a variety of factors, including investment performance, the range of products or services offered, brand recognition, business reputation, financial strength, stability and continuity of client and other intermediary relationships, quality of service, and level of fees charged for products and services. We continue to face market pressures regarding fee levels in certain products and services offered.
Our failure to successfully compete in any of our material operating businesses could have a material adverse effect on results of operations. Competition could also affect the revenue mix of products or services we provide, resulting in decreased revenues in lines of business with higher profit margins.

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We may not be able to sustain critical operations and provide essential products and services during system failures or catastrophic events.
Damage to our systems or facilities or those of third parties on which we rely could impact our operations or financial condition. The performance of our services also depends upon facilities that house central computer operations or operating centers, including facilities provided by third parties on which we rely. Significant damage to any of our operating facilities or those of third parties on which we rely could interrupt the operations at those facilities and interfere with our ability to serve clients. Moreover, in the event of a catastrophic event we may not be able to execute our business resumption strategies for data processing and capabilities, and we may not have the ability to recover critical data, programs, applications, and data processing capabilities in a timely manner; any of these could impact our ability to serve our clients. In addition, it is possible that hardware failures or errors or technical deficiencies in our systems or those of third parties on which we rely could similarly result in data loss or corruption. Any failure of our systems or facilities or those of third parties on which we rely could expose us to liability and damages relating to such failure, which could have a material adverse effect on our business and results of operations.
We operate internationally and are thus exposed to currency fluctuations and foreign political, economic and other conditions that could adversely affect our revenues from or support by foreign operations.
Inherent risks in our international business activities could decrease our international sales and also could adversely affect our ability to receive important support from our international operations, which could have a material adverse effect on our overall financial condition, operating results, and cash flow. These risks include potentially unfavorable foreign economic conditions, political conditions or national priorities, foreign government regulation, potential expropriation of assets by foreign governments, changes in intellectual property legal protections and remedies, the failure to bridge cultural differences, and limited or prohibited access to our foreign operations and the support they provide. We may also have difficulty repatriating any profits or be adversely affected by currency fluctuations in our international business.
As a result of the December 2016 referendum in the U.K. to exit the European Union (commonly referred to as “Brexit”), the value of the British pound has fluctuated greatly as compared to the US dollar.  The relative strengthening of the dollar relative to the British pound may adversely affect our revenues and operating results.  Any withdrawal of the U.K. from the European Union could significantly disrupt the movement of goods, services and people between the U.K. and the European Union; the financial services industry could be particularly sensitive to Brexit and it could result in increased legal and regulatory complexities for our operations.  There can be no assurance that these disruptions and regulatory changes would not have a material adverse effect on our business, financial condition, or operating results. 
Various events may cause our financial results to fluctuate from quarter-to-quarter or year-to-year. The nature of these events might inhibit our ability to anticipate and act in advance to counter them.
We may be unsuccessful in determining or controlling when and whether events occur that could cause varying financial results. Unfavorable results may occur that we did not anticipate or take advance action to address. We incur significant costs to develop products and services used to service our existing and potential client operations. The timing of these expenses may fluctuate as new client contracts are signed or existing client contracts are renewed or terminated, causing our results to vary accordingly. Factors contributing to the variability of our results include increased costs of supplies, increased costs relating to existing and potential client operations, and hiring staff to develop new and existing products. The timing of our fees associated with new and existing client contracts, including changes in recognition as a result of changes in accounting principles, may also cause results to vary from period to period.
Our revenues may decrease due to declines in the levels of participation and activity in the securities markets.
We generate significant revenues from the transaction processing fees we earn for our products and services. These revenue sources are substantially dependent on the levels of participation and activity in the securities markets. The number of unique securities positions held by investors through our clients and our clients’ customer trading volumes reflect the levels of participation and activity in the markets, which are impacted by market prices and the liquidity of the securities markets, among other factors. We could continue to be negatively impacted by the volatile markets as certain of our fees are tied to the asset bases of our clients. The occurrence of significant market volatility or decreased levels of participation would likely result in reduced revenues and decreased profitability from our business operations. Additionally, we may be exposed to operational or other risks in connection with any systematic failures in the markets, or the default due to market-related failures of one or more counterparties with whom we transact.
We also derive significant revenues from asset management, administration and distribution contracts with clients. Under these contracts, the fees paid to us are based on a variety of factors, including the market value of assets under management (“AUM”), assets under administration (“AUA”) and number of transactions processed. AUM, AUA or the number of transactions processed may decline for various reasons, causing results to vary. Factors that could decrease AUM and AUA

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(and therefore revenues) include declines in the market value of the assets in the funds (and accounts as applicable) managed, administered and distributed, redemptions and other withdrawals from, or shifts among, the funds (and accounts as applicable) managed, administered and distributed, as well as market conditions generally.
Our revenues may decrease due to changes in asset management, administration and distribution fees and industry trends.
The asset management, administration and distribution business is highly competitive and we compete for investors and clients on the basis of factors such as performance, reputation, service, and cost. Underperformance of any of our proprietary and client products and services, damage to our reputation, or service-related issues could lead to redemptions or terminations. Additionally, the asset management industry has generally been subject to fee compression and asset flows to lower cost products or services. Such a trend may result in fee compression in asset management, administration and distribution related contracts. The asset management, administration and distribution contracts may be terminated by the parties thereto, and the board of directors or trustees of certain funds may terminate investment management, administration and distribution agreements for any reason and without penalty. The factors and trends described above could have a material adverse effect on revenues.
Investment decisions with respect to cash balances, market returns or losses on investments, and limits on insurance applicable to cash balances held in bank and brokerage accounts, including those held by us and as agent on behalf of our clients, could expose us to losses of such cash balances and adversely affect revenues attributable to cash balance deposit investments.
As part of our transaction processing and other services, we maintain and manage large bank and investment accounts containing client funds, which we hold as agent, as well as operational funds. Our revenues include investment earnings related to client fund cash balances. Our choices in selecting investments, or market conditions that affect the rate of return on or the availability of investments, could have an adverse effect on the level of such revenues. The amounts held in our operational and client deposit accounts could exceed the limits of government insurance programs of organizations such as the Federal Deposit Insurance Corporation and the Securities Investors Protection Corporation, exposing us to the risk of loss. Any substantial loss would have an adverse impact on our business and our financial condition.
Operational errors in the performance of our services or contractual obligations, as well as unknown or undetected defects, could lead to liability for claims, client loss and result in reputational damage.
The failure to properly perform our services or contractual obligations could result in our clients and/or certain of our subsidiaries being subjected to losses including censures, fines, or other sanctions by applicable regulatory authorities, and we could be liable to parties who are financially harmed by those errors. Despite testing, defects or errors may occur in our existing or new services, which could cause us to compromise client data, lose revenues, lose clients, divert development resources, or damage our reputation, any of which could harm our business.
Our revenues could decrease if client contracts are terminated or fail to renew or if clients renegotiate contracts or utilize our services at lower than anticipated levels.
We derive most of our revenue by selling products and services under multi-year contracts, many of which contain terms and conditions based on anticipated levels of utilization of our services. We cannot unilaterally extend the terms of our client contracts when they expire. Contracts can terminate during the term of agreement for various reasons, including through “termination for convenience” clauses in some contracts that enable clients to cancel by written notice.  Our revenues could decrease as a result of terminations or non-renewals of client contracts; extensions of client contracts under, or contract re-negotiations resulting in, less favorable terms; or utilization of services at less than anticipated levels.
We are substantially dependent on our intellectual property rights, and a claim for infringement or a requirement to indemnify a client for infringement could adversely affect us.
We have made substantial investments in software and other intellectual property on which our business is highly dependent. Businesses we acquire also often depend on intellectual property portfolios, which increase the challenges we face in protecting our strategic advantage. Any disclosure, loss, invalidity of, or failure to protect our intellectual property could negatively impact our competitive position and, ultimately, our business. Our protection of our intellectual property rights in the U.S. or abroad may not be adequate and others, including our competitors, may use our proprietary technology without our consent. Furthermore, litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets, or to determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of resources and could harm our business, financial condition, results of operations and cash flows.

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To the extent available, we rely on patent, trade secret and copyright laws; however, significant portions of our proprietary intellectual property are not protected by patents. We also utilize nondisclosure and other contractual agreements and security measures to protect our proprietary technology. We cannot guarantee these measures will be effective. Our products and services rely on technology developed by others, including open source software, and we have no control over possible infringement of someone else’s intellectual property rights by the provider of this technology. The owner of the rights could seek damages from us rather than or in addition to the persons who provide the technology to us. We could be subject at any time to intellectual property infringement claims that are costly to evaluate and defend. Our clients may also face infringement claims, allege that such claims relate to our products and services, and seek indemnification from us. Any loss of our intellectual property rights, or any significant claim of infringement or indemnity for violation of the intellectual property rights, or any significant claim of infringement or indemnity for violation of the intellectual property rights of others, could have a material adverse effect on our financial condition, operating results, and cash flows.
Our investments in funds and our joint ventures could decline in value.
From time to time we add new investment strategies to our investment product offerings by providing the initial cash investments as “seed capital.” The seed capital investments may decline in value. A significant decline in their value could have a material adverse effect on our financial condition or operating results.
We are a limited partner in various private equity funds and have future capital commitments related to certain private equity fund investments. These investments are illiquid. Generally, private equity fund securities are non-transferable or are subject to long holding periods, and withdrawals from the private equity firm partnerships are typically not permitted. Even when transfer restrictions do not apply, there is generally no public market for the securities. Therefore, we may not be able to sell the securities at a time when we desire to do so. We may not always be able to sell those investments at the same or higher prices than we paid for them. We also participate in joint ventures with other companies. These joint venture investments could require further capital contributions.
We have restrictive covenants in our debt agreements, which may restrict our flexibility to operate our business.  If we do not comply with these restrictive covenants, our failure could result in material and adverse effects on our operating results and our financial condition.
Our debt agreements contain customary restrictive covenants, including limitations on consolidated indebtedness, liens, investments, subsidiary investments, and asset dispositions, and require us to maintain certain leverage and interest coverage ratios.  Failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in reduced liquidity for the Company and could have a material adverse effect on our operating results and financial condition. In addition, an event of default or declaration of acceleration under one of our debt agreements could result in a cross default under one or more of our other debt agreements, including our financing agreements. This would have a material adverse impact on our liquidity, financial position and results of operation.
Regulatory and Litigation Risks
We and our unconsolidated affiliates are subject to regulation. Any regulatory violations, changes or uncertainties could adversely affect our business.
A number of our businesses are subject to U.S. or foreign regulation, including privacy, licensing, processing, recordkeeping, investment adviser, broker/dealer, retirement, data protection, reporting and related regulations. New products and services we plan to offer may also be subject to regulation, either directly or as a downstream provider to customers or clients. Such regulations cover all aspects of our businesses including, but not limited to, sales and trading methods, trade practices among broker/dealers, use and safekeeping of clients’ funds and securities, use of client and employee data, capital structure of securities firms, net capital, anti-money laundering efforts, healthcare, recordkeeping and the conduct of directors, officers and employees. Any violation of applicable regulations could expose us or those businesses to civil or criminal liability, significant fines or sanctions, damage our reputation, the revocation of licenses, censures, or a temporary suspension or permanent bar from conducting business, which could adversely affect our business or our financial results. Governmental changes, changing interpretation of regulations, and uncertainties surrounding services we provide could increase our costs of business, result in penalties, or diminish business, which could materially and adversely affect our financial results.
The SEC or other regulatory agencies may issue regulations impacting mutual fund service providers, which could adversely affect our business. The Department of Labor (“DOL”) issued fiduciary regulations in 2016 that, if not delayed, repealed or substantially altered in the near future, are likely to impact our business.
The SEC or other regulatory agencies may issue regulations impacting third-party service providers of mutual funds and other fund-types products, such as distributors, administrators, or custodians, (collectively referred to as “mutual funds”), which

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could adversely affect our business.  The SEC may issue additional regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) or other legislative authority that would require brokers and financial intermediaries that distribute mutual funds to make more detailed fee disclosures at the point-of-sale.  Additionally, many brokers and financial intermediaries have become subject to a new DOL-imposed fiduciary standard-of-care that is causing them to review, and may impact, their methods of distribution, share class structures, and/or wholesaling activities.  Although the DOL rule is fully effective, the current administration has delayed implementation of the best interest contract exemption, providing an extended transition period for distributors to address their new fiduciary status.  It remains unclear whether the regulations will be replaced by an SEC standard, repealed or substantially altered within the near future.  We cannot predict all of the requirements the SEC or FINRA may impose.  Additionally, we cannot predict whether the SEC or FINRA proposal will provide a unified standard with the DOL rule, or whether it will provide a patchwork of standards that depend on the type of account in which the retirement assets are invested.  Additionally, while the industry would prefer a united federal fiduciary standard, individual states such as Nevada, New York and Maryland have recently begun to explore their own legislative options to provide a fiduciary standard for investment advice. Regulations that cause current distribution channels or interest in mutual fund investing to change could decrease the number of accounts on our systems as a result of changes in client offerings or the attractiveness of offerings to customers of our clients.  The fiduciary regulations are expected to primarily impact brokers and registered investment advisers who give individualized non-discretionary advice in the “retail” marketplace, but discretionary investment managers in the “institutional” space are also expected to be affected, primarily in connection with the sale of investment products and services.  To the extent that our business units, clients, unaffiliated intermediary partners and retirement plan service providers fit into these categories, this could adversely affect our business and operating results.  Additionally, to the extent the Dodd-Frank Act and/or DOL regulations impact the operations, financial condition, liquidity and capital requirements of unaffiliated financial institutions with whom we transact business, those institutions may seek to pass through increased costs to us or they may reduce their transactional volume which is a primary source of our revenues.
Our clients are subject to regulation that could affect our business.
Our clients are subject to extensive regulation, including investment adviser, broker/dealer and privacy regulations applicable to products and services we provide to the financial services industry and insurance, privacy and other regulations applicable to services we provide to the healthcare industry. Changes in, and any violation by our clients of, applicable laws and regulations (whether related to the products and services we provide or otherwise) could diminish their business or financial condition and thus their demand for our products and services or could increase our cost of continuing to provide our products and services to such industries. Demand could also decrease if we do not continue to offer products and services that help our clients comply with regulations. For example, our accounts in our Healthcare Services segment are impacted by the Affordable Care Act, including the Health Insurance Marketplace. Changes to the Affordable Care Act may be enacted by Congress in response to the current administration’s stated agenda, and we cannot predict the impact that will have on our clients and their demand for our products and services.
Our businesses expose us to risks of claims and losses that could be significant and damage our reputation and business prospects.
Our proprietary applications and related consulting and other services include the processing or clearing of financial and healthcare transactions for our clients and their customers and the design of benefit plans and compliance programs. The dollar amount of transactions processed or cleared is vastly higher than the revenues we derive from providing these services. In the event we make transaction processing or operational errors, or mismanage any process, we could be exposed to claims for any resulting processing delays, disclosure of protected information, miscalculations, mishandling of pass-through disbursements or other processes, and failure to follow a client’s instructions or meet specifications. Additionally, we may be subject to claims or liability resulting from a failure of third parties (including regulatory authorities) to recognize the limitations of our role as our clients’ agent or consultant, and we may be subject to claims or liability resulting from fraud committed by third parties. We may be exposed to the risk of counterparty breaches or failure to perform. We may be subject to claims, including class actions, for reimbursements, losses or damages arising from any transaction processing or operational error, or from process mismanagement. Because of the sensitive nature of the financial and healthcare transactions we process, our liability and any alleged damages may significantly exceed the fees we receive for performing the service at issue. Litigation could include class action claims based upon, among other theories, various regulatory requirements and consumer protection and privacy laws that class action plaintiffs may attempt to use to assert private rights of action. Any of these claims and related settlements or judgments could affect our operating results, damage our reputation, decrease demand for our products and services, or cause us to make costly operating changes. 

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Changes in tax laws, including the recently enacted federal tax legislation commonly referred to as the Tax Cuts and Jobs Act of 2017 (“Tax Act”), as well as other factors, could cause us to experience fluctuations in our tax obligations and effective tax rate in 2018 and thereafter.
We are subject to income taxes as well as non-income based taxes in federal and various state jurisdictions. We are currently evaluating the Tax Act with our professional advisers. We have recognized the provisional tax impacts, based on reasonable estimates, related to the one-time deemed mandatory repatriation of undistributed accumulated foreign earnings and the revaluation of deferred tax assets and liabilities and have included these amounts in our consolidated financial statements for the year ended December 31, 2017. The ultimate impact may differ from these provisional amounts, possibly materially, due to among other things, additional analysis, changes in interpretations and assumptions we have made, additional regulatory guidance that may be issued, and actions we may take as a result of the Tax Act. In addition, because of the uncertainties relating to the future application of the Tax Act and actions we may take in the future, the effect of the Tax Act on us in 2018 and future years may change significantly and cannot be predicted.
We are subject to audits by tax authorities from time to time in federal and state jurisdictions. Tax authorities may disagree with certain positions we have taken and assess additional taxes and penalties. We regularly assess the likely outcomes of these audits in order to determine the appropriateness of our tax provision. However, there can be no assurance that we will accurately predict the outcomes of these audits, and the actual outcomes of these audits could have a material impact on our results of operations.
Risks Related to Corporate Governance or our Equity Securities
We do not control certain businesses in which we have significant ownership.
We invest in joint ventures and other unconsolidated affiliates as part of our business strategy, and part of our net income is derived from our pro rata share of the earnings of those businesses. Despite owning significant equity interests in those companies and having directors on their boards, we do not control their operations, strategies or financial decisions. The other owners may have economic, business or legal interests or goals that are inconsistent with our goals or the goals of the businesses we co-own. Our pro rata share of any losses due to unfavorable performance of those companies could negatively impact our financial results.
Some of our joint venture investments are subject to buy-sell agreements, which could, among other things, restrict us from selling our interests even if we were to determine it would be prudent to do so.
We own interests in unconsolidated entities and various real estate joint ventures. Our interests in such unconsolidated entities are subject to buy/sell arrangements, which could restrict our ability to sell our interests even if we were to determine it would be prudent to do so. These arrangements could also allow us to purchase the other owners’ interests to prevent someone else from acquiring them and we cannot control the timing of occasions to do so. The businesses or other owners may encourage us to increase our investment in or make contributions to the businesses at an inopportune time.
In addition, some of the agreements governing our joint venture arrangements include buy/sell provisions that provide a party to the arrangement with the option to purchase the other party’s interests upon such other party’s change of control at a purchase price that may be less than fair market value. For instance, consummation of the proposed Merger would constitute a change of control of the Company under the partnership agreement of IFDS L.P. and, as a result, the other partner would have the option to purchase our interests in IFDS L.P. at a price equal to book value, unless another purchase provision in the partnership agreement was triggered prior to the change of control. Book value may be substantially less than fair market value at the time of any sale of our interests upon a change of control.
Provisions in our Certificate of Incorporation, Bylaws, certain plans and agreements, and applicable laws could discourage, delay or prevent a change in control of us that a stockholder may consider favorable.
The provisions include:
super-majority stockholder approval required for certain actions;
specific procedures for stockholders to nominate new directors;
the Board’s authority to issue and set the terms of preferred stock;
various rights of joint venture co-owners and contractual counterparties, including rights of lenders and certain clients and executives in the event of a change in control;
public reporting of ownership and of changes in ownership by stockholders with at least a 5% interest in us; and
legal restrictions on business combinations with certain stockholders.

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Because of contractual commitments, a change in control could affect our operating results and weaken our management retention and incentive tools.
A change in control of the Company could trigger various rights and obligations in service agreements with certain clients and other agreements. A change in control could also allow some clients to terminate their agreements with us or to obtain rights to use our processing software. Under certain executive equity-based and other incentive compensation awards, benefit programs and employment agreements with our management, a change in control by itself, or an individual’s termination of employment without “cause” or resignation for “good reason” (each as defined in applicable agreements) after a change in control could accelerate funding, payment or vesting of equity grants, as applicable, under such agreements and programs. This accelerated funding, vesting or payment may decrease an employee’s incentive to continue employment with us. We have adopted an executive severance plan which, among other things, provides benefits to participating senior officers and executives who are terminated in connection with a change of control. Certain other executive officers have agreements with us that require us to continue to employ them for three years after a change in control or to pay certain amounts if we terminate their employment without cause or they resign for good reason following a change in control. The executives might not be incented to achieve desired results for the new owners of our business, and the cost of keeping the executives on the payroll might deter potential new owners from acquiring us or hinder new owners from hiring replacement management.
We may not pay cash dividends on our common stock in the future.
Future cash dividends will depend upon our financial condition, earnings and other factors deemed relevant by our Board of Directors. Payment of dividends is subject to applicable laws and to restrictions in applicable debt agreements. We are currently precluded from declaring dividends pursuant to the definitive Merger Agreement with SS&C, as further described in Item 8, Financial Statements and Supplementary Data - Note 1, “Description of Business.”
Risks Related to our Proposed Merger Transaction with SS&C
The consummation of the Merger is subject to many conditions and if these conditions are not satisfied or waived, the Merger will not be completed.
We cannot provide any assurance that the Merger will be completed or that there will not be a delay in the completion of the Merger. Our ability to consummate the Merger is subject to risks and uncertainties, including, but not limited to, the risks that the conditions to the Merger are not satisfied, or if possible, waived, including, among others, (a) receipt of the approval by the affirmative vote of the holders of a majority of the outstanding shares of Company common stock entitled to vote (the “Company Stockholder Approval”); (b) receipt of certain regulatory approvals; and (c) the absence of governmental restraints or prohibitions preventing the consummation of the Merger. The process to obtain the requisite approvals could prevent, or substantially delay, the consummation of the Merger.
The closing of the Merger is also dependent on the accuracy of representations and warranties made by the parties to the Merger Agreement (subject to customary materiality qualifiers and other customary exceptions), the performance in all material respects by the parties of obligations imposed under the Merger Agreement and the receipt of officer certificates by the other party certifying the satisfaction of the preceding conditions. We cannot provide any assurance as to whether or when the conditions to the closing of the Merger will be satisfied or waived or as to whether or when the Merger will be consummated.
Regulatory approvals may not be received, may take longer than expected or may impose conditions that are not presently anticipated or that cannot be met.
Before the Merger may be completed, various approvals, authorizations and declarations of non-objection must be obtained from certain regulatory and governmental authorities. Subject to the terms and conditions of the Merger Agreement, each party has agreed to use their reasonable best efforts to cooperate with each other party in taking any and all actions, and to do all things reasonably necessary, appropriate or desirable, to consummate and make effective the Merger and the other transactions contemplated by the Merger Agreement, including obtaining any requisite approvals. These approvals include approval of, or under, the Hart-Scott-Rodino Antitrust Improvements Act of 1976, approval under the competition law of Ireland and approvals of the Financial Industry Regulatory Authority, the United Kingdom’s Financial Conduct Authority, the Central Bank of Ireland and Luxembourg’s Commission de Surveillance du Secteur Financier.
These regulatory and governmental entities may impose conditions on the granting of such approvals and if such regulatory and governmental entities seek to impose such conditions, lengthy negotiations may ensue among such regulatory or governmental entities, SS&C and DST. Such conditions and the process of obtaining regulatory approvals could have the effect of delaying completion of the Merger and such conditions may not be satisfied for an extended period of time.
We cannot assure you that these regulatory clearances and approvals will be timely obtained or obtained at all, or that the granting of these regulatory clearances and approvals will not involve the imposition of regulatory remedies on the completion

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of the Merger, including requiring changes to the terms of the Merger agreement. These conditions or changes could result in the conditions to the closing of the Merger not being satisfied.
The special meeting of our stockholders at which the adoption and approval of the Merger Agreement will be considered may take place before all of the required regulatory approvals have been obtained and before regulatory remedies, if any, are known. In this event, if the Company Stockholder Approval is obtained, we and SS&C may subsequently agree to regulatory remedies without further seeking stockholder approval, even if such regulatory remedies could have an adverse effect on us, SS&C or the combined company, except as required by applicable law.
The Merger Agreement contains restrictions on our ability to pursue other alternatives to the Merger and, in specified circumstances, could require us to pay SS&C a termination fee of $165.0 million.
The Merger Agreement contains non-solicitation provisions that, subject to limited exceptions, restrict our ability to solicit, initiate or knowingly facilitate or knowingly encourage any inquiry, discussion, offer or request that constitutes, or would reasonably be expected to lead to, an alternative proposal. Further, subject to limited exceptions, consistent with applicable law, the Merger Agreement provides that our Board of Directors will not fail to make, withdraw, qualify or modify, in a manner adverse to SS&C, its recommendation that our stockholders vote in favor of approving the Merger. Although our Board of Directors is permitted to take certain actions in response to a superior proposal or an intervening event if it determines that the failure to do so would reasonably be expected to be inconsistent with its fiduciary duties, doing so in specified situations could require us to pay SS&C a termination fee. There also is a risk that the requirement to pay the termination fee to SS&C in certain circumstances may result in a potential acquiror proposing to pay a lower per share price to acquire us than it might otherwise have proposed to pay.
The Merger Agreement may be terminated in accordance with its terms and the Merger will not be completed.
The Merger Agreement may be terminated if the Merger is not consummated on or before July 11, 2018 (subject to extension to November 11, 2018 by either party if all conditions are satisfied other than regulatory approvals) or if the Company Stockholder Approval has not been obtained. In addition, SS&C and DST may elect to terminate the Merger Agreement in certain other circumstances, including by SS&C if DST’s Board of Directors shall have changed its recommendation to stockholders and by DST in order to enter into an agreement providing for a superior proposal.
Upon a termination of the Merger Agreement due to entry into an agreement with respect to a superior proposal, and as a result of DST’s Board of Directors making a change of recommendation prior to the receipt of the Company Stockholder Approval, we will be required to pay SS&C a termination fee of $165.0 million.
Failure to consummate the Merger could negatively impact DST and our future operations.
If the Merger Agreement is terminated in accordance with its terms and the Merger is not consummated, our ongoing business may be adversely affected by a variety of factors. Our business may be adversely impacted by (i) the failure to pursue other beneficial opportunities during the pendency of the Merger, (ii) payment of certain significant transaction costs relating to the Merger without receiving the anticipated benefits and (iii) the focus of our management on the Merger for an extended period of time rather than on other management opportunities or other beneficial opportunities for our Company. The market price of Company common stock may also decline as a result of any such failures to the extent that the current market prices reflect a market assumption that the Merger will be completed.
We may be negatively impacted if the Merger Agreement is terminated and DST seeks but is unable to find another business combination or strategic transaction offering equivalent or more attractive consideration than the consideration to be provided in the Merger, or if we become subject to litigation related to entering into or failing to consummate the Merger, including direct actions by our stockholders against the directors and/or officers for breaches of fiduciary duty or derivative actions brought by our stockholders. Furthermore, we may experience negative reactions from our stockholders, clients and employees in the event the Merger is not consummated.
We will be subject to business uncertainties and contractual restrictions until the Merger is consummated.
Uncertainty about the effect of the Merger on clients, counterparties to contracts, employees and other parties may have an adverse effect on us. These uncertainties could disrupt our business and cause clients, suppliers, vendors, partners and others that deal with us to defer entering into contracts with us or making other decisions concerning us or seek to change or cancel existing business relationships with us. These uncertainties may also impair our ability to attract, retain and motivate key personnel until the Merger is completed and for a period of time thereafter. Employee retention and recruitment may be particularly challenging prior to completion of the Merger, as employees and prospective employees may experience uncertainty about their future roles following the Merger.

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The Merger Agreement restricts us, without the consent of SS&C, from making certain acquisitions and divestitures, entering into certain contracts, incurring certain indebtedness and expenditures, paying dividends, and taking other specified actions until the earlier of the completion of the Merger or the termination of the Merger Agreement. These restrictions may prevent us from pursuing attractive business opportunities that may arise prior to the completion of the Merger. Furthermore, the preparation for the integration of the two companies may place a significant burden on management and internal resources. Any significant diversion of management attention away from ongoing business and any difficulties encountered in the transition and integration process could affect our financial results prior to and/or following the completion of the Merger and could limit us from pursuing attractive business opportunities and making other changes to our business prior to completion of the Merger or termination of the Merger Agreement.
Completion of the Merger may trigger change in control or other provisions in certain agreements to which DST is a party.
The completion of the transactions may trigger change in control or other provisions in certain agreements to which DST is a party. If SS&C and DST are unable to negotiate waivers of those provisions, the counterparties may exercise their rights and remedies under the agreements, potentially terminating the agreements or seeking monetary damages. Even if SS&C and DST are able to negotiate waivers, the counterparties may require a fee for such waivers or seek to renegotiate the agreements on terms less favorable to DST.
For example, consummation of the proposed Merger would constitute a change of control of the Company under the partnership agreement of IFDS L.P. and, as a result, the other partner would have the option to purchase our interests in IFDS L.P. at a price equal to book value, which may be substantially less than fair market value, unless another purchase provision in the partnership agreement was triggered prior to the change of control.
We will incur substantial transaction fees and costs in connection with the Merger.
We expect to incur significant costs, expenses and fees for professional services and other transaction costs in connection with the Merger. A material portion of these expenses are payable by us whether or not the Merger is completed.
Further, while we have assumed that a certain amount of transaction expenses will be incurred, factors beyond our control could affect the total amount or the timing of these expenses. Many of the expenses that will be incurred, by their nature, are difficult to estimate accurately. These expenses may exceed the costs historically borne by DST. These costs could adversely affect the financial condition and results of our operations prior to the Merger.
Any legal proceedings in connection with the Merger could delay or prevent the completion of the Merger.
Transactions such as the Merger often give rise to lawsuits by stockholders or other third parties. One of the conditions to the closing of the Merger is that no judgment, order, injunction, ruling or decree, preliminary, temporary or permanent, or other legal restraint or prohibition and no action, proceeding, binding order or determination by any governmental entity, will be in effect preventing or otherwise making illegal the consummation of the Merger. In connection with the Merger, plaintiffs may file lawsuits against us and/or our directors and officers in connection with the Merger. Such legal proceedings could also prevent or delay the completion of the Merger and result in additional costs. In addition, if any lawsuit is successful in obtaining an injunction prohibiting us or SS&C from consummating the Merger on the agreed upon terms, the injunction may prevent the Merger from being completed within the expected timeframe, or at all. If the Merger is prevented or delayed, the lawsuits could result in substantial costs, including any costs associated with the indemnification of directors. The defense or settlement of any lawsuit or claim that remains unresolved at the time the Merger is completed may adversely affect our business, financial condition or results of operations.
We may waive one or more of the conditions to the Merger without resoliciting the Company Stockholder Approval.
We may determine to waive, in whole or in part, one or more of the conditions to our obligations to complete the Merger, to the extent permitted by applicable laws. We will evaluate the materiality of any such waiver and its effect on our stockholders in light of the facts and circumstances at the time to determine whether any amendment of this proxy statement and resolicitation of proxies is required or warranted. In some cases, if our Board determines that such a waiver is warranted but that such waiver or its effect on our stockholders is not sufficiently material to warrant resolicitation of proxies, we have the discretion to complete the Merger without seeking further stockholder approval. Any determination whether to waive any condition to the Merger or as to resoliciting stockholder approval or amending this proxy statement as a result of a waiver will be made by us at the time of such waiver based on the facts and circumstances as they exist at that time.

17


The opinion of our financial advisor will not reflect changes in circumstances between the signing of the Merger Agreement and the completion of the Merger.
We have not obtained an updated opinion in connection with the Merger from our financial advisor, Merrill Lynch, Pierce, Fenner & Smith Incorporated (“BofA Merrill Lynch”), as of the date of this Form 10-K and do not expect to receive an updated opinion prior to the completion of the Merger. Changes in our operations and prospects, general market and economic conditions and other factors that may be beyond our control, and on which the opinion of BofA Merrill Lynch was based, may significantly alter the value of our Company or the price of our common stock by the time the Merger is completed. The opinion does not speak as of the time the Merger will be completed or as of any date other than the date of the opinion. Because BofA Merrill Lynch will not be updating its opinion, which was issued in connection with the execution of the Merger Agreement on January 11, 2018, the opinion will not address the fairness of the Merger consideration from a financial point of view at the time the Merger is completed.
Item 1B.    Unresolved Staff Comments
None.
Item 2.        Properties
Our main operating facilities, including our corporate headquarters, are located in Kansas City, Missouri and consist of 1.1 million square feet of office space, of which 69% is owned and 31% is leased, and 160,000 square feet of owned data center space. Additionally, we own an aggregate 524,000 square feet of space consisting primarily of a back-up data center in St. Louis, Missouri and office space in Massachusetts, California and the United Kingdom. We lease an aggregate of 1.2 million square feet of other office space and production space in North America, United Kingdom, India, Ireland, Thailand, Australia and Canada. Of the 3.0 million square feet of space identified above, the Company leases and subleases approximately 54,000 square feet to third-parties. Approximately 65%, 24% and 11% of the remaining square footage is utilized by the Domestic Financial Services, International Financial Services and Healthcare Services segments, respectively. We also own undeveloped land in Kansas City, Missouri and California and an underground facility with approximately 538,000 square feet in Kansas City, Missouri, of which 497,000 square feet is leased to third parties. Our real estate joint ventures own 2.5 million square feet of real estate, of which 2.2 million square feet is occupied by third parties or is vacant. We believe our facilities are currently adequate for their intended purposes and are adequately maintained.

Item 3.        Legal Proceedings
The information set forth under the heading “Legal Proceedings” in Item 8. Financial Statement and Supplementary Data - Note 16, “Commitments and Contingencies” is incorporated herein by reference.
We are involved in various other legal proceedings arising in the normal course of our businesses. At this time, we do not believe any material losses under these claims to be probable. While the ultimate outcome of such legal proceedings cannot be predicted with certainty, it is in 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 our consolidated financial condition, results of operations or cash flows.
Item 4.        Mine Safety Disclosures
None.
PART II
Item 5.        Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s common stock trades under the symbol “DST” on the New York Stock Exchange (“NYSE”). As of February 22, 2018, there were approximately 7,798 registered holders of our common stock. In May 2017, our Board of Directors declared a two-for-one stock split of DST’s outstanding common stock effected in the form of a stock dividend, which was paid on June 8, 2017.  All share and per share data, excluding treasury shares, have been retroactively adjusted for all periods presented to reflect the stock split as if the stock split had occurred at the beginning of the earliest period presented.

18


The following table provides the quarterly high and low prices of, and quarterly cash dividends paid on, the Company’s common stock for the two-year period ended December 31, 2017. We are currently precluded from declaring dividends pursuant to the Merger Agreement with SS&C, as further described in Item 8, Financial Statements and Supplementary Data - Note 1, “Description of Business.”
 
Dividend
 
High
 
Low
2016
 
 
 
 
 
1st Quarter
$
0.16

 
$
54.40

 
$
47.50

2nd Quarter
0.17

 
58.91

 
51.80

3rd Quarter
0.17

 
61.03

 
56.47

4th Quarter
0.16

 
57.28

 
46.30

2017
 
 
 
 
 
1st Quarter
$
0.18

 
$
60.48

 
$
53.36

2nd Quarter
0.18

 
61.81

 
58.14

3rd Quarter
0.18

 
61.67

 
50.27

4th Quarter
0.18

 
62.63

 
54.50

The prices set forth above do not include commissions and do not necessarily represent actual transactions. The closing price of our common stock on the NYSE on December 31, 2017 was $62.07.
Stock Repurchases
The following table sets forth information with respect to shares of our common stock purchased by us during the quarter ended December 31, 2017.
Period
Total Number
of Shares
Purchased
 
 
Average Price
Paid Per Share
 
Total $ Amount of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
 
Approximate Dollar Value of Shares
That May Yet
Be Purchased Under
the Plans or Programs
 
October 1 - October 31
309,054

(1) 
 
$
57.92

 
$
17,668,473

 
$
207,331,540

 
November 1 - November 30
762,037

(1) 
 
59.68

 
45,478,375

 
161,853,165

 
December 1 - December 31
192,116

(1) 
 
61.82

 
11,853,122

 
150,000,043

 
Total
1,263,207

 
 
$
59.57

 
$
74,999,970

 
$
150,000,043

(2) 
_______________________________________________________________________
(1)
For the three months ended December 31, 2017, we purchased, in accordance with the 2015 Equity and Incentive Plan, 4,445 shares of our common stock for participant income tax withholding in conjunction with stock option exercises or from the vesting of restricted shares, as requested by the participants or from shares surrendered in satisfaction of the option exercise price. These purchases were not made under the publicly-announced repurchase plans or programs, but were allowed by the rules of the Compensation Committee of our Board of Directors. Of these shares, 4,054 shares were purchased in October 2017 and 391 shares were purchased in December 2017.
(2)
On May 9, 2017 our Board of Directors authorized a new $300.0 million share repurchase plan. The plan allows, but does not require, the repurchase of common stock in open market and private transactions. The plan does not have an expiration date. During 2017, we entered into one or more plans with our brokers or banks for pre-authorized purchases within defined limits pursuant to Rule 10b5-1 to affect all or a portion of such share repurchases. We are currently precluded from executing additional stock repurchases pursuant to the Merger Agreement with SS&C, as further described in Item 8, Financial Statements and Supplementary Data - Note 1, “Description of Business.”


19


Stock Performance Graph
The following graph shows the changes in value since December 31, 2012 of an assumed investment of $100 in: (i) DST Common Stock; (ii) the stocks that comprise the S&P MidCap 400 Index(1); and (iii) the stocks that comprise the S&P MidCap 400 Index - Information Technology Sector(1) (“S&P MidCap IT Index”). The table following the graph shows the dollar value of those assumed investments as of December 31, 2017 and as of December 31 for each of the five preceding years. The value for the assumed investments depicted on the graph and in the table has been calculated assuming that cash dividends, if any, are reinvested at the end of each quarter in which they are paid.
Comparison of Cumulative Five Year Total Return
dst10k2013_chart-36557a03.jpg
 
As of December 31,
 
2012
 
2013
 
2014
 
2015
 
2016
 
2017
DST Systems, Inc
$
100.00

 
$
152.21

 
$
159.95

 
$
195.87

 
$
186.18

 
$
218.36

S&P MidCap 400 Index
100.00

 
133.50

 
146.54

 
143.35

 
173.08

 
201.20

S&P MidCap IT Index
100.00

 
128.80

 
138.99

 
139.85

 
169.87

 
212.46

_______________________________________________________________________
(1)
Standard & Poor’s Corporation, an independent company, prepares the S&P MidCap 400 Index and the S&P Midcap IT Index.
The performance graph and related text are being furnished to and not filed with the SEC, and will not be deemed to be “soliciting material” or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to the liabilities of Section 18 of the Securities Exchange Act of 1934, and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate such information by reference into such a filing.

20


Item 6.        Selected Financial Data
The following table sets forth selected consolidated financial data of the Company. The selected consolidated financial data should be read in conjunction with and are qualified by reference to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 7 of this Form 10-K and our audited consolidated financial statements, including the notes thereto, and the report of the independent registered public accounting firm thereon and the other financial information included in Item 8 of this Form 10-K.
 
Year Ended December 31,
 
2017 (1)
 
2016 (2)
 
2015 (3)
 
2014 (4)
 
2013 (5)
Income Statement Data:
(dollars in millions, except per share amounts)
Operating revenues (excluding out-of-pockets)
$
2,086.7

 
$
1,474.4

 
$
1,405.0

 
$
1,445.5

 
$
1,368.2

Operating income
285.2

 
247.3

 
232.7

 
262.7

 
271.8

Other income, net
219.0

 
22.7

 
204.5

 
373.1

 
242.8

Income from continuing operations before income taxes and non-controlling interest
531.9

 
279.2

 
458.8

 
744.7

 
503.1

Income from continuing operations attributable to DST Systems, Inc.
447.0

 
179.0

 
309.7

 
560.8

 
324.7

Basic earnings per share - continuing operations attributable to DST Systems, Inc. (6)
7.28

 
2.71

 
4.30

 
7.00

 
3.75

Diluted earnings per share - continuing operations attributable to DST Systems, Inc. (6)
7.20

 
2.68

 
4.25

 
6.93

 
3.69

Non-GAAP diluted earnings per share - continuing operations attributable to DST Systems, Inc. (6) (7)
3.36

 
2.87

 
2.47

 
2.49

 
2.11

Cash dividends per share of common stock
0.72

 
0.66

 
0.60

 
0.60

 
0.60

 
 
 
 
 
 
 
 
 
 
 
 December 31,
 
2017 (1)
 
2016 (2)
 
2015 (3)
 
2014 (4)
 
2013 (5)
Balance Sheet Data:
(dollars in millions)
Total assets
$
2,938.2

 
$
2,771.8

 
$
2,813.2

 
$
2,942.9

 
$
3,090.5

Total debt
620.8

 
508.2

 
562.1

 
546.8

 
675.6

Stockholders’ equity
1,241.2

 
1,115.2

 
1,046.0

 
1,236.4

 
1,183.8

_______________________________________________________________________
(1)
In 2017, we recorded a $43.8 million net gain on previously held equity interests and $159.8 million of net gains on securities and other investments, which are included in Other income, net, in the Consolidated Statement of Income primarily as a result of the acquisition of State Street’s ownership in both BFDS and IFDS U.K. Additionally, as a result of a termination agreement reached with a wealth management platform client, operating revenues of $93.2 million related to previously deferred revenues and contractual termination payments received were recognized and bad debt expense, severance and other costs and expenses of $38.9 million were recorded in Costs and expenses within the Consolidated Statement of Income.
(2)
In 2016, we acquired Kaufman Rossin Fund Services LLC. Additionally, we recorded net gains on securities and other investments of $16.3 million, which is included in Other income, net, in the Consolidated Statement of Income.
(3)
In 2015, we acquired the following businesses: kasina LLC, Red Rocks Capital LLC and Wealth Management Systems Inc. Additionally, we recorded net gains on securities and other investments of $199.3 million, which is included in Other income, net, in the Consolidated Statement of Income.
(4)
In 2014, we recorded a pretax gain of $100.5 million on the sale of our wholly-owned subsidiary, DST Global Solutions, Ltd., which is included in Gain on sale of business in the Consolidated Statement of Income. In addition, we recorded net gains on securities and other investments of $343.5 million, which were included in Other income, net in the Consolidated Statement of Income.
(5)
In 2013, we recorded net gains on securities and other investments of $222.8 million, which were included in Other income, net in the Consolidated Statement of Income
(6)
During the years ended December 31, 2017, 2016, 2015, 2014, and 2013, we repurchased 5.1 million, 5.4 million, 7.2 million, 9.4 million and 7.6 million shares of our common stock, respectively, on a post stock split basis.
(7)
The reconciliation of reported diluted earnings per share to non-GAAP diluted earnings per share is presented below under the heading “Use of Non-GAAP Financial Information.”

21


Use of Non-GAAP Financial Information
In addition to reporting financial information in accordance with accounting principles generally accepted in the United States of America (“GAAP”), we have disclosed non-GAAP financial information which has been reconciled to the corresponding GAAP measures in the following financial schedules titled “Reconciliation of Reported Diluted Earnings per Share to Non-GAAP Diluted Earnings per Share - Continuing Operations Attributable to DST Systems, Inc.”  In making these adjustments to determine the non-GAAP results, we take into account the impact of items that are not necessarily ongoing in nature, that do not have a high level of predictability associated with them or that are non-operational in nature.  Generally, these items include net gains on dispositions of businesses, net gains (losses) associated with securities and other investments, acquired intangible asset amortization, restructuring and impairment costs, and other similar items. Our non-GAAP diluted earnings per share is also adjusted for the income tax impact of the above items, as applicable. The income tax impact of each item is calculated by applying the statutory rate and local tax regulations in the jurisdiction in which the item was incurred. Additionally, income tax is adjusted to remove the impacts of large discrete or unusual items. Management believes the exclusion of these items provides a useful basis for evaluating underlying business unit performance, but should not be considered in isolation and is not in accordance with, or a substitute for, evaluating business unit performance utilizing GAAP financial information.  Management uses non-GAAP measures in its budgeting and forecasting processes and to further analyze our financial trends and “operational run-rate,” as well as in making financial comparisons to prior periods presented on a similar basis.  We believe that providing such adjusted results allows investors and other users of our financial statements to better understand our comparative operating performance for the periods presented. 
Our management uses this non-GAAP financial measure in its own evaluation of the Company’s performance, particularly when comparing performance to past periods.  Our non-GAAP measures may differ from similar measures by other companies, even if similar terms are used to identify such measures.  Although our management believes non-GAAP measures are useful in evaluating the performance of its business, we acknowledge that items excluded from such measures may have a material impact on our financial information calculated in accordance with GAAP.  Therefore, management typically uses non-GAAP measures in conjunction with GAAP results.  These factors should be considered when evaluating our results.
Reconciliation of Reported Diluted Earnings per Share to Non-GAAP Diluted Earnings per Share - Continuing Operations Attributable to DST Systems, Inc.
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
2014
 
2013
Reported GAAP Diluted Earnings per Share
$
7.20

 
$
2.68

 
$
4.25

 
$
6.93

 
$
3.69

Adjusted to remove:
 
 
 
 
 
 
 
 
 
Net gains on securities and other investments
(2.57
)
 
(0.26
)
 
(2.74
)
 
(4.24
)
 
(2.53
)
Amortization of intangible assets
0.57

 
0.35

 
0.26

 
0.22

 
0.21

Restructuring charges
0.38

 
0.23

 
0.05

 
0.16

 
0.04

Income tax items
(0.49
)
 
0.06

 
(0.22
)
 
(0.46
)
 
(0.13
)
Business development/advisory expenses
0.30

 

 
0.02

 
0.07

 

Equity in earnings of unconsolidated affiliates items
(0.54
)
 

 
(0.05
)
 
(0.07
)
 
(0.08
)
Charitable contribution of securities
0.02

 

 

 
0.01

 

Contract termination payments received, net
(0.86
)
 

 

 

 
(0.07
)
Gain on previously held equity interest
(0.70
)
 

 

 

 

Loss accruals (loss accrual reversal)
0.05

 

 

 
(0.05
)
 
0.03

Net gain on sale of business

 
(0.07
)
 

 
(1.24
)
 

Software impairment

 
0.09

 

 

 

Reversal of accrued contingent consideration

 
(0.10
)
 

 

 

Net (gains) losses on real estate assets

 

 
(0.05
)
 

 
0.04

Gain on contract to repurchase common stock

 

 

 
(0.22
)
 

Income tax effect of adjustments

 
(0.11
)
 
0.95

 
1.38

 
0.91

Adjusted Non-GAAP Diluted Earnings per Share
$
3.36

 
$
2.87

 
$
2.47

 
$
2.49

 
$
2.11


22


Item 7.        Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD LOOKING STATEMENTS
This report contains “forward-looking statements” - that is, statements related to future, not past, events. In this context, forward-looking statements often address our expected future business and financial performance and financial condition, and often contain words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “see,” “will,” “would,” or “target.” Forward-looking statements by their nature address matters that are, to different degrees, uncertain.
For us, particular risks and uncertainties that could cause our actual results to be materially different than those expressed in our forward-looking statements include:
the effects of competition in the businesses in which we operate;
changes in client demand and our ability to provide products and services on terms that are favorable to us;
changes in law, economic and financial conditions;
the impacts of breaches or potential breaches of network, information technology or data security, natural disasters, terrorist attacks or acts of war or significant litigation and any resulting financial impact not covered by insurance;
the effectiveness of our risk management framework;
the impact of regulation and regulatory, investigative and legal proceedings and legal compliance risks, including the impact of financial services regulation and litigation and potential SEC or DOL regulations impacting third-party distributors of mutual funds;
our investments in funds and other companies may decline;
our ability to successfully complete acquisitions or integrate acquired businesses;
the risk that the proposed Merger with SS&C will not be consummated within the expected time period or at all, including the risk that the Company may be unable to obtain stockholder approval as required for the Merger and conditions to the closing of the Merger may not be satisfied or waived on a timely basis or otherwise;
the risk that a governmental entity or a regulatory body may prohibit, delay or refuse to grant approval for the consummation of the Merger and may require conditions, limitations or restrictions in connection with such approvals that can adversely affect the anticipated benefits of the proposed Merger or cause the parties to abandon the proposed Merger;
the risk that the business of the Company may suffer as a result of uncertainty surrounding the Merger or the potential adverse changes to business relationships resulting from the proposed Merger;
the risk that the Merger may involve unexpected costs, liabilities or delays;
the risk that legal proceedings may be initiated related to the Merger and the outcome of any legal proceedings related to the Merger may be adverse to the Company; and
the other factors that are described in Item 1A, “Risk Factors” of this Form 10-K.

These or other uncertainties may cause our actual future results to be materially different than those expressed in our forward-looking statements. This document includes certain forward-looking projected financial information that is based on current estimates and forecasts. Actual results could differ materially.
Future economic and industry trends that could potentially impact our financial statements or results of operations are difficult to predict. These forward-looking statements are based on information as of the date of this report. We assume no obligation to publicly update or revise our forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized, except as may be required by law. 
Introduction
DST Systems, Inc. and our consolidated subsidiaries use proprietary software applications to provide sophisticated information processing and servicing solutions through strategically unified data management and business process solutions to clients globally within the asset management, brokerage, retirement, healthcare and other markets. Our wholly-owned data centers provide the secure technology infrastructure necessary to support our solutions. In order to position the Company to take advantage of new and emerging technologies, we are embarking on an information technology transformation effort which will increase our operating expenses for the near term. We expect these investments will result in lower centralized infrastructure costs and a more agile platform on which to deliver future capabilities.
On January 11, 2018, we entered into a Merger Agreement wherein SS&C will acquire DST. Under the terms of the agreement, SS&C will purchase DST in an all-cash transaction for $84.00 per share plus the assumption of debt, equating to an enterprise value of approximately $5.4 billion. We have agreed to customary covenants in the Merger Agreement, including with respect to the operation of our business prior to the closing of the transaction or termination of the agreement, such as

23


restrictions on making certain acquisitions and divestitures, entering into certain contracts, incurring certain indebtedness and expenditures, paying dividends, repurchasing stock and taking other specified actions. The transaction is subject to DST stockholder approval, clearances by the relevant regulatory authorities and other customary closing conditions and is currently expected to close by the end of the second quarter 2018; however, there can be no assurances as to the actual closing or the timing of the closing. Consummation of the proposed Merger would constitute a change of control of DST under the partnership agreement of IFDS L.P. and, as a result, the other partner would have the option to purchase our interests in IFDS L.P. at a price equal to book value, unless another purchase provision in the partnership agreement was triggered prior to the change of control.
In March 2017, we acquired State Street’s ownership interests in our joint ventures BFDS and IFDS U.K., as well as other investments and real estate held by IFDS L.P. The BFDS acquisition was effectuated through a non-taxable exchange of our State Street common stock with a fair value of $163.4 million for State Street’s ownership interest in BFDS. We also acquired State Street’s ownership interest in IFDS U.K., and IFDS L.P.’s ownership in IFDS Percana and IFDS Realty U.K. for total cash consideration of $234.9 million.
In May 2017, we completed the sale of our U.K. Customer Communications business for cash consideration of $43.6 million. We recorded a pretax gain of $2.6 million on the sale during 2017. We sold our North American Customer Communications business for cash consideration of $410.7 million on July 1, 2016 and we recorded a pretax gain of $341.5 million on the sale in 2016. We have classified the results of the businesses sold as discontinued operations in our Consolidated Statements of Income for all periods presented. The net after-tax proceeds from these sales are being used in accordance with the Company’s capital plan, including investments in the business, share repurchases, strategic acquisitions, debt repayments and other corporate purposes, subject to the restrictions set forth in the Merger Agreement with SS&C.
Beginning in 2017, DST established a new reportable segment structure that reflects how management is now operating the business and making resource allocations following the acquisitions of IFDS U.K. and BFDS, as well as the recent reductions in non-core investment assets. The Company’s operating business units are now reported as three operating segments (Domestic Financial Services, International Financial Services and Healthcare Services). Prior periods have been revised to reflect the new reportable operating segments.
Domestic Financial Services Segment
Through the Domestic Financial Services segment, we provide investor, investment, advisor/intermediary and asset distribution services to companies within the U.S. financial services industry. Utilizing our proprietary software applications, we offer our clients information processing solutions that enable them to capture, analyze and report their investors’ transactions including direct and intermediary sales of mutual funds, alternative investments, securities brokerage accounts and retirement plans. Examples of the services we provide include tracking of purchases, redemptions, exchanges and transfers of shares; maintaining investor identification and ownership records; reconciling cash and share activity; processing dividends; reporting sales; and performing tax and other compliance functions. We also support full reporting to investors for confirmations, statements and tax forms, web access, and electronic delivery of documents.
Services are provided either on a Remote or BPO basis utilizing our proprietary software applications. Our BPO service offerings are enhanced by our proprietary workflow software, which is also licensed separately to third parties.
Domestic Financial Services fees are primarily charged to the client based on the number of accounts, participants or transactions processed. For subaccounts, a portion of the services we provide for registered accounts are provided directly by the broker/dealer. As a result, our revenue per account is generally higher for registered accounts than for subaccounts. On a more limited basis, we also generate revenue through asset-based fee arrangements and from investment earnings related to cash balances maintained in our full service transfer agency bank accounts. We typically have multi-year agreements with our clients. We are continuing to monitor changes in the financial services industry, including the shift from direct products to fee-based platforms which could reduce the number of direct mutual fund registered accounts we service.
In December 2017, we entered into a ten year contract with a new client to provide both mutual fund and retirement servicing solutions. Based on current volumes, the client is expected to convert approximately 2.0 million registered accounts and 0.3 million retirement accounts onto our platforms during mid to late 2019. This new client currently performs their processing in-house and in order to assist the new client with covering the costs to transition to our platforms we have agreed to pay them $13.0 million in transition assistance during the conversion, of which $2.0 million was paid in December 2017. The total amounts will be amortized as a reduction to revenue over the course of the ten year contractual term.
Additionally in December 2017, we renewed our largest Domestic Financial Services client to a new seven year contract. Based upon our new rate structure, we expect our operating revenue in 2018 associated with this client to be relatively consistent with the 2017 revenue.

24


As part of the continuing strategic review of our operations, we decided not to renew a long-term surety bond insurance agreement which expired in December 2017 as the proposed revised terms were no longer economically advantageous. This agreement historically generated approximately $14.0 million of annual revenue.
On February 24, 2016, we acquired all of the membership interests of Kaufman Rossin Fund Services LLC (“KRFS”), an independent, full-service provider of specialized hedge fund administration services to the global financial community. KRFS’ hedge fund services include accounting and valuation, back-office outsourcing, investor services, treasury services, and customized reporting.
During 2015, we acquired all of the membership interests of kasina LLC, a strategic advisory firm to the asset management industry, and Red Rocks Capital LLC, an asset manager which focuses on listed private equity and other private asset investments. In 2015, we also acquired all of the outstanding common stock of Wealth Management Systems Inc., a provider of technology-based rollover services in the retirement marketplace.
In December 2015, we entered into a ten year contract with a new client to provide both subaccounting and mutual fund servicing solutions. The client converted approximately 10.0 million subaccounts onto our platform during 2016 and converted approximately 2.6 million registered accounts onto our platform during the third quarter of 2017.
International Financial Services Segment
We offer investor and policyholder administration and technology services on a Remote and BPO basis in the U.K. and, through our joint venture IFDS L.P., in Canada, Ireland, and Luxembourg. Additionally, in Australia and in the U.K., we provide solutions related to participant accounting and recordkeeping for wealth management, “wrap platforms” and retirement savings (“superannuation”) industries/markets through use of our wealth management platform and our life and pension administration system.
Our primary clients are mutual fund managers, insurers and platform providers. International Financial Services fees are primarily charged to the client based on the number of accounts or transactions processed. We also realize revenues from fixed-fee license agreements that include provisions for ongoing support and maintenance and for additional license payments in the event that usage increases. Additionally, we derive professional service revenues from fees for implementation services, custom programming and data center operations. We typically have multi-year agreements with our clients.
In November 2016, we sold a wholly-owned foreign subsidiary that provides water billing software and services solutions for cash consideration of approximately $6.1 million. This business had approximately $5.4 million of operating revenue and $1.2 million of operating income on an annual basis. As these decisions were the result of a tactical review of our products and services, and not the result of a significant shift in strategic direction, the revenue and operating income from these products and services are included within our continuing operations.
During 2017, we reached a termination agreement with a wealth management platform client who had engaged us for a multi-year development and implementation effort as well as post-implementation services. The termination agreement resulted in incremental operating revenues of $93.2 million for the year ended December 31, 2017 as we accelerated recognition of previously deferred revenue and recognized termination payments received. Additionally, our International Financial Services segment has been notified that two of our clients, which have collectively contributed approximately $33.0 million of annual revenue, will be migrating off our FAST platform in stages through the end of 2018.
Healthcare Services Segment
The Healthcare Services segment uses our proprietary software applications to provide healthcare organizations a variety of medical and pharmacy benefit solutions to satisfy their information processing, quality of care, cost management concerns and payment integrity programs, while achieving compliance and improving operational efficiencies. Our healthcare solutions include claims adjudication, benefit management, care management, business intelligence and other ancillary services. We also continue to expand and enhance our Healthcare Services’ offerings to ensure we are able to address the changing needs of our clients within the complex and highly regulated health industries which we serve. For example, our pharmacy management business continues to make investments to expand our clinical, network, and analytic capabilities to help our clients and prospective clients achieve the best possible outcomes for their members and to allow us to more effectively compete in the broader competitive pharmacy benefit manager (“PBM”) market. Historically, we have acted as an agent within our pharmacy-solutions business and, accordingly, recognized revenue on a net basis. As our enhanced products evolve and we expand our pharmacy-solutions service offerings, we will evaluate the provisions within our new pharmacy network and client contracts to determine whether we are acting as a principal or an agent in the transactions.  If we determine that we are acting as a principal in the transactions, we will report the transactions on a gross basis, resulting in significantly higher revenues and costs reflected within our consolidated financial statements.

25


We generally derive revenue from our pharmacy-solutions business on a transactional fee basis. Fees are earned on pharmacy claims processing and payments services, pharmacy and member call center services, pharmaceutical rebate administration, administration or management of clinical programs, pharmacy network management, member and plan web services and management information and reporting. Further, revenues include investment earnings related to client cash balances maintained in our bank accounts. Medical claim processing revenues are generally derived from fees charged on a per member/per month basis or transactional basis. We also realize revenue from fixed-fee license agreements that include provisions for ongoing support and maintenance and for additional license payments in the event that usage or members increase. Additionally, we derive professional service revenues from fees for implementation services, custom programming and data center operations.
During 2017, we renewed our pharmacy services contract with our Healthcare Services segment’s third largest client extending the term of the contract through December 31, 2020. As previously announced, two of our Healthcare Services clients transitioned their services off our systems during 2017. Additionally, we have been notified that one of our largest Healthcare Services clients, which contributed approximately $50.0 million of annual revenue, will be migrating off our medical claims processing platform in stages through the end of 2019.
Seasonality
Generally, we do not have significant seasonal fluctuations in our business operations. Processing volumes for mutual fund clients within our Domestic and International Financial Services segment are usually highest during the quarter ended March 31 due primarily to processing year-end transactions during January. We have historically added operating equipment in the last half of the year in preparation for processing year-end transactions, which has the effect of increasing costs for the second half of the year. Revenues and operating results from individual license sales vary depending on the timing and size of the contracts.
New Authoritative Accounting Guidance
See Item 8, Financial Statements and Supplementary Data - Note 2, “Significant Accounting Policies - New authoritative accounting guidance.”
Critical Accounting Policies and Estimates
The following discussion and analysis of our financial condition, results of operations and cash flows are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements: revenue recognition; software capitalization and amortization; depreciation of fixed assets; valuation of long-lived and intangible assets and goodwill; accounting for investments; and accounting for income taxes.
Revenue recognition
We recognize revenue when it is realized or realizable and it is earned. The majority of our revenues are derived from computer processing and services and are recognized upon completion of the services provided. Software license fees, maintenance fees and other ancillary fees are recognized as services are provided or delivered and all client obligations have been met. We generally do not have payment terms from clients that extend beyond one year. Billing for services in advance of performance is recorded as deferred revenue.
We recognize revenue when the following criteria are met: 1) persuasive evidence of an arrangement exists; 2) delivery has occurred or services have been rendered; 3) the sales price is fixed or determinable; and 4) collectability is reasonably assured. If there is a client-specific acceptance provision in a contract or if there is uncertainty about client acceptance, the associated revenue is deferred until we have evidence of client acceptance.
Revenue arrangements with multiple deliverables are evaluated to determine if the deliverables (items) can be divided into more than one unit of accounting. An item can generally be considered a separate unit of accounting if both of the following criteria are met: 1) the delivered item(s) has value to the client on a standalone basis and 2) if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. Once separate units of accounting are determined, the arrangement consideration

26


should be allocated at the inception of the arrangement to all deliverables using the relative selling price method. Relative selling price is obtained from sources such as vendor-specific objective evidence, which is based on the separate selling price for that or a similar item or from third-party evidence such as how competitors have priced similar items. If such evidence is unavailable, we use our best estimate of the selling price, which includes various internal factors such as our pricing strategy and market factors.
We derive over 90% of our revenues as a result of providing processing and services under contracts. The majority of our fees are billed on a monthly basis, generally with thirty-day collection terms. Revenues are recognized for monthly processing and services upon performance of the services.
Our standard business practice is to bill monthly for development, consulting and training services on a time and materials basis. In some cases we bill a fixed fee for development and consulting services. For fixed fee arrangements, we recognize revenue on a “proportionate performance” basis. We periodically provide upfront cash payments to our clients to assist with the significant upfront costs associated with converting to new systems. Such payments are treated as a reduction of revenue over the term of the related contract.
We derive less than 10% of our revenues from licensing products. We license our wealth management products, life and pension administration system, AWD products and healthcare administration processing software solutions. Perpetual software license revenues are recognized at the time the contract is signed, the software is delivered and no future software obligations exist. Deferral of software license revenue billed results from delayed payment provisions, disproportionate discounts between the license and other services or the inability to unbundle certain services. Term software license revenues are recognized ratably over the term of the license agreement. While license fee revenues are not a significant percentage of our total operations, they can significantly impact earnings in the period in which they are recognized. Revenues from individual license sales depend heavily on the timing, size and nature of the contract. We recognize revenues for maintenance services ratably over the contract term, after collectability has been reasonably assured.
We may enter into arrangements with broker/dealers or other third parties to sell or market closed-end fund shares. Depending on the arrangement, we may earn distribution fees for marketing and selling the underlying fund shares. Conversely, we may incur distribution expenses, including structuring fees, finders’ fees and referral fees paid to unaffiliated broker/dealers or introducing parties for marketing and selling underlying fund shares of a closed-end fund we sponsor. While distribution revenues and expenses are not significant percentages of our operating revenues or costs and expenses, they can significantly impact operations and earnings in the period in which they are recognized.
We have entered into various agreements with related parties, principally unconsolidated affiliates, under which we have historically provided data processing and software services. We believe that the terms of our contracts with related parties are fair to us and are no less favorable than those obtained from unaffiliated parties.
We assess collection based on a variety of factors, including past collection history with the client and the credit-worthiness of the client. We generally do not request collateral from our client. If we determine that collection of revenues is not reasonably assured, revenue is deferred and is recognized at the time it becomes reasonably assured, which is generally upon receipt of cash. Allowances for billing adjustments and bad debt expense are estimated as revenues are recognized. Allowances for billing adjustments are recorded as reductions in revenues and bad debt expense is recorded within Costs and expenses. The annual amounts for these items are generally immaterial to our consolidated financial statements.
Software capitalization and amortization
We make substantial investments in software to enhance the functionality and facilitate the delivery of our processing services as well as our sale of licensed products. Purchased software is recorded at cost and is amortized on a straight-line basis over the estimated economic life, which is generally three to five years. We develop a large portion of our software internally. We capitalize software development costs for computer software developed or obtained for internal use after the preliminary project phase has been completed and management has committed to funding the project. For computer software to be sold, leased or otherwise marketed to third parties, we capitalize software development costs which are incurred after the products reach technological feasibility but prior to the general release of the product to clients. The capitalized software development costs are generally amortized on a straight-line basis over the estimated economic life, which is generally three to five years.
Significant management judgment is required in determining what projects and costs associated with software development will be capitalized and in assigning estimated economic lives to the completed projects. Management specifically evaluates software development projects and analyzes the percentage of completion as compared to the initial plan and subsequent forecasts, milestones achieved and the commitment to continue funding the projects. Significant changes in any of these items may result in discontinuing capitalization of development costs, as well as immediately expensing previously capitalized costs. We review, on a quarterly basis, our capitalized software for possible impairment.

27


Depreciation of fixed assets
For personal property, we generally prefer to own rather than lease the property when practicable. We believe this approach provides us with better flexibility for disposing or redeploying the asset as it nears the completion of its economic life. We depreciate technology equipment using accelerated depreciation methods over the following lives: (1) non-mainframe equipment—three years; (2) mainframe central processing unit—four years; and (3) mainframe direct access storage devices—five years. We depreciate furniture and fixtures over estimated useful lives, principally three to five years, using accelerated depreciation methods. We depreciate leasehold improvements using the straight-line method over the lesser of the term of the lease or life of the improvements. Management judgment is required in assigning economic lives to fixed assets. Management specifically analyzes fixed asset additions, remaining net book values and gain/loss upon disposition of fixed assets to determine the appropriateness of assigned economic lives. Significant changes in any of these items may result in changes in the economic life assigned and the resulting depreciation expense.
Valuation of long-lived and intangible assets and goodwill
Goodwill and indefinite-lived intangible assets are not amortized but are evaluated for impairment. We evaluate the impairment of goodwill at least annually (as of October 1) and evaluate identifiable intangibles, long-lived assets and related assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that could trigger an impairment review include the following: significant under-performance relative to expected historical or projected future operating results; significant changes in the manner of our use of the acquired assets or our strategy for the overall business; and significant negative industry or economic trends. When it is determined that the carrying value of intangibles, long-lived assets or goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we assess actual impairment based on cash flows.
Our assessment of goodwill for impairment may first include a qualitative assessment that considers various factors, including those described above as well as growth in operating revenues and income from operations of our reporting units since our last quantitative assessment. A quantitative assessment is performed if the qualitative assessment indicates that it is more likely than not that the fair value of a reporting unit is less than its carrying amount or if a qualitative assessment is not performed.
Our quantitative assessment of goodwill for impairment includes comparing the fair value of a reporting unit with its net book value, including goodwill. We estimate fair value using a combination of discounted cash flow models and market approaches. If the fair value of a reporting unit exceeds its net book value, goodwill of the reporting unit is considered not impaired. If the net book value of a reporting unit exceeds its fair value, we recognize an impairment loss equal to the excess, limited to the total amount of goodwill allocated to that reporting unit. After a goodwill impairment loss is recognized, the adjusted carrying amount of goodwill becomes its new accounting basis.
Our 2017, 2016 and 2015 annual goodwill impairment tests determined that goodwill was not impaired, except during 2016 for the goodwill held at the Customer Communications U.K. reporting unit, which is included as a component of discontinued operations, as further described in Item 8, Financial Statements and Supplemental Data - Note 4, “Discontinued Operations.”
Accounting for investments
We have four significant types of investments: 1) investments in available-for-sale securities; 2) investments in unconsolidated affiliates, which are comprised principally of IFDS L.P. and certain real estate joint ventures; 3) investments in private equity funds and other investments accounted for under the cost method; and 4) seed capital investments accounted for at fair value.
We account for investments in entities in which we own less than 20% and do not have significant influence in accordance with authoritative guidance related to accounting for certain investments in debt and equity securities, which requires us to designate our investments as trading or available-for-sale. Available-for-sale securities are reported at fair value with unrealized gains and losses excluded from earnings and recorded net of deferred taxes directly to Accumulated other comprehensive income within Stockholders’ equity.
We regularly review investment securities for impairment based on both quantitative and qualitative criteria that include the extent to which cost exceeds fair value, the duration of any market decline, and the financial health of and specific prospects for the issuer. We record an investment impairment charge for an investment with a gross unrealized holding loss resulting from a decline in value that is other than temporary. 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, which could have a material effect on our financial position.
The equity method of accounting is used for investments in entities, partnerships and similar interests (including investments in private equity funds where we are the limited partner) in which we have significant influence but do not control. We classify

28


these investments as unconsolidated affiliates. Under the equity method, we recognize income or losses from our pro-rata share of these unconsolidated affiliates’ net income or loss, which changes the carrying value of the investment of the unconsolidated affiliate. In certain cases, pro-rata losses are recognized only to the extent of our investment and advances to the unconsolidated affiliate.
The cost method of accounting is used for these investments when we have a de minimis ownership percentage and do not have significant influence. Our cost method investments are held at the lower of cost or market.
Accounting for income taxes
We account for income taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in addressing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns (e.g., realization of deferred tax assets, changes in tax laws or interpretations thereof).
On December 22, 2017, the United States enacted tax reform legislation commonly known as the Tax Cuts and Jobs Act (the “Tax Act”), resulting in significant modifications to existing U.S. tax law, including but not limited to, (1) lowering the corporate federal income tax rate from 35% to 21% effective January 1, 2018; (2) eliminating the domestic production activity deduction; (3) implementing a territorial tax system; and (4) imposing a one-time repatriation tax on deemed repatriated earnings of foreign subsidiaries. The SEC staff issued Staff Accounting Bulletin 118 (“SAB 118”) which provides additional clarification in situations where we do not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting for certain income tax effects of the Tax Act for the reporting period in which the Tax Act was enacted. We have recognized the provisional tax impacts, based on reasonable estimates, related to the one-time deemed mandatory repatriation of post-1986 undistributed foreign subsidiary earnings and profits through the year ended December 31, 2017 (“Transition Tax”) and the revaluation of deferred tax assets and liabilities and has included these amounts in its consolidated financial statements for the year ended December 31, 2017. The ultimate impact may differ from these provisional amounts, possibly materially, due to among other things, additional analysis, changes in interpretations and assumptions we have made, additional regulatory guidance that may be issued, and actions we may take as a result of the Tax Act. We intend to complete our accounting under the Tax Act within the measurement period set forth in SAB 118.
In addition, we are subject to examination of our income tax returns by the Internal Revenue Service (“IRS”) and other tax authorities. A change in the assessment of the outcomes of such matters could materially impact our consolidated financial statements. The calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for potential tax exposures based on our estimate of whether, and the extent to which, additional taxes may be required. If we ultimately determine that payment of these amounts is unnecessary, then we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer necessary. We also recognize tax benefits to the extent that it is more likely than not that our positions will be sustained if challenged by the taxing authorities. To the extent we prevail in matters for which liabilities have been established, or are required to pay amounts in excess of our liabilities, our effective tax rate in a given period may be materially affected. An unfavorable tax settlement would require cash payments and may result in an increase in our effective tax rate in the year of resolution. A favorable tax settlement would be recognized as a reduction in our effective tax rate in the year of resolution. We report interest and penalties related to uncertain income tax positions within income tax expense.

29


Results of Operations
The following table summarizes our consolidated operating results (in millions). Additional information regarding our segments is included below under the caption, “Year to Year Business Segment Comparisons.”
 
 
 
 
 
 
 
Change
 
Year Ended December 31,
 
2017 vs 2016
 
2016 vs 2015
 
2017
 
2016
 
2015
 
$
 
%
 
$
 
%
Operating revenues
$
2,086.7

 
$
1,474.4

 
$
1,405.0

 
$
612.3

 
41.5
 %
 
$
69.4

 
4.9
 %
Out-of-pocket reimbursements
131.5

 
82.3

 
69.0

 
49.2

 
59.8
 %
 
13.3

 
19.3
 %
     Total revenues
2,218.2

 
1,556.7

 
1,474.0

 
661.5

 
42.5
 %
 
82.7

 
5.6
 %
 

 
 
 
 
 
 
 
 
 
 
 
 
Costs and expenses
1,805.0

 
1,213.4

 
1,150.2

 
591.6

 
48.8
 %
 
63.2

 
5.5
 %
Depreciation and amortization
128.0

 
96.0

 
91.1

 
32.0

 
33.3
 %
 
4.9

 
5.4
 %
Operating income
285.2

 
247.3

 
232.7

 
37.9

 
15.3
 %
 
14.6

 
6.3
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense
(26.8
)
 
(23.5
)
 
(23.8
)
 
(3.3
)
 
(14.0
)%
 
(0.3
)
 
(1.3
)%
Gain on sale of business

 
5.5

 

 
(5.5
)
 
(100.0
)%
 
5.5

 
100.0
 %
Other income, net
219.0

 
22.7

 
204.5

 
196.3

 
864.8
 %
 
(181.8
)
 
(88.9
)%
Equity in earnings of unconsolidated affiliates
54.5

 
27.2

 
45.4

 
27.3

 
100.4
 %
 
(18.2
)
 
(40.1
)%
Income from continuing operations before income taxes and non-controlling interest
531.9

 
279.2

 
458.8

 
252.7

 
90.5
 %
 
(179.6
)
 
(39.1
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income taxes
84.3

 
101.1

 
149.2

 
(16.8
)
 
(16.6
)%
 
(48.1
)
 
(32.2
)%
Net income from continuing operations before non-controlling interest
447.6

 
178.1

 
309.6

 
269.5

 
151.3
 %
 
(131.5
)
 
(42.5
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income from discontinued operations, net of tax
4.5

 
248.3

 
48.5

 
(243.8
)
 
(98.2
)%
 
199.8

 
412.0
 %
Net income
452.1

 
426.4

 
358.1

 
25.7

 
6.0
 %
 
68.3

 
19.1
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net (income) loss attributable to non-controlling interest
(0.6
)
 
0.9

 
0.1

 
(1.5
)
 
(166.7
)%
 
0.8

 
800.0
 %
Net income attributable to DST Systems, Inc.
$
451.5

 
$
427.3

 
$
358.2

 
$
24.2

 
5.7
 %
 
$
69.1

 
19.3
 %
Revenues
Consolidated total revenues (including out-of-pocket (“OOP”) reimbursements) increased $661.5 million or 42.5% during the year ended December 31, 2017 as compared to the year ended December 31, 2016 and increased $82.7 million or 5.6% during the year ended December 31, 2016 as compared to the year ended December 31, 2015. Consolidated operating revenues increased $612.3 million or 41.5% in 2017 as compared to 2016 primarily due to the acquisition of the remaining interests in BFDS and IFDS U.K. in 2017 which collectively contributed $601.8 million of incremental operating revenue during 2017. Consolidated operating revenues increased $69.4 million or 4.9% in 2016 as compared to 2015 primarily as a result of the acquisitions of KRFS in February 2016, Red Rocks Capital LLC in July 2015 and Wealth Management Systems Inc. in August 2015.
Prior to the acquisitions of BFDS and IFDS U.K., we received revenues for processing services and products provided under agreements with these entities. Our operating revenues derived from sales to these entities were $138.5 million and $134.9 million for the years ended December 31, 2016, and 2015, respectively, and $35.2 million in the first quarter of 2017. The operating results of BFDS and IFDS U.K. were consolidated within our operating results subsequent to the acquisition dates.
Consolidated OOP reimbursements increased $49.2 million or 59.8% in 2017 as compared to 2016 and increased $13.3 million or 19.3% in 2016 as compared to 2015. The increase in consolidated OOP reimbursements in 2017 is primarily attributable to the acquisition of the remaining interests in BFDS and IFDS U.K. The increase in consolidated OOP reimbursements in 2016 is primarily attributable to increased client volumes in the Domestic Financial Services segment.

30


Costs and expenses
Consolidated costs and expenses (including OOP reimbursements) increased $591.6 million or 48.8% in 2017 as compared to 2016 and increased $63.2 million or 5.5% in 2016 as compared to 2015. Costs and expenses are primarily comprised of compensation and benefit costs, reimbursable operating expenses, information technology spend and professional fees. Reimbursable operating expenses included in costs and expenses were $131.5 million, $82.3 million and $69.0 million in 2017, 2016 and 2015, respectively. Excluding reimbursable operating expenses, costs and expenses increased $542.4 million in 2017 as compared to 2016 and increased $49.9 million in 2016 as compared to 2015.
The increase in costs and expenses in 2017, exclusive of reimbursable expenses, is primarily attributable to the consolidation of BFDS and IFDS U.K. following the acquisitions of the remaining interests in these entities during 2017. Share-based compensation expense increased $31.4 million during the year ended December 31, 2017 primarily driven by the prior year reversal of accrued performance-related share-based compensation expense as 2015 PSUs were not expected to achieve the required performance criteria combined with increased share-based compensation expense in 2017 related to 2016 and 2017 PSUs that are currently expected to vest at a higher conversion rate than target. In addition, we recorded increased bad debt expense and a significant charitable contribution transaction in 2017.
As a result of changes in our business environment, including the transition of certain Health Services clients off of our systems, the termination of a wealth management client in the International Financial Services segment, and the acquisitions of the remaining interests in BFDS and IFDS U.K., we have implemented restructuring initiatives to right-size our organization and enhance operational efficiencies, as well as achieve synergies from our recent acquisitions. During the year ended December 31, 2017, we incurred pretax restructuring charges primarily related to employee terminations and related costs of $23.4 million in Costs and expenses. Annualized savings achieved from the actions taken from March 2017 through October 2017 are currently expected to be approximately $22.0 million within the Domestic Financial Services segment, approximately $7.0 million within the International Financial Services segment and approximately $13.0 million within the Healthcare Services segment.
During the years ended December 31, 2016 and 2015, we incurred $10.4 million and $3.4 million of pretax restructuring charges, respectively.
Depreciation and amortization
Consolidated depreciation and amortization increased $32.0 million or 33.3% during the year ended December 31, 2017 as compared to the year ended December 31, 2016 primarily as a result of the acquisitions of the remaining interests in BFDS and IFDS U.K. and increased $4.9 million or 5.4% during the year ended December 31, 2016 as compared to the year ended December 31, 2015 primarily as a result of the acquisition of KRFS.
Operating income
Consolidated operating income increased $37.9 million or 15.3% to $285.2 million during the year ended December 31, 2017 as compared to 2016 and increased $14.6 million or 6.3% to $247.3 million during the year ended December 31, 2016 as compared to 2015.
Interest expense
Interest expense was $26.8 million, $23.5 million and $23.8 million during the years ended December 31, 2017, 2016 and 2015, respectively. Interest expense increased 14.0% during 2017 as compared to 2016 primarily due to higher borrowings as a result of the acquisition of IFDS U.K. and higher borrowing rates on the $350.0 million of debt issued in the fourth quarter of 2017. Interest expense decreased 1.3% during 2016 as compared to 2015 primarily from lower weighted average debt balances outstanding.
Gain on sale of business
On November 1, 2016, we sold DST Billing Solutions Limited (“Billing Solutions”) for cash consideration of approximately $6.1 million. Operating revenue and income generated for the Billing Solutions business sold was approximately $4.0 million and $0.7 million, respectively, for the year ended December 31, 2016. We recorded a pretax gain of $5.5 million on the sale of the business during 2016.

31


Other income, net
The components of other income, net are as follows (in millions):
 
Year Ended December 31,
 
2017
 
2016
 
2015
Net realized gains from the disposition of available-for-sale securities
$
155.9

 
$
2.3

 
$
168.4

Net gain on previously held equity interests
43.8

 

 

Net gain on private equity funds and other investments
15.4

 
16.5

 
35.7

Dividend income
3.5

 
5.8

 
8.3

Miscellaneous items
0.4

 
(1.9
)
 
(7.9
)
Other income, net
$
219.0

 
$
22.7

 
$
204.5

Included in the net realized gains from the disposition of available-for-sale securities during 2015 were gains of $157.3 million from the sale of approximately 2.3 million shares of State Street common stock as compared to no sales of State Street shares during 2016. We recognized a realized gain of $145.1 million from the exchange of State Street common stock for the remaining interests in BFDS in 2017. We also recognized a realized gain of $10.4 million from the charitable contribution of our remaining State Street shares in 2017. Additionally, as a result of the 2017 acquisitions, we recorded a net pretax gain of $43.8 million on the step-up of our previous 50% ownership interests in BFDS and IFDS U.K. during the year ended December 31, 2017.
We recorded a net gain on private equity funds and other investments of $15.4 million, $16.5 million and $35.7 million during the years ended December 31, 2017, 2016 and 2015, respectively, primarily due to distributions received from certain of our private equity fund investments resulting in realized gains. 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 and may require an impairment charge in the future, which could have a material effect on our net income.
We receive dividend income from certain investments held. The decline in dividend income for the year ended December 31, 2017 was primarily driven by our reduction of our investment in State Street common stock in March 2017. Dividends received from State Street common stock were $0.1 million, $3.1 million and $3.2 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Equity in earnings of unconsolidated affiliates
Equity in earnings of unconsolidated affiliates is as follows (in millions):
 
Year Ended December 31,
 
2017
 
2016
 
2015
International Financial Data Services U.K.
$
1.0

 
$
10.0

 
$
22.5

International Financial Data Services L.P.
18.3

 
2.2

 
7.4

Boston Financial Data Services, Inc. 
3.6

 
8.3

 
5.3

Other unconsolidated affiliates
31.6

 
6.7

 
10.2

Total
$
54.5

 
$
27.2

 
$
45.4

Equity in earnings of IFDS U.K. decreased $9.0 million during the year ended December 31, 2017, as compared to 2016, primarily as a result of the discontinuation of equity method accounting subsequent to our acquisition of the remaining interests in IFDS U.K. Equity in earnings of IFDS U.K. decreased $12.5 million during the year ended December 31, 2016, as compared to 2015, primarily attributable to lower revenues recognized related to client conversion activities and higher operating costs as IFDS U.K. expanded its infrastructure to address increasing regulatory, compliance and security needs.
Equity in earnings of IFDS L.P. increased $16.1 million during the year ended December 31, 2017, as compared to 2016, primarily as a result of $10.2 million of realized gains on the step-up of certain investments and real estate assets that were distributed from the joint venture to DST and State Street immediately prior to the acquisitions by DST of the remaining interests in IFDS U.K. and BFDS. Equity in earnings of IFDS L.P. decreased $5.2 million during the year ended December 31, 2016, as compared to 2015.
Equity in earnings of BFDS decreased $4.7 million during the year ended December 31, 2017 as compared to 2016. The decrease was primarily as a result of the discontinuation of equity method accounting subsequent to the acquisition of the remaining interests in BFDS in March 2017. Equity in earnings of BFDS increased $3.0 million during the year ended

32


December 31, 2016 as compared to 2015. The increase was primarily attributable to higher ancillary and non-operating revenues as well as a reduction in operating costs.
Our equity in earnings of other unconsolidated affiliates was $31.6 million during the year ended December 31, 2017, an increase of $24.9 million as compared to 2016. The increase was primarily due to a $23.0 million increase resulting from a gain on the step-up of real estate distributed from Broadway Square Partners, LLP (“Broadway Square Partners”), an unconsolidated affiliate, during 2017. Our equity in earnings of other unconsolidated affiliates was $6.7 million during the year ended December 31, 2016, a decrease of $3.5 million as compared to 2015. The decrease was primarily due to a $3.6 million gain resulting from the sale of real estate by an unconsolidated affiliate during 2015.
As of December 31, 2017, approximately $40.8 million of our consolidated retained earnings represents undistributed earnings in our unconsolidated affiliates accounted for by the equity method of accounting.
Income taxes
Our effective tax rate was 15.8%, 36.2% and 32.5% for the years ended December 31, 2017, 2016 and 2015, respectively. Our income tax rate for 2017 was lower than the statutory federal income tax rate of 35% primarily due to the non-taxable nature of the BFDS exchange transaction, the impacts of the Tax Act, the adoption of new accounting guidance issued for tax benefits on employee share-based compensation transactions, benefits realized from the settlement of uncertain tax positions, and a change in the proportional mix of domestic and international transactions. The 2017 impact of the Tax Act was a $13.7 million tax benefit, primarily from the net impact of the revaluation of our deferred tax assets and liabilities utilizing the enacted tax rate at the time they are anticipated to be realized less the estimated tax associated with the deemed mandatory repatriation of undistributed accumulated foreign earnings. This reflects our current estimate of the U.S. income tax effects of the Tax Act, however these are provisional amounts subject to adjustment during the one year measurement period provided pursuant to guidance in SAB 118.
Our effective income tax rate for 2016 was higher than the statutory federal income tax rate of 35% primarily attributable to state income taxes, transaction related taxes, and a change in the proportional mix of domestic and international income, partially offset by federal income tax credits for foreign income taxes and research and development costs.
Our effective income tax rate for 2015 was favorably impacted by an $11.9 million benefit from the completion of the IRS examination of previously filed federal income tax refund claims for Domestic Manufacturing Deductions, research and experimentation credits and capital losses for 2010 as well as other remeasurements during the period.
Excluding the effect of discrete period items, we currently expect our effective tax rate to be approximately 26.5% in 2018. The 2018 tax rate can be affected as a result of variances among the estimates and amounts of 2018 sources of taxable income (e.g., domestic consolidated, joint venture and/or international), the realization of tax credits, adjustments which may arise from the resolution of tax matters under review, our assessment of our liability for uncertain tax positions, changes in interpretations and assumptions we have made, federal tax regulations and guidance that may be issued by the U.S. Department of the Treasury and actions we may take as a result of the Tax Act.
Income from discontinued operations, net of tax
Income from discontinued operations, net of tax decreased $243.8 million during the year ended December 31, 2017 as compared to 2016 and increased $199.8 million during the year ended December 31, 2016 as compared to 2015. The decrease during the year ended December 31, 2017 was primarily due to the sale of our North American Customer Communications business in July 2016, partially offset by the sale of our U.K. Customer Communications business in May 2017. The increase during the year ended December 31, 2016 was primarily attributable to the $234.7 million gain, net of tax, on the sale of our North American Customer Communications business partially offset by $17.0 million of goodwill and asset impairments in our U.K. Customer Communications business.


33


YEAR TO YEAR BUSINESS SEGMENT COMPARISONS
DOMESTIC FINANCIAL SERVICES SEGMENT
The following table presents the financial results of the Domestic Financial Services segment (in millions):
 
 
 
 
 
 
 
Change
 
Year Ended December 31,
 
2017 vs 2016
 
2016 vs 2015
 
2017
 
2016
 
2015
 
$
 
%
 
$
 
%
Operating revenues
$
1,187.2

 
$
995.8

 
$
983.1

 
$
191.4

 
19.2
 %
 
$
12.7

 
1.3
 %
Out-of-pocket reimbursements
111.8

 
73.0

 
60.7

 
38.8

 
53.2
 %
 
12.3

 
20.3
 %
Total revenues
1,299.0

 
1,068.8

 
1,043.8

 
230.2

 
21.5
 %
 
25.0

 
2.4
 %
Costs and expenses
1,072.2

 
829.0

 
792.3

 
243.2

 
29.3
 %
 
36.7

 
4.6
 %
Depreciation and amortization
86.8

 
77.3

 
67.7

 
9.5

 
12.3
 %
 
9.6

 
14.2
 %
Operating income
$
140.0

 
$
162.5

 
$
183.8

 
$
(22.5
)
 
(13.8
)%
 
$
(21.3
)
 
(11.6
)%
 
 
 
 
 
 
 

 

 

 

Operating margin
11.8
%
 
16.3
%
 
18.7
%
 
 
 
 
 
 
 
 
The following table summarizes the Domestic Financial Services segment’s statistical metrics (in millions, except as noted):
 
 
December 31,
 
 
2017
 
2016
 
2015
Domestic mutual fund shareowner accounts processed:
 
 
 
 
 
 
Registered accounts - non tax-advantaged
 
24.2

 
25.3

 
27.0

IRA mutual fund accounts
 
20.5

 
21.1

 
21.8

Other retirement accounts
 
7.8

 
8.0

 
8.2

Section 529 and Educational IRAs
 
7.8

 
7.5

 
8.4

Registered accounts - tax-advantaged
 
36.1

 
36.6

 
38.4

Total registered accounts
 
60.3

 
61.9

 
65.4

Subaccounts
 
46.2

 
42.1

 
31.3

Total domestic mutual fund shareowner accounts processed
 
106.5

 
104.0

 
96.7

 
 
 
 
 
 
 
Defined contribution participant accounts
 
7.2

 
6.8

 
7.0

 
 
 
 
 
 
 
ALPS (in billions of U.S. dollars):
 
 
 
 
 
 
Assets Under Management
 
$
18.4

 
$
17.2

 
$
14.7

Assets Under Administration
 
$
225.9

 
$
179.1

 
$
140.4



34


 
 
Year Ended December 31,
 
 
2017
 
2016
 
2015
Changes in registered accounts:
 
 
 
 
 
 
Beginning balance
 
61.9

 
65.4

 
68.8

New client conversions
 
3.0

 
0.1

 

Subaccounting conversions to DST platforms
 
(0.9
)
 
(0.9
)
 
(1.8
)
Subaccounting conversions to non-DST platforms
 
(1.0
)
 
(0.5
)
 
(1.1
)
Conversions to non-DST platforms
 
(0.3
)
 
(0.7
)
 
(0.3
)
Organic decline
 
(2.4
)
 
(1.5
)
 
(0.2
)
Ending balance
 
60.3

 
61.9

 
65.4

 
 
 
 
 
 
 
Changes in subaccounts:
 
 
 
 
 
 
Beginning balance
 
42.1

 
31.3

 
28.6

New client conversions
 
0.3

 
10.7

 

Conversions from non-DST registered platforms
 
1.6

 

 
1.1

Conversions from DST’s registered accounts
 
0.9

 
0.9

 
1.8

Conversions to non-DST platforms
 
(0.4
)
 

 

Organic growth (decline)
 
1.7

 
(0.8
)
 
(0.2
)
Ending balance
 
46.2

 
42.1

 
31.3

 
 
 
 
 
 
 
Changes in defined contribution participant accounts:
 
 
 
 
 
 
Beginning balance
 
6.8

 
7.0

 
7.2

New client conversions
 
0.5

 

 
0.1

Organic decline
 
(0.1
)
 
(0.2
)
 
(0.3
)
Ending balance
 
7.2

 
6.8

 
7.0

Comparison of 2017 versus 2016 results
Operating revenues
Domestic Financial Services segment operating revenues of $1,187.2 million reflect an increase of $191.4 million or 19.2% in 2017 as compared to 2016. The increase in operating revenues during the year ended December 31, 2017 was primarily attributable to the acquisition of the remaining interest in BFDS, which contributed $176.6 million of incremental operating revenues. Excluding the BFDS operating revenues in 2017, operating revenues for the Domestic Financial Services segment for the year ended December 31, 2017 increased $14.8 million or 1.5%. This increase in operating revenues for the year ended December 31, 2017 was partially due to a $5.0 million increase in revenue at ALPS resulting from an insurance claim reimbursement of $2.0 million received in fourth quarter 2017 as compared to a reduction to ALPS revenue of $3.0 million during 2016 for the processing error that generated the insurance claim.  In addition, operating revenues were higher as a result of increased fund flows and higher market performance at ALPS, partially offset by decreased revenues resulting from the exit of certain product offerings and lower subaccounting and mutual fund registered shareowner account processing revenues. Additionally, software license revenues were $17.7 million for the year ended December 31, 2017, a decrease of $3.9 million as compared to 2016.
Costs and expenses
Domestic Financial Services segment costs and expenses for the year ended December 31, 2017 were $1,072.2 million, an increase of $243.2 million as compared to 2016. Reimbursable operating expenses included in costs and expenses were $111.8 million in 2017, an increase of $38.8 million as compared to 2016.
Excluding reimbursable operating expenses, Domestic Financial Services costs and expenses increased $204.4 million or 27.0% for the year ended December 31, 2017 as compared to 2016. This increase was primarily attributable to $176.3 million of incremental costs and expenses from the consolidation of BFDS following the acquisition of the remaining interest in that entity in 2017 and higher share-based compensation expense which increased $25.2 million during the year ended December 31, 2017 as compared to the prior year.

35


In addition, costs and expenses increased from higher integration and restructuring costs related to our BFDS acquisition and higher information technology transformation spend partially offset by the non-recurrence of a software impairment recorded in 2016. We recorded restructuring charges of $16.3 million and $10.4 million during the years ended December 31, 2017 and 2016, respectively. During the year ended December 31, 2017, we also recognized $11.6 million of expense related to a charitable contribution of our remaining State Street stock.
Depreciation and amortization
Domestic Financial Services segment depreciation and amortization costs for the year ended December 31, 2017 were $86.8 million, an increase of $9.5 million or 12.3% as compared to 2016. The increase in 2017 was primarily attributable to incremental amortization associated with acquired intangibles from the recent acquisitions as well as increased depreciation from capitalized costs incurred to enhance our network infrastructure, security and regulatory compliance.
Operating income
Domestic Financial Services segment operating income for 2017 was $140.0 million, a decrease of $22.5 million or 13.8% as compared to 2016. The decrease in Domestic Financial Services operating income was primarily due to higher share-based compensation expense, higher advisory and restructuring costs due to the integration activities for the recently acquired BFDS business and increased depreciation and amortization expense. Operating income also decreased due to an increase in information technology transformation spend, partially offset by higher revenues.
Comparison of 2016 versus 2015 results
Operating revenues
Domestic Financial Services segment operating revenues of $995.8 million increased $12.7 million or 1.3% in 2016 as compared to 2015. The increase in operating revenues during the year ended December 31, 2016 as compared to the year ended December 31, 2015 was primarily driven from businesses acquired during 2015 and 2016, which contributed $31.8 million of incremental operating revenues. During 2016, we also completed the conversion of approximately 10.0 million subaccounts associated with a previously announced new client, which resulted in incremental revenues. These increases were partly offset by a decline in mutual fund registered shareowner account processing revenue due to lower registered accounts, primarily as a result of subaccounting conversions, and lower revenue due to extending certain long-term contracts with lower pricing. Additionally, software license revenues were $21.6 million for the year ended December 31, 2016, a decrease of $0.9 million as compared to 2015.
Costs and expenses
Domestic Financial Services segment costs and expenses for the year ended December 31, 2016 were $829.0 million, an increase of $36.7 million as compared to 2015. Reimbursable operating expenses included in costs and expenses were $73.0 million for the year ended December 31, 2016, an increase of $12.3 million as compared to 2015.
Excluding reimbursable operating expenses, Domestic Financial Services costs and expenses increased $24.4 million or 3.3% for the year ended December 31, 2016 as compared to 2015. On this basis, the increase in costs and expenses during 2016 was primarily from acquisitions completed during 2015 and 2016, which included approximately $33.7 million of incremental expenses. Also, contributing to the increase in costs and expenses were the restructuring activities, which resulted in $10.4 million of employee and lease termination costs during the year ended December 31, 2016 to enhance operational efficiency within the Domestic Financial Services segment. We also incurred increased costs to enhance the network infrastructure utilized across all of our operating businesses and incremental costs to service new and existing clients. During the year ended December 31, 2016, we also recognized a $6.0 million software impairment. These costs and expenses were partially offset by the reversal of accrued performance-related share-based compensation expense as 2015 PSUs were not expected to achieve the required performance criteria required for vesting and further savings realized from cost containment initiatives.
Depreciation and amortization
Domestic Financial Services segment depreciation and amortization costs for the year ended December 31, 2016 were $77.3 million, an increase of $9.6 million or 14.2% as compared to 2015. The increase in 2016 was primarily attributable to incremental amortization associated with acquired intangibles from the acquisitions completed in 2015 and 2016 as well as increased depreciation from capitalized costs incurred to enhance our network infrastructure and increase security and regulatory compliance. The increase in 2016 was also attributable to the acceleration of depreciation on certain capitalized software during 2016.

36


Operating income
Domestic Financial Services segment operating income for 2016 was $162.5 million, a decrease of $21.3 million or 11.6% as compared to 2015. The decrease in Domestic Financial Services operating income was primarily due to restructuring costs incurred during 2016, a software impairment charge, and increased costs incurred to enhance our network infrastructure, maintain security and regulatory compliance. These decreases were partially offset by the reversal of accrued performance-related share-based compensation expense, higher operating revenues and cost containment efforts during 2016.
INTERNATIONAL FINANCIAL SERVICES SEGMENT
The following table presents the financial results of the International Financial Services segment (in millions):
 
 
 
 
 
 
 
Change
 
Year Ended December 31,
 
2017 vs 2016
 
2016 vs 2015
 
2017
 
2016
 
2015
 
$
 
%
 
$
 
%
Operating revenues
$
538.4

 
$
110.9

 
$
93.4

 
$
427.5

 
385.5
%
 
$
17.5

 
18.7
 %
Out-of-pocket reimbursements
12.2

 
1.2

 
1.7

 
11.0

 
916.7
%
 
(0.5
)
 
(29.4
)%
Total revenues
550.6

 
112.1

 
95.1

 
438.5

 
391.2
%
 
17.0

 
17.9
 %
Costs and expenses
449.3

 
98.2

 
86.1

 
351.1

 
357.5
%
 
12.1

 
14.1
 %
Depreciation and amortization
30.7

 
3.1

 
4.8

 
27.6

 
890.3
%
 
(1.7
)
 
(35.4
)%
Operating income
$
70.6

 
$
10.8

 
$
4.2

 
$
59.8

 
553.7
%
 
$
6.6

 
157.1
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating margin
13.1
%
 
9.7
%
 
4.5
%
 
 
 
 
 
 
 
 
The following table summarizes the International Financial Services segment’s statistical metrics (in millions, except as noted):
 
 
December 31,
 
 
2017
 
2016
 
2015
International mutual fund shareowner accounts processed:
 
 
 
 
 
 
IFDS U.K.
 
8.6

 
8.9

 
8.8

IFDS L.P. (Unconsolidated affiliate principally based in Canada)
 
14.5

 
13.7

 
13.3

Total international mutual fund shareowner accounts processed
 
23.1

 
22.6

 
22.1

 
 
 
 
 
 
 
Comparison of 2017 versus 2016 results
Operating revenues
International Financial Services segment operating revenues of $538.4 million reflect an increase of $427.5 million or 385.5% in 2017 as compared to 2016. The increase in operating revenues during the year ended December 31, 2017 was primarily driven by the acquisition of the remaining interest in IFDS U.K., which contributed $425.2 million of incremental operating revenues, including the financial impacts resulting from the termination of a wealth management client agreement. The termination agreement resulted in incremental operating revenues of $93.2 million for the year ended December 31, 2017 as DST accelerated recognition of previously deferred revenue and recognized termination payments received. Additionally, software license revenues were $12.5 million for the year ended December 31, 2017, an increase of $2.6 million as compared to 2016. These increases were partly offset by lower revenues as a result of the previously discussed client termination in mid-2017 as well as the sale of DST Billing Solutions during 2016.
Costs and expenses
International Financial Services segment costs and expenses for the year ended December 31, 2017 were $449.3 million, an increase of $351.1 million as compared to 2016. Costs and expenses in the International Financial Services segment are primarily comprised of compensation and benefit costs as well as technology-related expenditures. Reimbursable operating expenses included in costs and expenses were $12.2 million in 2017, an increase of $11.0 million as compared to 2016.

37


Excluding reimbursable operating expenses, International Financial Services costs and expenses increased $340.1 million for the year ended December 31, 2017 as compared to 2016 primarily due to the acquisition of the remaining interests in IFDS U.K. Additionally, in connection with the termination agreement described above, we incurred bad debt expense of $34.5 million for previously invoiced services performed prior to the termination and $5.2 million of other termination-related charges.
Depreciation and amortization
International Financial Services segment depreciation and amortization costs for the year ended December 31, 2017 were $30.7 million, an increase of $27.6 million as compared to 2016. The increase in 2017 was primarily attributable to incremental amortization of intangible assets and depreciation of fixed assets from the acquisition of the remaining interests in IFDS U.K.
Operating income
International Financial Services segment operating income for 2017 was $70.6 million, an increase of $59.8 million or 553.7% as compared to 2016. The increase in International Financial Services operating income was primarily due to the impact of the termination of the wealth management client agreement of $53.5 million, including the recognition of previously deferred revenue and termination payments received as described above. The increase in operating income was also due to the higher revenues resulting from the acquisition of the remaining interest in IFDS U.K., partially offset by higher costs and expenses due to on-going development and implementation efforts for wealth management platform clients, share-based compensation expense, and restructuring charges.
Comparison of 2016 versus 2015 results
Operating revenues
International Financial Services segment operating revenues of $110.9 million increased $17.5 million or 18.7% in 2016 as compared to 2015. The increase in operating revenues during the year ended December 31, 2016 as compared to the year ended December 31, 2015 was primarily due to the increased professional services revenues associated with our international wealth management platform business. Software license revenues were $9.9 million for the year ended December 31, 2016, a decrease of $1.1 million as compared to 2015.
Costs and expenses
International Financial Services segment costs and expenses for the year ended December 31, 2016 were $98.2 million, an increase of $12.1 million as compared to 2015. Reimbursable operating expenses included in costs and expenses were $1.2 million for the year ended December 31, 2016, a decrease of $0.5 million as compared to 2015.
Excluding reimbursable operating expenses, International Financial Services costs and expenses increased $12.6 million or 14.9% for the year ended December 31, 2016 as compared to 2015. On this basis, the increase in costs and expenses during 2016 was primarily from higher staffing costs to support the increase in professional services revenues.
Depreciation and amortization
International Financial Services segment depreciation and amortization costs for the year ended December 31, 2016 were $3.1 million, a decrease of $1.7 million or 35.4% as compared to 2015. The decrease in 2016 was primarily attributable to lower depreciation from lower capital expenditures.
Operating income
International Financial Services segment operating income for 2016 was $10.8 million, an increase of $6.6 million or 157.1% as compared to 2015. The increase in International Financial Services operating income was primarily due to the increased professional services revenues associated with our international wealth management platform business.


38


HEALTHCARE SERVICES SEGMENT
The following table presents the financial results of the Healthcare Services segment (in millions):
 
 
 
 
 
 
 
Change
 
Year Ended December 31,
 
2017 vs 2016
 
2016 vs 2015
 
2017
 
2016
 
2015
 
$
 
%
 
$
 
%
Operating revenues
$
418.5

 
$
426.2

 
$
376.4

 
$
(7.7
)
 
(1.8
)%
 
$
49.8

 
13.2
 %
Out-of-pocket reimbursements
7.5

 
8.5

 
8.2

 
(1.0
)
 
(11.8
)%
 
0.3

 
3.7
 %
Total revenues
426.0

 
434.7

 
384.6

 
(8.7
)
 
(2.0
)%
 
50.1

 
13.0
 %
Costs and expenses
340.9

 
345.1

 
321.3

 
(4.2
)
 
(1.2
)%
 
23.8

 
7.4
 %
Depreciation and amortization
10.5

 
15.6

 
18.6

 
(5.1
)
 
(32.7
)%
 
(3.0
)
 
(16.1
)%
Operating income
$
74.6

 
$
74.0

 
$
44.7

 
$
0.6

 
0.8
 %
 
$
29.3

 
65.5
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating margin
17.8
%
 
17.4
%
 
11.9
%
 
 
 
 
 
 
 
 
The following tables summarize the Healthcare Services segment’s statistical metrics (in millions):
 
 
December 31,
 
 
2017
 
2016
 
2015
DST Health Solutions covered lives
 
21.8

 
22.8

 
26.0

 
 
 Year Ended December 31,
 
 
2017
 
2016
 
2015
Argus pharmacy paid claims
 
500.0

 
507.0

 
494.4

Comparison of 2017 versus 2016 results
Operating revenues
Healthcare Services segment operating revenues of $418.5 million decreased $7.7 million or 1.8% in 2017 compared to 2016. The decrease in operating revenue during the year ended December 31, 2017 was primarily due to the previously announced client transitions off of our systems, which resulted in approximately $46.5 million of lower revenues. Excluding client migrations, Healthcare Services operating revenues increased by $38.8 million or 10.2%. On this basis, the increase in operating revenues primarily resulted from organic growth and the expansion of the high-value services that we are offering to existing clients in both the medical and pharmacy businesses. These increases were partially offset by reductions in membership related to exchanges and lower consulting and development revenues which we believe is the result of a decline in healthcare technology spending due to the ongoing uncertainty around government policy changes. Additionally, operating revenues included approximately $9.8 million of software license fee revenues for the year ended December 31, 2017, an increase of $1.8 million as compared to 2016.
Costs and expenses
Healthcare Services segment costs and expenses for the year ended December 31, 2017 were $340.9 million, a decrease of $4.2 million as compared to 2016. Reimbursable operating expenses included in costs and expenses were $7.5 million in 2017, a decrease of $1.0 million as compared to 2016. Excluding reimbursable operating expenses, costs and expenses were $333.4 million for 2017, a decrease of $3.2 million as compared to 2016. On this basis, the decrease in costs and expenses during 2017 was primarily due to lower staffing needs resulting from the previously announced client migrations, partially offset by increased restructuring charges and increased share-based compensation expense. We recorded $4.4 million of restructing charges in 2017, as compared to none in 2016.
Depreciation and amortization
Healthcare Services segment depreciation and amortization costs for the year ended December 31, 2017 were $10.5 million, a decrease of $5.1 million or 32.7% as compared to 2016. The decrease is attributable to lower capital expenditures and an intangible asset becoming fully amortized during 2017.

39


Operating income
Healthcare Services segment operating income for 2017 was $74.6 million, an increase of $0.6 million or 0.8% as compared to 2016. The slight increase in operating income was primarily attributable to organic growth and the expansion of the high-value services that we are offering to existing clients in both the medical and pharmacy businesses and decreases in depreciation and amortization. These increases were partially offset by the negative impact of client migrations, restructuring charges, and increased share-based compensation expenses.
Comparison of 2016 versus 2015 results
Operating revenues
Healthcare Services segment operating revenues of $426.2 million increased $49.8 million or 13.2% in 2016 as compared to 2015. The increase in operating revenues for the year ended December 31, 2016 was primarily from new medical claims processing clients implemented during 2016, organic growth and the expansion of high-value services we are offering to existing clients in both the medical and pharmacy businesses. Operating revenues included approximately $8.0 million of software license fee revenues for the year ended December 31, 2016, a decrease of $1.1 million as compared to 2015.
Costs and expenses
Healthcare Services segment costs and expenses for the year ended December 31, 2016 were $345.1 million, an increase of $23.8 million as compared to 2015. Reimbursable operating expenses included in costs and expenses were $8.5 million in 2016, an increase of $0.3 million as compared to 2015. Excluding reimbursable operating expenses, costs and expenses were $336.6 million for 2016, an increase of $23.5 million as compared to 2015. On this basis, the increase in costs and expenses during 2016 was primarily attributable to increased staffing costs incurred to support the higher medical transaction volumes due to the growth in BPO services. These costs and expenses were partially offset by restructuring costs that occurred during 2015 that did not recur during 2016 and a $2.4 million reduction of share-based compensation expense as certain PSUs were no longer expected to vest.
Depreciation and amortization
Healthcare Services segment depreciation and amortization costs for the year ended December 31, 2016 were $15.6 million, a decrease of $3.0 million or 16.1% as compared to 2015 primarily due to lower capital expenditures.
Operating income
Healthcare Services segment operating income for 2016 was $74.0 million, an increase of $29.3 million or 65.5% as compared to 2015. The increase in operating income was primarily attributable to higher revenues from organic growth and new medical claims processing clients implemented in 2016, resulting in enhanced economies of scale as clients were converted as well as a reduction of share-based compensation expense as certain PSUs were no longer expected to vest. These increases were partially offset by increased staffing costs incurred to support the higher medical transaction volumes due to the growth in BPO services.
LIQUIDITY AND CAPITAL RESOURCES
Company’s Assessment of Short-term and Long-term Liquidity
We believe that our existing cash balances and other current assets, together with cash provided by operating activities and, as necessary, our revolving credit facilities, are sufficient to meet our operating and debt service requirements and other current liabilities for at least the next 12 months. Further, we believe that our longer term liquidity and capital requirements will also be met through cash provided by operating activities, bank credit facilities and other investments.
At December 31, 2017, total cash and cash equivalents were $80.5 million, of which $46.0 million was held outside of the U.S. Although the amounts held outside the U.S. have been taxed through the Transition Tax, these amounts could be subject to other taxes such as withholding taxes and local taxes. We have accrued for withholding taxes and local taxes on the earnings of our international subsidiaries except when the earnings are considered indefinitely reinvested outside of the U.S. The repatriation of these earnings could result in additional withholding and local tax payments in future years. We utilize a variety of funding strategies in an effort to ensure that our worldwide cash is available in the locations in which it is needed.
At December 31, 2017, we had approximately $990.7 million of availability under our domestic revolving credit facilities, including our accounts receivable securitization program. Debt obligations, classified as long-term when originally issued, existing as of December 31, 2017 that are scheduled to mature in 2018 include $65.0 million of Series C 2010 Senior Notes that are scheduled to mature in August 2018 and $3.7 million of payments related to outstanding mortgages. We are scheduled

40


to issue $65.0 million of Series C 2017 Senior Notes in August 2018 which are expected to be utilized to repay the Series C 2010 Senior Notes.
We may need to access debt and equity markets in the future if unforeseen costs or opportunities arise, to fund acquisitions or investments or to repay indebtedness. If we need to obtain new debt or equity financing in the future, the terms and availability of such financing may be impacted by economic and financial market conditions as well as our financial condition and results of operations at the time we seek additional financing. We currently have $585.0 million of additional capacity pursuant to the master note purchase agreement dated November 14, 2017 that could be utilized for future debt issuances.
Sources and Uses of Cash
We had $80.5 million, $195.5 million and $79.5 million of cash and cash equivalents at December 31, 2017, 2016 and 2015, respectively. Our primary source of liquidity has historically been cash provided by operations. In addition, we have used proceeds from the sale of investments to fund other investing and financing activities. Principal uses of cash are operations, reinvestment in our proprietary technologies, capital expenditures, investment purchases, business acquisitions, payments on debt, stock repurchases and dividend payments. Additionally, we expect to incur significant transaction costs associated with the completion of the Merger. Information on our consolidated cash flows for the years ended December 31, 2017, 2016 and 2015 is presented in the Consolidated Statement of Cash Flows, categorized by operating activities, investing activities, and financing activities.
The sale of our North American Customer Communications business on July 1, 2016 and our U.K. Customer Communications business on May 4, 2017 resulted in cash consideration of approximately $410.7 million and $43.6 million, respectively, net of tax. The after-tax proceeds from the sales were used in accordance with the Company’s capital plan, including investments in the business, share repurchases, strategic acquisitions, debt repayments and other corporate purposes.
Operating Activities
Cash flows provided from continuing operating activities were $164.0 million during the year ended December 31, 2017. Operating cash flows from continuing operating activities during 2017 resulted principally from income from continuing operations of $447.6 million, adjusted for non-cash or non-operating items of $108.2 million including depreciation and amortization, equity in earnings of unconsolidated affiliates, net gains on investments and gains recognized on the step up of the carrying value of our previously held equity interests in unconsolidated affiliates as a result of the acquisitions of the remaining interests in BFDS and IFDS U.K., and a use of cash due to changes in operating assets and liabilities of $175.4 million. Significant changes in operating assets and liabilities include a $127.9 million use of cash related to other assets primarily due to up-front payments made to clients which are expected to be recovered over the clients’ contractual arrangements and higher prepaid software costs, a $39.9 million use of cash for accounts payable and accrued liabilities, and a $29.6 million use of cash related to deferred revenue and gains primarily as a result of the wealth management platform client termination.
Cash flows provided from continuing operating activities were $162.7 million for the year ended December 31, 2016. Operating cash flows from continuing operations during 2016 resulted principally from income from continuing operations of $178.1 million, adjusted for non-cash or non-operating items of $90.4 million including depreciation and amortization and equity in earnings from unconsolidated affiliates, and a use of cash due to changes in operating assets and liabilities of $105.8 million. Significant changes in operating assets and liabilities include a $26.9 million use of cash related to accrued compensation and benefits, a $16.6 million source of cash resulting from accounts payable and accrued liabilities, a $16.0 million use of cash related to accounts receivable, and a $67.9 million use of cash related to timing of income tax payments.
Cash flows provided from continuing operating activities were $135.7 million for the year ended December 31, 2015. Operating cash flows from continuing operating activities during 2015 resulted principally from income from continuing operations of $309.6 million, adjusted for non-cash or non-operating items of $110.3 million including depreciation and amortization, equity in earnings of unconsolidated affiliates and net gains on investments, and a use of cash due to changes in operating assets and liabilities of $63.6 million. Significant changes in operating assets and liabilities include a $10.6 million use of cash related to accounts receivable, and a $31.6 million use of cash related to timing of income tax payments.
Investing Activities
Cash flows used in continuing investing activities were $0.7 million for the year ended December 31, 2017. Sources of our cash inflows were net investment activities (proceeds from investment sales, net of investments in securities) of $39.8 million, fluctuations in funds held on behalf of clients of $43.3 million and distributions received from unconsolidated affiliates of $32.7 million, primarily from IFDS L.P in connection with the acquisition of the remaining interests in BFDS and IFDS U.K., offset by cash used to acquire IFDS U.K. (net of cash acquired) of $38.9 million and capital expenditures of $78.8 million.

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Cash flows used in continuing investing activities during 2016 of $117.3 million were primarily attributable to net investment activities (proceeds from investment sales, net of investments in securities) of $59.5 million, offset by cash used to acquire KRFS of $93.5 million, capital expenditures of $60.4 million, fluctuations in funds held on behalf of clients of $20.3 million, as well as approximately $28.0 million of cash loaned to IFDS U.K. during 2016.
Cash flows used in continuing investing activities were $102.4 million for the year ended December 31, 2015, primarily attributable to net investment activities (proceeds from investment sales, net of investments in securities) of $192.2 million, which includes $176.1 million of pretax proceeds from the sale of State Street stock. These sources of cash were offset by $117.4 million of cash used to acquire kasina LLC, Red Rocks Capital LLC and Wealth Management Systems, Inc. during 2015, $88.9 million used to purchase capital assets, as well as $113.5 million due to fluctuations in funds held on behalf of clients.
Capital Expenditures
The following table summarizes capital expenditures by segment (in millions):
 
Year Ended December 31,
 
2017
 
2016
 
2015
Domestic Financial Services segment
$
63.3

 
$
52.4

 
$
79.0

International Financial Services segment
8.8

 
2.6

 
3.8

Healthcare Services segment
6.7

 
5.4

 
6.1

 
$
78.8

 
$
60.4

 
$
88.9

During 2017, 2016 and 2015, we capitalized software development costs of $24.1 million, $21.5 million and $23.3 million, respectively, which are included within the capital expenditures listed above. Capital expenditures using debt are treated as non-cash transactions and are not included in the annual capital expenditure amounts above.
Financing Activities
Cash flows used in continuing financing activities totaled $317.4 million, $374.8 million and $278.7 million during the years ended December 31, 2017, 2016 and 2015, respectively.
Common Stock Issuances and Repurchases
We received cash proceeds of $2.8 million, $5.3 million and $11.8 million from the issuance of common stock from the exercise of employee stock options during the years ended December 31, 2017, 2016 and 2015, respectively. The value of shares received in exchange for satisfaction of the exercise price and for tax-withholding obligations arising from the exercise of options to purchase our stock or from the vesting of restricted shares are included in Common stock repurchased in the Consolidated Statement of Cash Flows. 
As of December 31, 2016, we had $150.0 million of capacity remaining under our share repurchase plan authorized in 2016. On May 9, 2017, our Board of Directors authorized a new $300.0 million share repurchase plan, which allows, but does not require, the repurchase of common stock in open market and private transactions. We repurchased the equivalent of 5.0 million shares of our common stock on a post stock split basis for $300.0 million during the year ended December 31, 2017, which left approximately $150.0 million remaining under our share repurchase plan authorized in 2017. The 2017 share repurchase plan does not have an expiration date, however we are currently precluded from executing additional stock repurchases pursuant to the Merger Agreement with SS&C. Under previous share repurchase plans, we expended $300.0 million for approximately 5.4 million shares on a post stock split basis and $400.0 million for approximately 7.2 million shares on a post stock split basis during the years ended December 31, 2016 and 2015, respectively.
Dividends
We paid cash dividends of $0.72, $0.66 and $0.60 per common share in 2017, 2016 and 2015, respectively. The total cash paid for dividends in 2017, 2016 and 2015 was $43.7 million, $43.4 million and $43.1 million, respectively. We are currently precluded from declaring dividends pursuant to the Merger Agreement with SS&C.

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Client Funds Obligations
Client funds obligations represent our contractual obligations to remit funds to satisfy client pharmacy claim obligations and are recorded on the balance sheet when incurred, generally after a claim has been processed by us. In addition, client funds obligations include transfer agency client balances invested overnight. Our contractual obligations to remit funds to satisfy client obligations are primarily sourced by funds held on behalf of clients. We had $504.2 million, $564.6 million and $533.4 million of client funds obligations at December 31, 2017, 2016 and 2015, respectively.
Debt Activity
During 2017, we had the following primary sources of debt financing: our syndicated revolving credit facility; accounts receivable securitization program; and privately placed senior notes (the “2010 Senior Notes” and “2017 Senior Notes”).  We had $620.8 million, $508.2 million and $562.1 million of debt outstanding at December 31, 2017, 2016 and 2015, respectively, an increase of $112.6 million during 2017 and a decrease of $53.9 million during 2016.
The increase in debt outstanding during 2017 resulted primarily from issuing $350.0 million of 2017 Senior Notes in November 2017, the assumption of a mortgage as a result of the acquisition of the remaining interests in IFDS U.K. and the assumption of a mortgage associated with a real estate distribution from Broadway Square Partners, partially offset by a reduction in amounts outstanding under our accounts receivable securitization program and revolving credit facilities. Proceeds from the 2017 Senior Notes were primarily used to pay down our revolving credit facilities. The decrease in debt outstanding during 2016 resulted primarily from the utilization of the proceeds from the sale of our North American Customer Communications business to pay down outstanding balances, partially offset by borrowings to fund the KRFS business acquisition, share repurchases and working capital uses.
Our debt agreements contain customary restrictive covenants, including limitations on consolidated indebtedness, liens, investments, subsidiary indebtedness, asset dispositions and require certain consolidated leverage and interest coverage ratios to be maintained. We are currently in compliance with these covenants. A default under certain of our borrowings could trigger defaults under certain of our other debt obligations, which in turn could result in their maturities being accelerated. Our debt arrangements are further described in Item 8, Financial Statements and Supplementary Data - Note 10, “Debt.”
Contractual Obligations and Commercial Commitments
The following table sets forth our contractual obligations and commercial commitments as of December 31, 2017 (in millions):
 
Payment Due by Period
 
Total
 
Less than
1 Year
 
1 - 3 Years
 
3 - 5 Years
 
More than
5 Years
Debt obligations
$
623.3

 
$
83.7

 
$
187.3

 
$
1.5

 
$
350.8

Operating lease obligations
104.0

 
23.8

 
35.5

 
27.2

 
17.5

Software license agreements
135.0

 
34.9

 
63.6

 
36.5

 

Other
39.2

 
18.9

 
15.8

 
4.5

 

 
$
901.5

 
$
161.3

 
$
302.2

 
$
69.7

 
$
368.3

Interest obligations on our outstanding debt are not included in the table above. The syndicated revolving credit facility contains grid schedules that adjust borrowing costs up or down based upon our consolidated leverage ratio. The grid schedules may result in fluctuations in borrowing costs ranging from 1.00% to 1.70% over Eurodollar and 0.00% to 0.70% over base rate, as defined. The 2010 Senior Notes outstanding have fixed interest rates and are comprised of $65.0 million of 5.06% Series C Senior Notes and $160.0 million of 5.42% Series D Senior Notes. The $350.0 million of 2017 Senior Notes outstanding have an average fixed interest rate of approximately 4.0%. In addition to the financial instruments listed above, the program fees incurred on proceeds from the sale of receivables under our accounts receivable securitization program are determined based on variable interest rates associated with LIBOR plus an applicable margin.
We have liabilities for income tax uncertainties of $67.7 million at December 31, 2017. These obligations are classified as non-current on our Consolidated Balance Sheet as resolution of these matters is expected to take more than a year; however, the ultimate timing of resolution is uncertain. As we are unable to make a reasonably reliable estimate as to when payments may occur for our unrecognized tax benefits, our liability for income tax uncertainties is not included in the table above.
Due to the enactment of the Tax Act, we recorded a provisional income tax payable related to the Transition Tax of $8.4 million, of which $7.3 million is reported as noncurrent as it is not expected to be paid within one year. As permitted by the Tax Act, the Transition Tax will be paid over an eight-year period, beginning in 2018, and will not accrue interest. This

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provisional amount, as well as the current estimated timing of payments, is subject to change based on additional guidance from and interpretations by U.S. regulatory and standard-setting bodies and changes in assumptions.
Other Commercial Commitments
In the normal course of business, to facilitate transactions of services and products and other business assets, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. At December 31, 2017, except for certain immaterial items, there were no liabilities for guarantees or indemnifications as it is not possible to determine either the maximum potential amount under these indemnification agreements or the timing of any such payments due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made under these agreements have not had a material impact on our consolidated financial position, results of operations or cash flows.
SS&C Merger Agreement
Under certain circumstances, we would be required to pay a termination fee of $165.0 million to SS&C in the event the Merger Agreement with SS&C is terminated.
Off-Balance Sheet Arrangements
An off-balance sheet arrangement is any transaction, agreement or other contractual arrangement involving an unconsolidated entity under which a company has (1) made guarantees, (2) a retained or a contingent interest in transferred assets, (3) an obligation under derivative instruments classified as equity, or (4) any obligation arising out of a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the company, or that engages in leasing, hedging or research and development arrangements with the company.
We believe that our guarantee arrangements will not have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, capital expenditures, capital resources, liquidity or results of operations. These arrangements are described above and in Item 8, Financial Statements and Supplementary Data - Note 16, “Commitments and Contingencies.”
Item 7A.    Quantitative and Qualitative Disclosures About Market Risk
The operation of our businesses and our financial results can be affected by changes in interest rates and currency exchange rates. Changes in interest rates and exchange rates have not materially impacted our consolidated financial position, results of operations or cash flows.
Interest rate risk
We derive service revenues from investment earnings related to cash balances maintained in bank accounts on which we are the agent for clients. The balances maintained in the bank accounts will fluctuate. For the year ended December 31, 2017, DST had average daily cash balances of approximately $2.0 billion maintained in such accounts. We estimate that a 100 basis point change in the short-term interest earnings rate would equal approximately $8.6 million of net income (loss).
At December 31, 2017, we had $620.8 million of debt, of which $14.9 million was subject to variable interest rates (LIBOR rates). We estimate that a 10% increase in interest rates would not have a significant impact to our consolidated pretax earnings or to the fair value of our debt.
The effect of changes in interest rates on our variable rate debt is mitigated by changes in interest rates attributable to balance earnings.
Foreign currency exchange rate risk
The operation of our subsidiaries in international markets results in our exposure to movements in currency exchange rates. The principal currencies involved are the British pound, Canadian dollar, Australian dollar, Thai baht and Indian rupee. Our international subsidiaries use the local currency as the functional currency. We translate our assets and liabilities at year-end exchange rates and translate income and expense accounts at average rates during the year. Currency exchange rate fluctuations have not historically significantly affected our consolidated financial results.

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At December 31, 2017, our international subsidiaries for our continuing operations had approximately $758.1 million in total assets and for the year ended December 31, 2017, these international subsidiaries recorded net income of approximately $70.4 million. We estimate that a 10% change in exchange rates would have changed total consolidated assets by approximately $75.8 million. Furthermore, a 10% change in exchange rates based upon historical earnings in international operations would have changed consolidated net income for 2017 by approximately $7.0 million.
We have entered into foreign currency cash flow and economic hedging programs to mitigate the impact of movements in foreign currency (principally British pound, Australian dollar, Thai baht and Indian rupee) on our operations. The total notional value of our foreign currency derivatives was $101.1 million at December 31, 2017. The fair value of the contracts that qualify for hedge accounting resulted in an asset of $0.2 million at December 31, 2017. We estimate that a 10% change in exchange rates would result in a $0.9 million change in other comprehensive income. The fair value of the contracts that do not qualify for hedge accounting resulted in a liability of $0.3 million at December 31, 2017. We estimate a 10% change in exchange rates on these contracts would result in a $4.8 million change to consolidated net income. Gains and losses on the derivative instruments are largely offset by changes in the underlying hedged items, resulting in a minimal impact on earnings.

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Item 8.        Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of DST Systems, Inc.:

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of DST Systems, Inc. and its subsidiaries as of December 31, 2017 and December 31, 2016, and the related consolidated statements of income, of comprehensive income, of changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2017, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and December 31, 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013)