UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
		THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended March 31, 2006
		or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
		THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

Commission File Number 1-14036

 

DST SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware		43-1581814
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
333 West 11th Street, Kansas City, Missouri		64105
(Address of principal executive offices)		(Zip Code)

 

(816) 435-1000

(Registrant’s telephone number, including area code)

 

No Changes

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x     No o

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

                 Large accelerated filer x         Accelerated filer o         Non-accelerated filer o

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

Number of shares outstanding of the Company’s common stock as of April 30, 2006:
Common Stock $0.01 par value — 69,706,083

DST Systems, Inc.
Form 10-Q
March 31, 2006
Table of Contents

				Page(s)
PART I. FINANCIAL INFORMATION
Item 1.		Financial Statements (unaudited)
		Introductory Comments		3
		Condensed Consolidated Balance Sheet – March 31, 2006 and December 31, 2005		4
		Condensed Consolidated Statement of Income – Three Months Ended March 31, 2006 and 2005		5
		Condensed Consolidated Statement of Cash Flows – Three Months Ended March 31, 2006 and 2005		6
		Notes to Condensed Consolidated Financial Statements		7-22
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		23-39
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		39-40
Item 4.		Controls and Procedures		40
PART II. OTHER INFORMATION
Item 1.		Legal Proceedings		40
Item 1A.		Risk Factors		40
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		40-41
Item 3.		Defaults Upon Senior Securities		41
Item 4.		Submission of Matters to a Vote of Security Holders		41
Item 5.		Other Information		41
Item 6.		Exhibits		41
SIGNATURE				41

 

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

2

DST Systems, Inc.
Form 10-Q
March 31, 2006

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, 2005.

The results of operations for the three months ended March 31, 2006, are not necessarily indicative of the results to be expected for the full year 2006.

3

 DST Systems, Inc.
 Condensed Consolidated Balance Sheet
 (dollars in millions, except per share amounts)
(unaudited)

		March 31,			December 31,
		2006			2005
ASSETS
Current assets
Cash and cash equivalents		$	99.3		$	80.2
Transfer agency investments		69.4			93.3
Accounts receivable		360.6			386.2
Deferred income taxes		33.6			32.9
Other assets		47.6			48.9
Assets of businesses held for sale					118.9
		610.5			760.4
Investments		1,702.7			1,405.2
Properties		499.1			492.4
Goodwill		75.2			75.1
Intangibles		18.8			18.9
Other assets		75.6			90.8
Assets of business held for sale					186.7
Total assets		$	2,981.9		$	3,029.5
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Debt due within one year		$	861.2		$	863.1
Transfer agency deposits		69.4			93.3
Accounts payable		94.8			97.6
Accrued compensation and benefits		64.3			90.2
Deferred revenues and gains		69.5			69.4
Other liabilities		157.4			160.3
Income taxes payable		153.2			137.7
Liabilities of businesses held for sale					110.7
		1,469.8			1,622.3
Long-term debt		548.0			541.4
Deferred income taxes		385.5			318.0
Other liabilities		57.2			52.1
		2,460.5			2,533.8
Commitments and contingencies (Note 9)
Stockholders’ equity
Common stock, $0.01 par; 400 million shares authorized, 95.3 million shares issued		1.0			1.0
Additional paid-in capital		112.2			209.8
Retained earnings		1,243.7			1,162.0
Unearned Compensation					(106.8		)
Treasury stock (25.8 million and 23.6 million shares, respectively), at cost		(1,273.4		)	(1,148.2		)
Accumulated other comprehensive income		437.9			377.9
Total stockholders’ equity		521.4			495.7
Total liabilities and stockholders’ equity		$	2,981.9		$	3,029.5

 

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

4

DST Systems, Inc.
Condensed Consolidated Statement of Income
(in millions, except per share amounts)
(unaudited)

		For the Three Months
		Ended March 31,
		2006			2005
Operating revenues		$	382.7		$	437.1
Out-of-pocket reimbursements		193.3			191.2
Total revenues		576.0			628.3
Costs and expenses		477.3			515.7
Depreciation and amortization		29.3			35.8
Income from operations		69.4			76.8
Interest expense		(29.5		)	(16.6		)
Other income, net		24.5			7.7
Gains on sale of businesses		52.8
Equity in earnings of unconsolidated affiliates		16.1			7.9
Income before income taxes		133.3			75.8
Income taxes		51.6			26.6
Net income		$	81.7		$	49.2
Average common shares outstanding		67.9			78.4
Diluted shares outstanding		73.4			80.9
Basic earnings per share		$	1.20		$	0.63
Diluted earnings per share		$	1.11		$	0.61

 

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

5

DST Systems, Inc.
 Condensed Consolidated Statement of Cash Flows
(in millions)
(unaudited)

		For the three Months
		Ended March 31,
		2006			2005
Cash flows — operating activities:
Net income		$	81.7		$	49.2
Depreciation and amortization		29.3			35.8
Equity in earnings of unconsolidated affiliates		(16.1		)	(7.9		)
Net realized gain on investments		(16.1		)	(1.0		)
Gains on sale of businesses and properties		(52.8		)
Share-based compensation expense		6.3			6.4
Amortization of debt issuance costs		12.7			0.9
Deferred income taxes		23.8			9.6
Cash dividend from unconsolidated affiliates		25.1
Changes in accounts receivable		26.2			44.7
Changes in other assets		5.4			(20.8		)
Changes in transfer agency investments		23.9			(228.0		)
Changes in transfer agency deposits		(23.9		)	228.0
Changes in accounts payable and accrued liabilities		(2.7		)	(9.7		)
Changes in income taxes payable		19.8
Changes in deferred revenues and gains		(0.1		)	31.8
Changes in accrued compensation and benefits		(22.1		)	(30.0		)
Other, net		6.2			3.1
Total adjustments to net income		44.9			62.9
Net		126.6			112.1
Cash flows — investing activities:
Capital expenditures		(35.4		)	(33.8		)
Proceeds from sale of investments		97.4			3.2
Investments in securities		(23.9		)	(7.7		)
Investments in and advances to unconsolidated affiliates		(10.7		)	(0.7		)
Other, net		(0.8		)
Net		26.6			(39.0		)
Cash flows — financing activities:
Proceeds from issuance of common stock		21.7			7.0
Principal payments on long-term debt		(22.6		)	(27.5		)
Net increase (decrease) in revolving credit facilities		16.0			(47.8		)
Common stock repurchased		(153.0		)	(1.6		)
Excess tax benefits from share based compensation		3.8
Net		(134.1		)	(69.9		)
Net increase in cash and cash equivalents		19.1			3.2
Cash and cash equivalents at beginning of period		80.2			96.6
Cash and cash equivalents at end of period		$	99.3		$	99.8

 

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

6

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 (“GAAP”) have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to enable a reasonable understanding of the information presented. The Condensed Consolidated Balance Sheet as of December 31, 2005 has been derived from the audited Consolidated Balance Sheet at that date, but does not include all of the information and notes required by GAAP for complete financial statements. These Condensed Consolidated Financial Statements should be read in conjunction with the Company’s audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

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, 2006, and the results of operations for the three months ended March 31, 2006 and 2005, and cash flows for the three months ended March 31, 2006 and 2005.

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, 2006, are not necessarily indicative of the results to be expected for the full year 2006.

2. Merger of lock\line with Asurion

On January 1, 2006, the Company completed the transaction to merge its DST lock\line, Inc. subsidiary (“lock\line”) into a wholly-owned subsidiary of Asurion Corporation (“Asurion”), a privately held company with principal operations in Nashville, Tennessee.

The merger was structured as a tax free reorganization, and resulted in the Company acquiring a 37.4% ownership interest in Asurion. The Company received no cash proceeds in connection with the merger. Effective January 1, 2006, the Company began recording 37.4% of Asurion’s net income as equity in earnings of unconsolidated affiliates. For financial accounting purposes, the Company has treated the merger as both a sale of lock\line and a corresponding purchase of a 37.4% interest in Asurion. For financial accounting purposes, the sale portion of the transaction resulted in a net pre-tax gain of $52.8 million which has been included in gains on sale of businesses in DST’s consolidated statement of income during the first quarter 2006. The pre-tax gain has been calculated using an estimated fair market value for lock\line of $287 million and has been reduced by a required gain deferral of $31.6 million that results from the Company’s 37.4% ownership in the merged entity. Approximately $12.5 million of the deferred gain will be amortized primarily over a 15 year life, while the residual will be deferred indefinitely. For financial accounting purposes the purchase portion of the acquired interest in Asurion exceeded DST’s pro-rata portion of Asurion’s stockholders’ equity by $174.8 million. As a result, the Company has performed a preliminary allocation of the excess purchase price and has currently allocated approximately $44.6 million to certain identifiable intangibles (net of deferred taxes) that will be amortized primarily over a 15 year life. The remaining excess purchase price has been allocated to goodwill, which is included in the Company’s investment in Asurion, and will not be subject to amortization, but rather on-going impairment tests. The Company estimates that for 2006, the deferred gain amortization will increase equity in earnings of Asurion by approximately $1.0 million while the amortization of identifiable intangibles will reduce equity in earnings of Asurion by approximately $3.8 million.

7

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Asurion accounted for the merger as a purchase of lock\line. Asurion has performed a purchase price allocation for lock\line using an estimated fair market value of $287 million. The purchase price exceeded the net tangible assets of lock\line by approximately $260 million, of which Asurion has preliminarily allocated approximately $100 million to certain identifiable intangibles that will be amortized primarily over a 15 year life. The residual has been allocated to goodwill and will not be subject to amortization, but rather on-going impairment tests. The Company estimates that the 2006 after-tax impact of Asurion amortizing the identifiable intangibles will be approximately $4.8 million, of which DST’s 37.4% pro-rata portion would result in a $1.8 million reduction in equity in earnings of Asurion due to the amortization.

The calculation of DST’s equity in earnings of Asurion for the quarter ended March 31, 2006 is as follows:

 

 

For diluted earnings per share purposes, DST’s equity in earnings of Asurion is calculated using a 35.5% pro-rata share based on Asurion’s fully diluted shares outstanding.

lock\line related operating revenues for the three months ended March 31, 2005 and the year ended December 31, 2005 were $35.4 million and $164.8 million, respectively. Because of the significant continuing involvement as an equity method investment of the Company, the merger of lock\line does not qualify as a discontinued operation.

Asurion provides services related to warranty management, device protection, roadside assistance and enterprise managed mobility solutions for technology firms in the U.S., Canada and Asia. Asurion had approximately 4,500 employees at March 31, 2006.

At December 31, 2005, the assets and liabilities of lock\line have been categorized as assets and liabilities held for sale in the consolidated balance sheet.

3. Share-Based Compensation

The Company has a share-based compensation plan covering its employees and a share-based compensation plan covering its non-employee directors and has outstanding share awards (primarily in the form of stock options and restricted stock) under each of these plans. Both of these share-based compensation plans have been approved by the Company’s Board of Directors. The DST  Systems,  Inc. 2005  Equity Incentive Plan (the “Employee Plan”) and the DST Systems, Inc. 2005 Non-Employee Directors’  Award  Plan  (the  “Directors’  Plan”) became effective on May 10, 2005. The term of both the Employee Plan and the Directors’ Plan is from May 10, 2005 through May 9, 2015.

8

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The Employee Plan amends, restates and renames the DST Systems, Inc. 1995 Stock Option and Performance Award Plan (“1995 Plan”). The number of shares of common stock reserved for delivery under the Employee Plan is the sum of (a) 4.0 million shares, plus (b) the number of shares remaining under the 1995 Plan (originally 30 million shares available) as of May 10, 2005 (not subject to outstanding Awards under the 1995 Plan and not delivered out of the Shares reserved thereunder), plus (c) shares that become available under the 1995 Plan after May 10, 2005 pursuant to forfeiture, termination, lapse or satisfaction of an award in cash or property other than shares of common  stock,  application  as payment for an award, or, except with respect to restricted  stock, to satisfy tax withholding, plus (d) any shares of common stock required to satisfy substitute awards. The Employee Plan provides for the availability of shares of the Company’s common stock for the grant of awards to employees, prospective employees and consultants to the Company or an affiliate. Awards under the Employee Plan may take the form of shares, dividend equivalents, options, stock appreciation rights, limited stock appreciation rights, performance units, restricted stock, restricted stock units, deferred stock, annual incentive awards, service awards and substitute awards (each as defined in the plan).

The Directors’ Plan will replace the component of the 1995 Plan that provided for equity awards to directors who are not employees of DST or any affiliate (“Non-Employee Directors”). Subject to adjustment,  as provided in the  Directors’  Plan, the number of shares of common stock  reserved  for delivery under this plan is the sum of (a) 0.3 million shares plus (b) any shares of common stock required to satisfy “substitute awards”, as defined in the Directors’ Plan. The Directors’ Plan provides for the availability of shares of the Company’s common stock for awards to non-employee members of the Company’s board of directors. Awards under the Directors’ Plan may take the form of shares, dividend equivalents, options, restricted stock, restricted stock units, deferred stock and substitute awards (each as defined in the plan).

Prior to January 1, 2006, the Company accounted for stock-based compensation utilizing the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees” and related Interpretations. Accordingly, no compensation expense was recognized for fixed option plans because the exercise prices of employee stock options equaled or exceeded the market prices of the underlying stock on the dates of grant. However, share-based compensation has been included in pro forma disclosures in the financial statement notes in prior periods as required under FAS 123. For restricted stock awards granted prior to January 1, 2006, the Company expensed the grant date fair value of these awards using the straight-line method over the service period.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards 123R, “Share-Based Payment” (“SFAS 123R”), using the modified prospective application transition method. Among other items, SFAS 123R eliminates the use of APB 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements.

Under the modified prospective application method, the historical financial statements of the Company have not been adjusted. Instead, SFAS 123R has been applied to new awards granted by the Company after January 1, 2006 and any portion of awards that were not fully vested on January 1, 2006. At January 1, 2006, the Company had unvested stock option awards with remaining unvested grant date fair value of approximately $800,000. These stock option awards will be substantially vested at December 31, 2006 and, accordingly, the remaining unvested grant date fair value will be recorded in costs and expenses evenly throughout 2006. Upon adoption of SFAS 123R, the Company discontinued its historical accounting practice of recognizing forfeitures when they occurred and now estimates compensation costs related to awards that are not expected to vest. In measuring compensation costs for outstanding restricted stock awards, the Company determined that the adjustment to record estimated forfeitures as of January 1, 2006 was $1.4 million. This amount has been included as a reduction to costs and expenses during the three months ended March 31, 2006.

9

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The following table illustrates the effect on net income and earnings per share, for the prior year quarter, if the Company had applied the fair value recognition provisions of SFAS 123 to share-based employee compensation related to all awards (in millions, except per share amounts):

				For the Three Months Ended March 31, 2005
Net income:		As reported		$	49.2
Stock-based employee compensation cost, net of related tax effects, included in the determination of net income as reported				4.1
Stock-based employee compensation cost, net of related tax effects, that would have been included in the determination of net income if the fair value based method had been applied to all awards				(5.1		)
Net Income		Pro forma		$	48.2
Basic earnings per share:		As reported		$	0.63
		Pro forma		$	0.62
Diluted earnings per share:		As reported		$	0.61
		Pro forma		$	0.61

 

The Company did not issue any stock option awards during the three months ended March 31, 2006 or the year ended December 31, 2005. The fair value of historical option grants, which generally had a ten year contractual life, was estimated on the date of grant using the Black-Scholes option pricing model. Prior to the adoption of SFAS 123R, the Company presented the benefit of all tax deductions resulting from the exercise of stock options and restricted stock awards as operating cash flows in the Consolidated Statement of Cash Flows. SFAS 123R requires the benefits of tax deductions in excess of grant-date fair value be reported as a financing cash flow, rather than as an operating cash flow. Excess tax benefits of $3.8 million were classified as a financing inflow during the three months ended March 31, 2006. Cash proceeds from options exercised for the three months ended March 31, 2006 and 2005 were $21.7 million and $7.0 million, respectively. The Company generally issues shares out of treasury to satisfy stock option exercises.

Summary stock option activity is presented in the table below (shares in millions):

 

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. Subject to early lapsing and forfeiture provisions, the restrictions on shares granted to participants lapse on November 10, 2009 and January 31, 2010. The restricted stock grants cover the five-year period of 2005 through 2009 and are intended to be the only restricted stock grants for such periods other than for new hires or promotions and for special employee recognition purposes. The restrictions on shares granted after November

10

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2004 also lapse on November 10, 2009. Grants of restricted stock are valued at the date of grant and expensed using the straight-line method over the service period. Unvested shares of restricted stock may be forfeited upon termination of employment with the Company depending on the circumstances of the termination. Except for restrictions placed on the transferability of the restricted stock, holders of restricted stock have full stockholders rights during the term of restriction, including voting rights and the right to receive cash dividends, if any.

Summary restricted stock activity is presented in the table below (shares in millions):

 

The fair value of vested restricted stock awards during the three months ended March 31, 2006 was $4.9 million. At March 31, 2006, the Company had $83.3 million of total unrecognized compensation expense related to restricted shares, net of estimated forfeitures. The impact of amortized compensation expense for the three months ended March 31, 2006 was $7.4 million, net of the Company’s accrual for estimated forfeitures. This amount includes $1.7 million from accelerated vesting of restricted stock awarded to lock\line employees resulting from the merger with Asurion. The Company estimates that the amortized compensation expense attributable to the grants will be approximately $17.1 million for the remainder of 2006, $22.8 million for each of the years 2007 and 2008, $20.1 million for 2009 and $0.5 million for 2010. In accordance with SFAS 123R, unearned compensation on January 1, 2006 was combined into additional paid-in capital upon adoption of this standard.

11

4. Investments

Investments are as follows (in millions):

		2006		Carrying Value
		Ownership		March 31,			December 31,
		Percentage		2006			2005
Available-for-sale securities:
State Street Corporation		3%		$	683.5		$	709.2
Computershare Ltd.		5%		156.1			147.3
Euronet Worldwide, Inc.		5%		71.3			52.4
Other available-for-sale securities				203.2			179.8
				1,114.1			1,088.7
Unconsolidated affiliates:
Asurion Corporation		37%		263.2
Boston Financial Data Services, Inc.		50%		99.9			118.3
International Financial Data Services, U.K.		50%		37.4			38.4
International Financial Data Services, Canada		50%		12.3			8.0
Argus Health Systems		50%		10.1			9.1
Unconsolidated Real Estate Affiliates				109.7			93.6
Other unconsolidated affiliates				12.3			12.3
				544.9			279.7
Other:
Trading securities				36.2			29.7
Held-to-maturity				7.5			7.8
				43.7			37.5
Total investments				$	1,702.7		$	1,405.9

 

The table above includes $700,000 of investments classified as Assets of businesses held for sale in the consolidated balance sheet as of December 31, 2005. During the three months ended March 31, 2006, the Company sold approximately 1.5 million shares of State Street Corporation (“State Street”) which resulted in gains on sales of securities of $15.9 million and cash proceeds of $89.9 million. The Company continues to hold approximately 11.3 million shares of State Street Corporation and has no current intention to further reduce its holdings.

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

 

12

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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 had $69.4 million and $93.3 million of transfer agency investments and deposits at March 31, 2006 and December 31, 2005, respectively.

During the three months ended March 31, 2006 and 2005, the Company received $97.4 million and $3.2 million, respectively, from the sale of investments in available-for-sale securities. Gross realized gains of $16.3 million and $1.4 million and gross losses of $200,000 and $400,000 were recorded during the three months ended March 31, 2006 and 2005, respectively, from available-for-sale securities.

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, as of March 31, 2006 (in millions):

		Less than 12 months						Greater than 12 months						Total
					Unrealized						Unrealized						Unrealized
		Fair Value			losses			Fair Value			losses			Fair Value			losses
Common Stock		$	24.4		$	1.4		$			$			$	24.4		$	1.4

 

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. These 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 $400,000 of investment impairments for the three months ended March 31, 2005, which the Company believed were other than temporary. No such impairments were recorded during the three months ended March 31, 2006. The impairments recorded during the three months ended March 31, 2005 related to available for sale investments 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 or derived 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):

13

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5. Goodwill, Intangibles and Other Assets

The following table summarizes intangible assets (in millions):

 

The table above includes $85.6 million of net intangible assets classified as Assets of business held for sale in the consolidated balance sheet as of December 31, 2005.

Amortization of intangible assets for the three months ended March 31, 2006 and 2005 was approximately $600,000 and $1.9 million, respectively. Annual amortization amounts for intangible assets recorded as of March 31, 2006 are estimated at $2.2 million for each of 2006 and 2007, $2.1 million for 2008, $2.0 million for each of 2009 and 2010, and $1.7 million for 2011.

The following table summarizes the changes in the carrying amount of goodwill for the three months ended March 31, 2006, by segment (in millions):

		December 31,												March 31,
		2005			Acquisitions			Disposals			Other			2006
Financial Services		$	152.8					$	(86.9	)	$	0.1		$	66.0
Output Solutions		9.2												9.2
Investments and Other
Total		$	162.0		$			$	(86.9	)	$	0.1		$	75.2

 

The table above includes $86.9 million of goodwill classified as Assets of business held for sale in the consolidated balance sheet as of December 31, 2005.

6. Debt

Syndicated Line of Credit Amendment

The Company amended its revolving $600 million syndicated line of credit facility during the three months ended March 31, 2006. The amendment (i)  subject to certain conditions,  allows the Company to request  an  increase  of up to $600 million  in the aggregate revolving commitment, and (ii) clarifies that the Company is allowed to use cash and/or the Company’s stock to settle both the  principal and accrued  interest  portion of the Company’s Series  A  and  B  convertible  senior  debentures  (upon  conversion  or otherwise) and use the Company’s stock to settle any conversion  premium  payable upon any conversion of the Company’s Series A and B convertible senior debentures.

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BFDS Promissory Note

The Company entered into a promissory note with Boston Financial Data Services, Inc. (“BFDS”) on March 1, 2006. The agreement provides for unsecured revolving borrowings by the Company of up to $50 million and matures on July 1, 2010. From time to time, BFDS may, subject to a ten day notice period, demand a prepayment of the loan by the Company in an amount not to exceed $25 million in each instance. The interest rate applicable to the loan is based on the British Bankers Association LIBOR rate plus an applicable margin correlating to the applicable margin under the Company’s $600 million syndicated line of credit facility. The loan agreement incorporates by reference and requires the Company to comply with the affirmative and negative covenants contained in the Company’s $600 million syndicated line of credit facility. There were no amounts borrowed under this loan agreement at March 31, 2006.

Senior Convertible Debentures

Holders of the Company’s $840 million senior convertible debentures were eligible to convert these bonds during the three months ended March 31, 2006 as a result of DST’s common stock trading above 120% of the applicable conversion price ($49.08) for at least 20 trading days during the period of 30 consecutive trading days ended December 30, 2005. Because 100% of the outstanding debentures could have been converted during the three months ended March 31, 2006, and in accordance with GAAP, the Company amortized the remaining net book value of its debenture issuance costs, in the amount of $12.7 million, during the three months ended March 31, 2006. These debt issuance costs were included in other non-current assets at December 31, 2005. This non-cash charge has been included in interest expense. The right to convert these bonds is not effective for the three months ending June 30, 2006 due to the conversion feature hurdle not being met at the end of the three months ended March 31, 2006. Conversion rights for subsequent quarters will be a function of future DST stock prices.

Equipment Promissory Note

During the three months ended March 31, 2006, DST purchased $10.7 million of computer equipment with a promissory note. Principal and interest are payable monthly at a fixed interest rate of approximately 4.5% per year. The note matures on February 1, 2009. The note is secured by the equipment.

7. Income Taxes

In general, the Company provides income taxes during interim periods based on its best estimate of the full year’s effective tax rate. Certain items, however, are given discrete period treatment and, as a result, the tax effects of such items are reported in full in the relevant interim period. The Company’s effective tax rate was 38.7% for the three months ended March 31, 2006 compared to 35.1% for the three months ended March 31, 2005. Excluding the effects of discrete period items, the Company estimates its recurring effective tax rate for the remainder of 2006 will be 36.3%. The effective tax rates for 2006 are higher principally due to higher effective tax rates relating to the lock\line merger with Asurion (see Note 2). The full year 2006 effective tax rate can be affected as a result of variances among the estimates and amounts of full year sources of taxable income (e.g. domestic consolidated, joint venture and/or international), the realization of tax credits (e.g. historic rehabilitation, research and experimental and state incentive) and adjustments which may arise from the resolution of tax matters under review.

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8. Stockholders’ Equity

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

		For the Three Months
		Ended March 31,
		2006			2005
Net income		81.7			49.2
Dilutive securities at unconsolidated affiliates		(0.3		)
Net income for dilutive computation		$	81.4		$	49.2
Average common shares outstanding (excluding restricted stock)		67.9			78.4
Incremental shares from assumed conversions of stock options, vesting of stock based compensation and debenture conversion		5.5			2.5
Diluted potential common shares		73.4			80.9
Basic earnings per share		$	1.20		$	0.63
Diluted earnings per share		$	1.11		$	0.61

 

The Company had approximately 69.6 million and 83.4 million shares outstanding at March 31, 2006 and 2005, respectively. For financial reporting purposes, however, unvested restricted shares in the amount of 2.5 million and 2.8 million at March 31, 2006 and 2005, respectively, are excluded from the determination of average common shares outstanding used in the calculation of basic earnings per share in the above table. Shares from options to purchase common stock that were excluded from the diluted earnings per share calculation because they were anti-dilutive totaled 900,000 and 2.4 million for the three months ended March 31, 2006 and 2005, respectively. The Company has 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 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. For the three months ended March 31, 2006, there was additional dilution of approximately 2.6 million shares related to the Company’s average daily share price exceeding $49.08 during the quarter.

Stock repurchases

The Company repurchased approximately 2.5 million shares of DST common stock for $144.5 million or $57.29 per share during the three months ended March 31, 2006. Cash proceeds from the State Street stock sale and from stock option exercises and cash flow from operations were used to repurchase these shares. At March 31, 2006, 2.8 million shares remained under the existing share repurchase authorization.

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

 

9. Commitments and Contingencies

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

The Company has entered into an agreement to guarantee 50% of a construction loan of a 50% owned joint venture. The construction loan becomes due and the Company’s guarantee thereof expires in June 2008 and allows for borrowings up to $2.6 million. At March 31, 2006, total borrowings against the loan were $100,000.

The Company has entered into an agreement to guarantee 50% of a $10.0 million line of credit for a 50% owned real estate joint venture. The line of credit becomes due and the Company’s guarantee thereof expires on June 17, 2006. At March 31, 2006, total borrowings against the line of credit were $6.3 million.

The Company entered into an agreement to guarantee 10% of any amounts between $10.0 million and $20.0 million, and 20% of any amounts thereafter, related to a $48.2 million construction loan to a 50% owned real estate joint venture. The $48.2 million loan matures on the earlier of the completion of the project or December 31, 2007. At March 31, 2006, total borrowings on the loan were $21.7 million, resulting in a guarantee of $1.3 million by the Company.

The Company and a wholly owned subsidiary of the Company have entered into an agreement to guarantee $1.0 million (which, in the event a certain debt service coverage ratio requirement is not met, will increase to $2.0 million) plus any enforcement costs related to a $32.0 million mortgage loan to a 33% owned real estate joint venture. The $32.0 million loan matures on July 1, 2010. At March 31, 2006, total borrowings on the loan were $28.4 million.

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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 $315.4 million of non-recourse insured bonds (issued June 2004) with the remainder in the form of equal equity contributions from the Company and its real estate joint venture partner. At March 31, 2006, the Company and its joint venture partner had each contributed half of the equity of $60.4 million. The Company and its joint venture partner have committed up to $31.8 million of equity investments in the aggregate in the event of delays in construction or lease commencement. The remaining equity contributions up to $31.8 million have been secured through $31.8 million of letters of credit that will begin expiring in 2007 through 2008. The Company is responsible for $15.9 million of the letters of credit at March 31, 2006. At March 31, 2006, there were no outstanding borrowings against the letters of credit.

The Company and 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 $3.5 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 is financed with a $19.5 million mortgage loan from a bank. At March 31, 2006, amounts borrowed under this loan were $19.1 million. 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 $300,000.

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 specified period of time to either accept the offer to purchase, or to elect to purchase the offering party’s interest 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.

Guarantees

In addition to the guarantees entered into as mentioned above, the Company has also guaranteed certain obligations of certain joint ventures under service agreements entered into by the joint ventures and their customers. The amount of such obligations is not stated in the agreements. Depending on the negotiated terms of the guaranty and/or 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 warranties and infringement indemnities to the licensee, the terms of which vary depending on the negotiated terms of each respective license agreement, but which generally warrant that such systems will perform in accordance with their specifications. The amount of such obligations is not stated in the lease agreements. The Company’s liability for breach of such warranties may be subject to time and materiality limitations, monetary caps and other conditions and defenses.

From time to time, the Company enters into agreements with unaffiliated parties containing indemnification provisions, the terms of which vary depending on the negotiated terms of each respective agreement. The amount of such obligations is not stated in the agreements. The Company’s liability under such indemnification provisions may

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be subject to time and materiality limitations, monetary caps and other conditions and defenses. Such indemnity obligations include the following:

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

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

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

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

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

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

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At March 31, 2006 and December 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.

10. Recently Issued Accounting Standards

On September 30, 2005, the Financial Accounting Standards Board (the “FASB”) issued an exposure draft on a proposed accounting standard that would amend SFAS 128, “Earnings per Share”, to clarify guidance for mandatorily convertible instruments, the treasury stock method, contingently issuable shares, and contracts that may be settled in cash or shares.

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 conversions of its convertible debentures with cash for the principal and accrued and unpaid interest and issue common stock for any conversion value amount over the principal and accrued and unpaid interest amounts would no longer be accepted under SFAS 128, if amended as proposed. The final statement is expected to be issued later this year. The statement would be effective for interim and annual periods ending after June 15, 2006. Retrospective application would be required for all changes to SFAS 128, except that retrospective application would be prohibited for contracts that were either settled in cash prior to adoption or modified prior to adoption to require cash settlement. For DST, adoption of this statement, as proposed, will require retroactive restatement of the Company’s diluted earnings per share calculations subsequent to the issuance of the convertible debentures. In calculating diluted earnings per share under the revised SFAS 128 “if converted” method included in the exposure draft, 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 by 17.1 million shares (less shares already included in diluted earnings per share), the amount of shares that would be issued if all $840 million of convertible debentures would be converted to equity. Under this “if converted” method, diluted earnings per share would have been $1.08 and $0.56 for the three months ended March 31, 2006 and 2005, respectively. The above pro-forma information presents only the effect on diluted earnings per share of the “if converted” method included in the exposure draft, but does not include any other computational changes (i.e., treasury stock method considerations) discussed in the exposure draft. DST is still evaluating the remaining aspects of this proposed accounting standard.

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

The estimated impact of this new accounting standard reflects the Company’s current estimates based upon the exposure draft in its current form. There may be material differences between these estimates and the actual impact of the standard when issued as final.

11. Segment Information

The Company’s operating business units offer sophisticated information processing and software services and products. The Company has elected to organize and report on these business units as two operating Segments (Financial Services and Output Solutions). 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. Prior to July 1, 2005, the Company had an additional operating segment (Customer Management) which was essentially comprised of DST Innovis, Inc. and DST Interactive, Inc. (the “Innovis Entities”). The Customer Management Segment provided customer management, billing and marketing solutions to the video / broadband/cable/satellite TV industry. The Innovis Entities were sold on July 1, 2005.

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As more fully described in Note 3 “Significant Business Transactions” in the Company’s Consolidated Financial Statements included in its December 31, 2005 annual report on Form 10-K, there were certain changes in the composition of the Financial Services Segment during the year ended December 31, 2005. Health Solutions became a subsidiary of DST on April 29, 2005 through an exchange transaction with Computer Sciences Corporation. On June 17, 2005, the Company sold its wholly owned subsidiary, EquiServe, Inc. to Computershare Ltd. As discussed in Note 2 to the Condensed Consolidated Financial Statements included in this report, on January 1, 2006, the Company merged its wholly-owned subsidiary, lock\line, into a wholly-owned subsidiary of Asurion for an approximate 37.4% equity interest in Asurion.

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.

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

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		Three Months Ended March 31, 2006
		Financial Services			Output Solutions			Customer Management			Investments/ Other			Eliminations			Consolidated Total
Operating revenues		$	242.2		$	135.8		$			$	4.7		$			$	382.7
Intersegment operating revenues		1.2									10.7			(11.9		)
Out-of-pocket reimbursements		16.3			177.4						0.1			(0.5		)	193.3
Total revenues		259.7			313.2						15.5			(12.4		)	576.0
Costs and expenses		177.9			301.9						9.9			(12.4		)	477.3
Depreciation and amortization		19.3			7.1						2.9						29.3
Income (loss) from operations		62.5			4.2						2.7						69.4
Other income, net		3.8									20.7						24.5
Gains on sale of businesses		52.8															52.8
Equity in earnings of unconsolidated affiliates		17.0									(0.9		)				16.1
Earnings before interest and income taxes		$	136.1		$	4.2		$			$	22.5		$			$	162.8

 

		Three Months Ended March 31, 2005
		Financial Services			Output Solutions			Customer Management			Investments/ Other			Eliminations			Consolidated Total
Operating revenues		$	277.5		$	109.1		$	46.3		$	3.4		$			$	437.1
Intersegment operating revenues		2.2			18.5						14.6			(35.3		)
Out-of-pocket reimbursements		43.2			152.3			13.2			0.1			(17.6		)	191.2
Total revenues		322.9			280.7			59.5			18.1			(52.9		)	628.3
Costs and expenses		245.9			262.1			50.4			10.2			(52.9		)	515.7
Depreciation and amortization		23.4			6.7			1.5			4.2						35.8
Income from operations		53.6			11.9			7.6			3.7						76.8
Other income, net		3.0			0.2						4.5						7.7
Equity in earnings of unconsolidated affiliates		8.4									(0.5		)				7.9
Earnings before interest and income taxes		$	65.0		$	12.1		$	7.6		$	7.7		$			$	92.4

 

Earnings before interest and income taxes in the segment reporting information above less interest expense of $29.5 million and $16.6 million for the three months ended March 31, 2006 and 2005, respectively, is equal to the Company’s income before income taxes on a consolidated basis for the corresponding periods.

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