DST Systems net income slides in third quarter

Source: DST Systems

DST Systems, Inc. (NYSE:DST) reported consolidated net income attributable to DST ("DST Earnings") of $35.3 million ($0.76 per diluted share) for the third quarter 2011 compared to $54.3 million ($1.16 per diluted share) for the third quarter 2010.

DST Earnings for the nine months ended September 30, 2011 were $143.9 million ($3.07 per diluted share) compared to $225.2 million ($4.74 per diluted share) for the nine months ended September 30, 2010.

Taking into account certain non-GAAP adjustments explained herein, consolidated DST Earnings were $41.6 million ($0.90 per diluted share) for third quarter 2011 compared to $48.4 million ($1.03 per diluted share) for third quarter 2010, and $141.7 million ($3.02 per diluted share) for the nine months ended September 30, 2011 compared to $159.8 million ($3.36 per diluted share) for the nine months ended September 30, 2010.

Third quarter 2011 financial highlights, taking into account non-GAAP adjustments, were as follows:

* Consolidated operating revenues (excluding out-of-pocket reimbursements) increased $29.8 million or 7.4% to $433.1 million as compared to third quarter 2010. Financial Services operating revenues decreased $4.3 million or 1.5% resulting primarily from lower shareowner processing revenues which were partially offset by higher DST Global Solutions professional services revenues. Output Solutions operating revenues increased $33.1 million or 26.7% reflecting the positive impact of Innovative Output Solutions Limited's ("IOS") acquisition of dsicmm Group Limited ("dsicmm") in July 2010, DST's acquisition of Newkirk Products, Inc. ("Newkirk") in May 2011 and IOS's acquisition of Lateral Group Limited ("Lateral") in August 2011.
* Income from operations decreased $5.7 million or 8.3% compared to third quarter 2010.
o Financial Services income from operations decreased $4.9 million or 7.4% during the quarter to $61.1 million from lower operating revenues and higher costs associated with the development of new business initiatives, which were offset by a decrease of $9.1 million in deferred compensation costs (the effect of which is offset in other income).
o Output Solutions income from operations increased $100,000 during the h is offset in other income).
o Output Solutions income from operations increased $100,000 during the quarter to $1.9 million as increases in the North America operations were substantially offset by decreases in the United Kingdom operations.
o Investments and Other income from operations decreased $800,000 during the quarter to $1.7 million from recognition of charges related to the vacating of a leased office facility.
* Equity in earnings of unconsolidated affiliates decreased $4.6 million as declines in earnings at Boston Financial Data Services ("BFDS"), International Financial Data Services ("IFDS") and other unconsolidated affiliates were incurred.
* Other income decreased $8.0 million over the prior year quarter primarily from unrealized depreciation on trading securities (offsetting the reduction in deferred compensation expense in the Financial Services Segment).
* The Company's income tax rate was 29.4% for third quarter 2011 as compared to 35.2% in third quarter 2010. Income taxes during third quarter 2011 included an income tax benefit of approximately $2.5 million, or $0.05 per diluted share, associated with increased utilization of foreign credits.


Share-related and debt activity during third quarter 2011 was as follows:

* On September 20, 2011, DST's Board of Directors declared a cash dividend of $0.35 per share payable on November 4, 2011 to shareholders of record as of the close of business on October 14, 2011.
* The Company had 44.2 million shares of common stock outstanding at September 30, 2011. During third quarter 2011, the Company repurchased 2.4 million shares of DST common stock for $107.0 million or approximately $45.15 per share. An additional 130,000 shares of DST common stock were repurchased in late September 2011, which settled in early October 2011 for $5.9 million or $45.45 per share. After completion of these purchases, the Company had approximately 50,000 shares remaining under its existing share repurchase authorization.
* As noted in a separate announcement today, DST's Board of Directors increased its share repurchase authorization by 2.0 million shares. This additional share repurchase authorization will become effective January 1, 2012 and expire on December 31, 2013. When the new repurchase authorization is combined with remaining shares from the existing authorization, the Company will have approximately 2,050,000 shares available to repurchase. The Company expects to return capital to shareholders through additional share repurchases where excess cash is not needed to pay down debt or other obligations or to grow the Company's business organically or through acquisitions or strategic partnerships.
* Average diluted shares outstanding for third quarter 2011 were 46.4 million shares, a decrease of 800,000 shares, or 1.7%, from second quarter 2011 and a decrease of 500,000 shares, or 1.1% from third quarter 2010.
* Total stock options, restricted stock and restricted stock units ("equity units") outstanding at September 30, 2011 were 4.4 million, of which 3.5 million were stock options, 100,000 were restricted stock and 800,000 were restricted stock units. Equity units decreased 100,000 units or 2.2% from June 30, 2011 and 2.0 million units or 31.3% from September 30, 2010. The decrease in equity units from June 30, 2011 and September 30, 2010 results from the exercise and expiration of stock options, partially offset by new restricted stock unit grants. Approximately 10% of the outstanding stock options at September 30, 2011 are scheduled to expire during the fourth quarter 2011. The Company anticipates a minimal increase in shares outstanding during fourth quarter from the exercise of these options.
* During third quarter 2011, the Company repurchased $3.5 million of aggregate principal of the Series C senior convertible debentures for $3.8 million, resulting in a pretax loss of approximately $300,000. At September 30, 2011, the Company had approximately $86.5 million of Series C debentures outstanding.
* At September 30, 2011, the Company's total debt outstanding was $1,274.7 million, an increase of $110.6 million as compared to June 30, 2011, from the funding of previously announced acquisitions and the repurchase of DST common stock.


Business development activities

DST continued to make acquisitions in 2011 as part of its strategy to increase product capabilities and expand its presence in markets it currently serves and in adjacent markets.

During the third quarter 2011, DST completed the following acquisitions:

On August 5, 2011, DST's IOS subsidiary completed the acquisition of the outstanding stock of Lateral, a U.K. company engaged in integrated, data driven, multi-channel marketing. The acquisition of Lateral complements the existing IOS business in terms of services offered and business outlook. In addition, this acquisition allows IOS to extend and develop its service/product offerings by further integrating communications through print, data and e-solutions and by providing additional solutions such as data insight and online marketing to the IOS client base. IOS paid $41.7 million to acquire Lateral, which has approximately 440 employees and recorded $80.0 million of revenues during the year ended December 31, 2010.

On July 1, 2011, DST completed the acquisition of the assets of IntelliSource Healthcare Solutions ("IntelliSource"), whose principal product is CareConnect which provides an automated care management system. The addition of the IntelliSource suite of solutions broadens DST Health Solutions' (medical claims processing) product offering for integrated care management. IntelliSource is a wholly-owned subsidiary of DST Health Solutions and will be included in the Financial Services Segment.

ALPS Acquisition

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

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

* Open-end mutual funds
* Exchange traded funds
* Closed-end mutual funds
* Hedge funds


ALPS' fund servicing platform offers:

* Fund administration
* Tax administration
* Fund accounting
* Transfer agency
* Legal and compliance
* Creative services
* Medallion distribution
* Hedge fund administration


ALPS' asset gathering solutions include:

* Marketing and wholesaling services
* Closed-end fund IPO launch platform providing product sales, road show and marketing support


ALPS has approximately 340 employees and recorded $65.4 million of revenues for the nine months ended September 30, 2011. ALPS has demonstrated a strong track record of growth. Revenue growth for the year ended September 30, 2011 was 24.4%. DST expects the addition of ALPS to be accretive to earnings before taking into account anticipated synergies from the transaction. The Company now estimates that ALPS will contribute approximately $0.22 per share in 2012 on a GAAP basis, prior to synergies and costs associated with the transaction, compared to DST's prior estimate of $0.06 per share. The increase is the result of an updated estimate of the amortization of ALPS intangible assets. Excluding the net income effect of non-cash charges, DST projects ALPS to contribute approximately $0.31 per share in 2012.

Amortization expense recorded in third quarter 2011 from intangible assets (principally customer relationship assets and proprietary software) acquired in connection with 2011 business combinations was approximately $1.0 million comprised of $400,000 in Financial Services and $600,000 in Output Solutions. Amortization expense for fourth quarter 2011 from the full year 2011 acquisitions, including ALPS, is projected to be $2.2 million ($1.4 million in Financial Services and $800,000 in Output Solutions). For 2012, amortization expense from the full year 2011 acquisitions is projected to be $11.0 million ($8.0 million in Financial Services and $3.0 million in Output Solutions).

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