SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

ý  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2005

or

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 1-14036

DST SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

(816) 435-1000

(Registrant’s telephone number, including area code)

No Changes

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý     No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes ý     No o

Number of shares outstanding of the Company’s common stock as of April 29, 2005:

Common Stock $0.01 par value — 83,457,923

DST Systems, Inc.

Form 10-Q

March 31, 2005

Table of Contents

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

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DST Systems, Inc.

Form 10-Q

March 31, 2005

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Introductory Comments

The Condensed Consolidated Financial Statements of DST Systems, Inc. (“DST” or the “Company”) included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission.  Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to enable a reasonable understanding of the information presented.  These Condensed Consolidated Financial Statements should be read in conjunction with the Company’s audited financial statements and the notes thereto for the year ended December 31, 2004.

The results of operations for the three months ended March 31, 2005, are not necessarily indicative of the results to be expected for the full year 2005.

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DST Systems, Inc.

Condensed Consolidated Balance Sheet

(dollars in millions, except per share amounts)

(unaudited)

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

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DST Systems, Inc.

Condensed Consolidated Statement of Income

(in millions, except per share amounts)

(unaudited)

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

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DST Systems, Inc.

Condensed Consolidated Statement of Cash Flows

(in millions)

(unaudited)

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

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DST Systems, Inc.

Notes to Condensed Consolidated Financial Statements

(unaudited)

1.  Summary of Accounting Policies

The Condensed Consolidated Financial Statements of DST Systems, Inc. (“DST” or the “Company”) included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission.  Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to enable a reasonable understanding of the information presented.  These Condensed Consolidated Financial Statements should be read in conjunction with the Company’s audited financial statements and the notes thereto including the Company's Annual Report of Form 10-K for the year ended December 31, 2004.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal interim closing procedures) necessary to present fairly the financial position of the Company and its subsidiaries at March 31, 2005, and the results of operations and cash flows for the three months ended March 31, 2005 and 2004.

Certain amounts in the prior year’s consolidated financial statements have been reclassified to conform to the current year presentation.

The results of operations for the three months ended March 31, 2005, are not necessarily indicative of the results to be expected for the full year 2005.

2.  Agreement to Sell EquiServe

The Company announced on October 20, 2004 that it has signed a definitive agreement for Computershare Ltd. (“CPU”) to acquire, in a taxable transaction, the Company’s wholly owned subsidiary, EquiServe, Inc. (“EquiServe”).  Upon closing, the Company will receive U.S. $216 million of cash plus 29.6 million shares of CPU common stock.  The CPU stock is traded on the Australian Stock Exchange (ASX: CPU).  The CPU common stock to be received represents slightly less than 5% of CPU’s total issued capital, post-transaction, and had a value of approximately U.S. $125 million on April 27, 2005.

Under terms of the agreement, the Company will continue to provide EquiServe various services, including data processing support, AWD products and services, Output Solutions services, E-Proxy services and lost instrument surety bond coverage.  The disposition does not qualify to be reported as a discontinued operation due to ongoing cash flows from the aforementioned agreements.  The Company recorded EquiServe operating revenues of $52.7 million and $54.3 million, and Out-of-Pocket (“OOP”) reimbursements of $18.1 million and $20.9 million, for the three months ended March 31, 2005 and 2004, respectively.  EquiServe is included in the Financial Services Segment.

The Company expects to record a one-time after-tax gain of approximately $57 million associated with the transaction.  The Company estimates that it will receive approximately $147 million of after-tax cash proceeds associated with the transaction that may be used to reduce debt or repurchase shares of DST common stock.  The estimated after-tax gain and after-tax cash proceeds will fluctuate based on changes in the value of the CPU common stock to be received at closing.  The value of the CPU stock will fluctuate from changes in price and changes in the U.S. and Australian foreign currency exchange rates.  The transaction is subject to approval from the Office of the Comptroller of Currency.  The Company believes the transaction will close during the second quarter of 2005.

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The following table summarizes the assets and liabilities of EquiServe, categorized as held for sale in the consolidated balance sheet (in millions).

3.  Acquisition of Health Plan Solutions

The Company announced on April 8, 2005 that one of its subsidiaries had entered into a definitive agreement with Computer Sciences Corporation (“CSC”) under which the subsidiary would acquire CSC’s Health Plan Solutions (“HPS”) business for 7.1 million shares of CSC common stock held by the DST subsidiary, and on April 29, 2005, DST’s subsidiary completed the acquisition of HPS.  The exchange value of the CSC shares at closing was $45.53 per share and HPS held $224.6 million of cash at the time of the exchange.

HPS is an enterprise software developer, software application services provider and business process outsourcer for the U.S. commercial healthcare industry and has been serving the healthcare industry since the 1960’s.  HPS has 270 clients and its proprietary systems are used to provide claims administration services for approximately 24 million covered lives.  HPS has approximately 700 employees and had revenues of $110 million for the year ended April 2, 2004 and $82 million for the nine months ended December 31, 2004.

The Company believes that the HPS business will expand its presence in the healthcare processing services industry, which currently uses DST’s AWD and Output Solutions products.  The Company expects to record net income of approximately $50 million from the exchange of the CSC shares.  The Company believes operations of HPS will be essentially neutral to DST’s diluted earnings per share in 2005 and accretive in 2006.  The actual impact on earnings per share will be dependent, among other factors, upon the finalization of the business combination accounting entries, which includes the allocation of approximately $85 million of value in excess of the net tangible assets of the HPS business to be received.

The transaction has been structured to meet the requirements for treatment as a tax-free reorganization in accordance with Section 355 of the Internal Revenue Code.  The Company has received two separate tax opinions at the “more likely” level of assurance that the transaction will comply with the provisions of Section 355.  The tax opinions are not binding on the IRS.  It is possible that the IRS could take a position contrary to the Company’s.  If the IRS were to take such a contrary position and ultimately prevail, then the Company could be required to recognize a gain on the exchange as if the Company sold the CSC shares at fair market value.  The Company estimates, that under those circumstances, it would recognize a tax gain of approximately $283 million and would incur federal and state tax liabilities of approximately $111 million.  Given the size and unique nature of the transaction, and the fact that the tax opinions of the Company’s tax advisors have not reached the “should” level of assurance, the Company, for financial accounting purposes, has provided a tax reserve for the potential tax.  The Company has provided an additional $32 million of tax provision in April 2005, which, when added to previously recorded amounts results in a $111 million accrual for the full amount of the potential tax.  The Company will accrue interest related to the potential tax, until such tax treatment is finally determined.

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4.  Investments

Investments are as follows (in millions):

The table above includes $0.8 million and $0.9 million of investments classified as Assets of business held for sale in the Consolidated Balance Sheet as of March 31, 2005 and December 31, 2004, respectively.

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

The Company has a cash management service for full service mutual fund transfer agency clients, whereby end of day available client bank balances are invested overnight by and in the name of the Company into credit-quality money market funds.  All invested balances are returned to the full service mutual fund transfer agency client accounts the following business day.  The Company has initiated a similar cash management service for a portion of its corporate securities processing transfer agency accounts.  The Company had $303.3 million and $75.2 million of transfer agency investments and deposits at March 31, 2005 and December 31, 2004, respectively.  These amounts include $233.0 million and $0 of transfer agency investments and deposits related to its corporate securities processing business as of March 31, 2005 and December 31, 2004, respectively, classified as Assets of business held for sale and Liabilities of business held for sale in the Consolidated Balance Sheet.

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The following table summarizes the fair value and gross unrealized losses of the Company’s investments by the length of time that the securities have been in a continuous loss position, at March 31, 2005 (in millions):

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

The Company recognized $0.4 million and $1.2 million of investment impairments for the three months ended March 31, 2005 and 2004, respectively, which the Company believed were other than temporary.  The impairments related primarily to investments available for sale in the Investments and Other Segment.  A decline in a security’s net realizable value that is other than temporary is treated as a loss based on quoted market value and is reflected in the Other income, net line in the statement of income.

The following table summarizes equity in earnings (losses) of unconsolidated affiliates net of income taxes (in millions):

5.  Goodwill, Intangibles and Other Assets

The following table summarizes intangible assets (in millions):

The table above includes $22.7 million and $23.0 million of intangible assets classified as Assets of business held for sale in the Consolidated Balance Sheet as of March 31, 2005 and December 31, 2004, respectively.

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Amortization of intangible assets for the quarter ended March 31, 2005 and 2004 was $1.9 million and $2.1 million, respectively.  Annual amortization amounts for intangible assets recorded as of March 31, 2005 are estimated at $7.7 million for each of the years 2005, 2006, and 2007, $7.3 million for 2008 and $7.0 million for 2009.  Substantially all of the intangibles are tax-deductible.

The following table summarizes the changes in the carrying amount of goodwill for the three months ended March 31, 2005, by Segment (in millions):

The table above includes $170.9 million of goodwill classified as Assets of business held for sale in the Consolidated Balance Sheet as of March 31, 2005 and December 31, 2004.

The August 2, 2002 acquisition of lock\line was accounted for as a purchase.  The minimum purchase price of $190 million was paid in cash at closing and was financed by debt.  There are provisions in the acquisition agreement that allow for additional consideration to be paid in cash if lock\line’s revenues, as defined in the acquisition agreement, exceed certain targeted levels for 2004.  Goodwill will be increased by the amount of additional consideration paid.

6.  Stockholders’ Equity

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

Shares from options to purchase shares of common stock that were excluded from the diluted earnings per share calculation because they were anti-dilutive totaled 2.4 million and 4.8 million for the three months ended March 31, 2005 and 2004, respectively.  The Company issued convertible senior debentures that if converted in the future would have a potentially dilutive effect on the Company’s stock.  The Series A debentures are convertible into 11.0 million

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shares of common stock and the Series B debentures are convertible into 6.1 million shares of common stock, subject to adjustment.  The Company intends to settle any conversions with cash for the principal and accrued and unpaid interest and issue common stock for any conversion value amount over the principal and accrued and unpaid interest amounts.  Related to the debentures, the calculation of diluted earnings per share would begin to include an incremental amount of shares assumed to be issued for the conversion spread if the Company’s stock price exceeds $49.08 per share.  There was no impact during the first quarter of 2005 because the Company’s average daily stock price for the quarter did not exceed $49.08.

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

Stock repurchases.  On October 19, 2004, DST’s Board of Directors authorized an additional 5.5 million share repurchase to the 6.0 million share repurchase plan authorized on February 26, 2004.  The plan allows, but does not require, the repurchase of common stock in open market and private transactions through February 28, 2007.  In the first quarter of 2005, 2.1 million shares were repurchased under the forward stock purchase agreement as explained below.  At March 31, 2005, the Company had purchased 7.8 million shares at an average price of $49.08 per share since the program commenced.  At March 31, 2005, the Company had approximately 3.7 million shares remaining to be purchased under this program.

During the fourth quarter 2004, the Company entered into a forward stock purchase agreement for the repurchase of its common stock as a means of securing potentially favorable prices for future purchases of its stock.  During 2004, 0.7 million shares were purchased by the Company under this agreement.  This agreement contained provisions which allowed the Company to elect a net cash or net share settlement in lieu of physical settlement of shares.  On January 3, 2005, the Company entered into a new forward stock purchase agreement that requires physical settlement of shares.  The shares held under the 2004 forward stock purchase agreement were assumed under the January 2005 forward stock purchase agreement.  As of March 31, 2005, 2.1 million shares of common stock have been purchased under the January 2005 agreement at an average price of $51.14 per share.  In connection with this agreement, the Company increased debt due within one year and increased stock under forward purchase agreement by $105.8 million.

Restricted Stock Grant.  On October 29, 2004, the Compensation Committee of the Board of Directors of the Company voted to grant as of November 10, 2004, approximately 2.8 million shares of restricted common stock of the Company to officers and certain other participants in the DST Systems, Inc. 1995 Stock Option and Performance Award Plan.  For ten senior executive officers, the restricted shares are subject to the earnings per share goal that must be met as an additional condition to the lapse of restrictions on January 31, 2010.  Subject to early lapsing and forfeiture provisions, the restrictions on the shares granted to all other officers and participants lapse on November 10, 2009.  The restricted stock grants cover the five-year period of 2005 through 2009 and are intended to be the only

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restricted stock grants for such periods other than for new hires or promotions, for special employee recognition purposes, and, in accordance with past practice, for the portion of each annual incentive bonus the executive officers are required to take in the form of equity compensation.  The Compensation Committee made the grant after evaluating the Company’s equity compensation practices, particularly in light of changes pending at the time of the grant in the accounting rules applicable to stock options.

The Company recorded a total of $137.1 million of unearned compensation in relation to the grant.  The impact of amortized compensation expense for the quarter ended March 31, 2005 was $6.4 million.  The Company estimates that the impact of amortized compensation expense attributable to the grant for each subsequent year covered by the grant, based upon the average of the high and low trading prices for the Company’s shares on November 10, 2004, will be approximately $27 million for the years 2005 through 2008 and $22.5 million in 2009.  These estimates assume that all shares will be vested and all performance criteria will be met.

Stock-based compensation.  The Company accounts for stock-based compensation in accordance with Accounting Principles Board Opinion (“APBO”) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations and has presented the required Statement of Financial Accounting Standards (“SFAS”) No. 123 “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” pro forma disclosure in the table below.

At March 31, 2005, the Company maintained a stock option plan which provides for the availability of 30,000,000 shares of the Company’s common stock for the grant of awards to officers, directors and other designated employees.  The awards may take the form of an option, stock appreciation right, limited right, performance share or unit, dividend equivalent, or any other right, interest or option relating to shares of common stock granted under the plan.  The option prices must be at least equal to the fair market value of the underlying shares on the date of grant.  Options become exercisable and expire as determined by the Compensation Committee of the Board of Directors at the date of grant.  The Company applies APBO No. 25 and related interpretations in accounting for its stock based compensation, and accordingly, no compensation cost has been recognized for the Company’s stock option awards under the plan.  Had compensation cost been determined consistent with SFAS No. 123, as amended by SFAS No. 148, the Company’s net income would have been reduced to the following pro forma amounts:

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The Company uses the Black-Scholes option pricing model which requires the Company to make certain assumptions in order to estimate fair value.

7.  Commitments and Contingencies

The Company has entered into an agreement to guarantee 50% of a construction loan of a 50% owned joint venture.  The construction loan expires in June 2005.  At March 31, 2005, there were no outstanding borrowings against the loan.

The Company has entered into an agreement to guarantee 49% of a $2.2 million mortgage loan of a 50% owned real estate joint venture.  The mortgage loan expires in August 2005.

The Company and DST Realty, Inc. have entered into an agreement to guarantee 50% of a $10.0 million line of credit loan for a 50% owned real estate joint venture.  The loan expires on June 17, 2006.  At March 31, 2005, total borrowings against the line of credit were $5.3 million.

The Company has entered into an agreement to guarantee, jointly and severally, and limited to $10.0 million related to a $60.0 million construction loan for a 50% owned real estate joint venture.  The $60.0 million loan expires on December 31, 2005.  At March 31, 2005, total borrowings on the loan were $33.6 million.

The Company is a 50% partner in a limited purpose real estate joint venture.  The real estate joint venture is developing approximately 1.1 million square feet of office space to be leased to the U.S. government.  The project is estimated to cost approximately $362 million and has been financed with $315 million of non-recourse insured bonds (issued June 2004) with the remainder in the form of equal equity contributions from the real estate joint venture partners.  At March 31, 2005, each partner had contributed half of the aggregate equity of $22.7 million.  The real estate joint venture partners have committed aggregate additional equity investments of approximately $23.9 million to complete the financing and up to $33.3 million of equity investments in the aggregate in the event of delays in construction or lease commencement.  The remaining equity contributions of $23.9 million to $57.1 million have been secured through $57.1 million of letters of credit that will expire beginning in 2007 through 2008.  The Company is responsible for $28.6 million of the letters of credit.  At March 31, 2005, there were no outstanding borrowings against the letters of credit.

The Company and State Street Corporation (“State Street”) have each guaranteed 50% of a lease obligation of International Financial Data Services, U.K. Limited (“IFDS U.K.”), which requires IFDS U.K. to make annual rent payments of approximately $3.8 million through 2017, for its use of a commercial office building.  The commercial office building is owned by a wholly owned affiliate of International Financial Data Services, (Canada) Limited (“IFDS Canada”) and was financed with a $19.5 million mortgage loan from a bank.  The loan has a floating interest rate based upon LIBOR and fully amortizes over the 15 year term.  To fix the rate of borrowing costs, the IFDS Canada affiliate entered into a 15 year interest rate hedge agreement with the same bank.  The interest rate hedge, which has an initial notional amount value of approximately $19.5 million and scheduled reductions that coincide with the scheduled principal payments for the mortgage loan, was entered into for the purpose of fixing the borrowing costs of the mortgage at approximately 6.3%.  The Company and State Street have each guaranteed 50% of the amounts of the interest rate hedge obligations.  Upon default, the Company would be required to pay 50% of the total amount to close out of the hedge, which is approximately $0.2 million at March 31, 2005.

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

The agreements generally provide that the Company or the other party has the option to establish a price payable in cash, or a promise to pay cash, for all of the other’s ownership in the joint venture and to submit an offer, in writing, to the other party to sell to the other party all of its ownership interests in the joint venture or to purchase all ownership interests owned by the other party at such offering price.  The party receiving the offer generally has a

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specified period of time to either accept the offer to purchase, or to elect to purchase the offering party’s stock at the offering price.  The Company cannot estimate the potential aggregate offering price that it could be required to receive or elect to pay in the event this option becomes operable, however the amount could be material.

FIN 45 Disclosures

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

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

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

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

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

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

The Company has entered into agreements with lenders providing financing to the Company pursuant to which the Company agrees to indemnify such lenders for third party claims arising from or relating to such financings.  In connection with real estate mortgage financing, the Company has entered into environmental indemnity agreements in which the Company has agreed to indemnify the lenders for any damage sustained by the lenders relating to any environmental contamination on the subject properties.

In connection with the acquisition or disposition of real estate by the Company, the Company has entered into real estate contracts containing indemnification provisions, the terms of which vary depending on the negotiated terms of

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

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

At March 31, 2005, the Company had not accrued any liability on the aforementioned guarantees or indemnifications as they relate to future performance criteria or indirect indebtedness of others in accordance with FIN 45.

FIN 46 Disclosures

In December 2003, the revised FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51” was issued, which requires the consolidation of certain types of entities in which the Company absorbs a majority of another entity’s expected losses, receives a majority of the other entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the other entity.  These entities are called “variable interest entities.”  The principal characteristics of variable interest entities are (1) an insufficient amount of equity to absorb the entity’s expected losses, (2) equity owners as a group are not able to make decisions about the entity’s activities, or (3) equity that does not absorb the entity’s losses or receive the entity’s residual returns.  “Variable interests” are contractual, ownership or other monetary interests in an entity that change with fluctuations in the entity’s net asset value.  As a result, variable interest entities can arise from items such as joint ventures, lease agreements, loan arrangements, guarantees or service contracts.

If an entity is determined to be a “variable interest entity,” the “primary beneficiary” must consolidate the entity.  The primary beneficiary is the holder of the variable interests that absorb a majority of the variable interest entity’s expected losses or receive a majority of the entity’s residual returns in the event no holder has a majority of the expected losses.  There is no primary beneficiary in cases where no single holder absorbs the majority of the expected losses or receives a majority of the residual returns.  The determination of the primary beneficiary is based on projected cash flows at the inception of the variable interests.

With regard to real estate, the Company is the lessee in a series of operating leases covering a large portion of its Kansas City based leased office facilities.  The lessors are generally joint ventures (in which the Company has a 50% ownership) that have been established specifically to purchase, finance and engage in leasing activities with the joint venture partners and unrelated third parties.  Two of the real estate joint ventures, which the Company entered into during 2001 and 2003, have entered into financing arrangements with the Company’s wholly owned captive insurance company.  In each case, the other joint venture partner has guaranteed at least 50% of the joint venture’s borrowings ($38.2 million at March 31, 2005) from the Company’s captive insurance company.  The Company is generally not the primary beneficiary of the joint ventures if the lease terms are consistent with market terms at the inception of the lease and do not include a residual value guarantee, fixed-price purchase options or similar features that disproportionately obligate it to absorb decreases in value or entitle it to participate in increases in the value of the real estate.  The Company’s analyses of its real estate joint ventures indicate that a large portion of the real estate joint ventures are variable interest

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entities, however the real estate joint ventures do not need to be consolidated because the Company is not the primary beneficiary.

With regard to operating joint ventures, the Company has formed or entered into operating joint ventures to enter into or expand its presence in target markets.  The Company has three significant operating joint ventures; BFDS; IFDS (includes IFDS U.K., IFDS Canada and International Financial Data Services, Luxembourg); and Argus.  Each of these operating joint ventures was formed prior to February 1, 2003.  The Company’s FIN 46 analyses of these operating joint ventures indicate that none qualify as variable interest entities due to meeting the criteria for the operating joint venture exception in FIN 46.  Accordingly, the Company does not consolidate the operating results of these operating joint ventures.

8.  Recently Issued Accounting Standards

In December 2004, the FASB issued its final standard on accounting for share-based payments, Statement of Financial Accounting Standards No. 123R (“SFAS No. 123R”) (revised 2004).  SFAS 123R requires that the compensation cost relating to share-based payment transactions be recognized in financial statements.  The cost will be measured based on the fair value of the instruments issued.  SFAS No. 123R covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans.  SFAS No. 123R replaces SFAS No. 123 and supersedes APB Opinion No. 25.  As originally issued in 1995, SFAS No. 123 established as preferable the fair value based method of accounting for share-based payment transactions with employees.  However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to financial statements disclosed what net income would have been had the fair value method been applied.  The Company will apply SFAS No. 123R effective January 1, 2006 and expects to use the modified prospective method to adopt the standard.  The Company is currently evaluating the impact of this new accounting standard.

There is a proposed accounting standard that involves an amendment to SFAS No. 128, “Earnings per Share” that would impact the way the Company treats the incremental shares to be issued from the assumed conversion of the $840 million of convertible debentures issued in August 2003 in calculating diluted earnings per share.  The proposed amendment, which is designed for convergence with international accounting standards, would require the use of the “if-converted” method from the date of issuance of the convertible debentures.  The proposed amendment would remove the ability of a company to support the presumption that the convertible securities will be satisfied in cash and not converted into shares of common stock.  Accordingly, the Company’s stated intention to settle the conversions with cash for the principal and accrued and unpaid interest and issue common stock for any conversion value amount over the principal and accrued and unpaid interest amounts would no longer be accepted under SFAS 128.  The proposed amendment to SFAS 128 is expected to be issued in the third quarter 2005, and would require retroactive restatement of a company’s diluted earnings per share calculations.  This would require the Company to restate its 2003, 2004 and 2005 diluted earnings per share calculations.  Under the proposed amended SFAS 128 “if converted” method, in calculating diluted earnings per share the Company would need to increase net income for the interest expense associated with the convertible debentures, net of tax, and increase the incremental shares assumed to be issued upon conversion to 17.1 million shares, the amount of shares that would be issued if all $840 million of convertible debentures would be converted to equity.  Under this method, diluted earnings per share would have been $0.56 for each of the quarters ended March 31, 2005 and 2004, as compared to the reported amounts of $0.61 and $0.60, respectively.

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

The estimated impact of this new accounting standard reflects the Company’s current views.  There may be material differences between these estimates and the actual impact of the standard.

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9.  Segment Information

The Company has several operating business units that offer sophisticated information processing and software services and products.  The Company has elected to organize and report on these business units as three operating Segments (Financial Services, Output Solutions and Customer Management).  In addition, investments in equity securities and certain financial interests and the Company’s real estate subsidiaries and affiliates have been aggregated into an Investments and Other Segment.

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

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

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

Earnings before interest and income taxes in the segment reporting information above less interest expense of $16.6 million and $13.5 million for the three months ended March 31, 2005 and 2004, respectively, is equal to the Company’s income before income taxes on a consolidated basis for the corresponding periods.

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The discussions set forth in this Quarterly Report on Form 10-Q contain statements concerning potential future events.  Such forward-looking statements are based upon assumptions by the Company’s management, as of the date of this Quarterly Report, including assumptions about risks and uncertainties faced by the Company.  In addition, management may make forward-looking statements orally or in other writings, including, but not limited to, in press releases, in the annual report to shareholders and in the Company’s other filings with the Securities and Exchange Commission (“SEC”).  Readers can identify these forward-looking statements by the use of such verbs as expects, anticipates, believes or similar verbs or conjugations of such verbs.  If any of management’s assumptions prove incorrect or should unanticipated circumstances arise, the Company’s actual results could materially differ from those anticipated by such forward-looking statements.  The differences could be caused by a number of factors or combination of factors including, but not limited to, those factors identified below in “Company-Specific Trends and Risks.”  Readers are strongly encouraged to consider the factors listed in such section and any amendments or modifications thereof when evaluating any forward-looking statements concerning the Company.  The Company’s reports filed with or furnished to the SEC on Form 8-K, Form 10-K, Form 10-Q and other forms and any amendments to those reports, may be obtained by contacting the SEC’s Public Reference Branch at 1-800-SEC-0330 or by accessing the forms electronically, free of charge, through the SEC’s Internet website at http://www.sec.gov or through the Company’s Internet website, as soon as reasonably practicable after filing with the SEC, at http://www.dstsystems.com.  The Company will not update any forward-looking statements in this Quarterly Report to reflect future events or developments.

The information contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto included in this Form 10-Q and the audited financial statements and notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

INTRODUCTION

The Company has several operating business units that offer sophisticated information processing and software services and products.  These business units are reported as three operating Segments (Financial Services, Output Solutions and Customer Management).  In addition, investments in equity securities and certain financial interests and the Company’s real estate subsidiaries and affiliates have been aggregated into an Investments and Other Segment.

Financial Services

The Company’s Financial Services Segment provides sophisticated information processing and computer software services and products primarily to mutual funds, investment managers, corporations, insurance companies, banks, brokers and financial planners.  The Segment also provides design, management and transaction processing services for customized consumer equipment maintenance and debt protection programs.

Output Solutions

The Company’s Output Solutions Segment provides single source, integrated print and electronic statement and billing output solutions.  The Segment also offers a variety of related professional services, including statement design and formatting, customer segmentation, and personalized messaging tools.  The Segment also provides electronic bill payment and presentment solutions and computer output archival solutions.

Customer Management

The Company’s Customer Management Segment provides customer management, billing and marketing solutions to the video/broadband, direct broadcast satellite, wire-line and Internet Protocol telephony, Internet and utility markets.

Investments and Other

The Company’s Investments and Other Segment holds investments in equity securities and certain financial interests and the Company’s real estate subsidiaries and affiliates.

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RESULTS OF OPERATIONS

The following table summarizes the Company’s operating results (dollars in millions, except per share amounts):