DST Systems Inc. (DST) posted decent third quarter earnings per share (EPS) of $1.03, beating the Zacks Consensus Estimate of $1.01.

The quarter’s EPS of $1.03 excludes a contract termination payment gain net of related expenses, termination benefit expenses related to a reduction in the workforce, net gain on securities and other investments, net loss on repurchase of senior convertible debentures and a tax gain.

Revenue

Total revenue in the third quarter was $567.2 million, up 2.8% from $551.7 million in the year-ago quarter. Excluding reimbursements, consolidated operating revenue came in at $419.0 million, which was up 5.9% from $395.6 million in the year-ago quarter.

The quarter’s results also exceeded the Zacks Consensus Estimate of $408.0 million. This marginal increase may be attributed to a 4.9% year-over-year increase in Financial Services revenue and 1.1% year-over-year increase in Output Solutions revenue, partially offset by a 3.3% decline in the Investments and Other segment’s revenue.

Excluding reimbursements of $11.5 million, Financial Services operating revenues increased 5.1% year over year to $290.4 million. The upside is attributable to higher revenues from DST Global Solutions and Argus Health Systems, partially offset by lower revenues from DST Health Solutions.

Excluding reimbursements of $138.0 million, revenues from Output Solutions increased 8.6% year over year to $130.7 million. Contribution from dsicmm Group Limited (“dsicmm”) was $22.0 million, excluding which revenue would have decreased 10.7% from the year-ago quarter.

During the second quarter, DST reached a definitive agreement with stockholders of dsicmm Group Limited (“dsicmm”). As per the agreement, DST System’s debt-free U.K. print/mail operations and additional working capital in the form of cash and loans will be combined with dsicmm.

Excluding reimbursements of $0.1 million, Investments & Other operating revenues dropped 3.3% year over year to $14.6 million.

During the quarter, total mutual fund shareowner accounts serviced increased by 9.0 million, or 7.2% sequentially to 115.9 million accounts. Registered accounts and sub-accounts serviced by the company during the quarter were 103.0 million and 12.9 million, respectively.

Operating Results

Total cost and expenses in the quarter inched up 1.0% from the year-earlier period to $459.3 million. The decrease in costs and expenses was due to a 1.9% year-over-year decrease in costs in Financial Services, which was mainly due to lower employee-related costs, partially offset by higher foreign currency exchange and new product development costs. However, cost and expenses in the Output Solutions segment increased 2.1%.

Consolidated operating income was $74.4 million, up 18.8% from $62.6 million in the year-ago quarter.

Financial Services operating income increased 30.9% from the year-ago period to $72.8 million, attributable to lower compensation and benefit-related costs stemming from lower staffing levels and higher software license revenues.

Output Solutions operating income plunged 85.7% from the year-ago quarter to $1.0 million. Investments and Other operating income increased 31.6% year over year to $2.5 million.

Reported net income in the quarter was $54.3 million or $1.16 per share compared to a $60.9 million or $1.21 per share in the year-ago quarter. Excluding the above-mentioned one-time items, adjusted net income in the quarter came in at $48.4 million or $1.03 per share compared to $47.2 million or 94 cents per share in the year-ago quarter.

Balance Sheet

The balance sheet appears highly leveraged. DST Systems exited the quarter with $75.0 million in cash and equivalents, down from $79.0 million reported in the previous quarter, and debt of $1.26 billion, up from $1.22 billion reported in the previous quarter.

During the quarter, DST Systems issued senior notes amounting to $370.0 million The company redeemed $84.1 million of the Series A debentures and $168.5 million of the Series B debentures. DST Systems also repurchased Series C convertible debentures of approximately $36.1 million in principal amount.

Share Repurchases & Dividend

In the recently concluded quarter, 515,000 shares were repurchased by DST Systems for an amount of $21.2 million, or around $41.17 per share. In the month of May, DST Systems’ board of directors authorized the repurchase of 1.0 million additional shares under the existing plan, which will allow the company to repurchase shares through December 31, 2012. As of September 30, DST Systems had 46.2 million shares remaining under the current repurchase authorization plan.

DST Systems will return cash to its shareholders in the form of a cash dividend, which will be paid on November 5 to shareholders of record as of the close of business on October 21, 2010. The company has also received a cash dividend of $49.5 million from a private equity placement.

Our Take

DST Systems is one of the leading global providers of sophisticated information processing software and products to the financial services industry, primarily mutual funds. DST Systems has supplemented internal growth with strategic acquisitions.

We remain encouraged with the quarter’s top-line and bottom-line performances, since they surpassed the Zacks Consensus Estimates. We believe that DST Systems’ leadership and scale in Financial Services will attract new customers based on the increasing popularity of mutual funds. Moreover, we expect the steady contribution from “dsicmm” to provide continuous support to Output Solutions revenue growth.

On the other hand, tough competition from Lombardi, Savvion, and TIBCO Software and a high debt burden remain reasons for concern.

Currently, DST Systems has a short-term Hold recommendation implying Zacks #3 Rank.

 
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