DST Systems Inc. (DST) reported adjusted earnings of $1.23 per share in the second quarter, exceeding the Zacks Consensus Estimate of 93 cents.
The adjusted figure excludes a contract termination payment gain net of related expenses, termination benefit expenses related to reductions in workforce, net gain on securities and other investments, and net gain on extinguishment of senior convertible debentures.
Total revenue in the second quarter was $613.9 million, up 10.8% from $554.0 million in the year-ago quarter. Excluding reimbursements, consolidated operating revenue came in at $465.6 million, which was up 15.1% from $404.5 million in the year-ago quarter and exceeded the Zacks Consensus Estimate of $392.0 million. This increase may be attributed to a 23.6% year over year increase in Output Solutions revenue (including a contract termination benefit). Financial Services and Investments & Other segments were flat year over year.
Excluding reimbursements of $138.8 million, revenues from Output Solutions increased 50.4% year over year to $176.7 million. The segment’s revenues include a contract termination payment of $63.0 million. Excluding the benefit, consolidated operating revenue was $402.6 million.
Excluding reimbursements of $10.9 million, Financial Services operating revenues increased 0.9% year over year to $290.2 million. The upside is attributable to higher revenues from DST Global Solutions and Argus, partially offset by lower revenues from DST Health Solutions.
Excluding reimbursements of $0.1 million, Investments & Other operating revenues remained flat year over year at $14.7 million.
During the quarter, total mutual fund shareowner accounts serviced increased by 2.8 million, or 2.3% sequentially to 124.9 million accounts. Registered accounts and sub-accounts serviced by the company during the quarter were 107.3 million and 17.6 million, respectively.
Operating Results
Total cost and expenses in the quarter dropped 4.1% from the year-earlier period to $436.0 million. The decrease in the costs and expenses could be due to a 2.3% year-over-year decrease in costs in the Output Solutions segment and 7.3% decrease in costs related to the Financial Services segment.
Consolidated operating income was $142.3 million, up 107.7% from $68.5 million in the year-ago quarter.
Financial Services operating income increased 20.8% from the year-ago period to $74.8 million, attributable to lower compensation and benefit-related costs stemming from lower staffing levels and higher software license revenues.
Output Solutions operating income was $66.4 million, a significant increase from $5.9 million reported in the year-ago period. The upside is primarily attributable to lower operating costs. Investments and Other operating income increased 14.8% year over year to $3.1 million.
Reported net income in the quarter was $94.0 million or $2.00 per share compared with a net income of $48.7 million or 97 cents in the year-ago quarter. Excluding certain one-time items, adjusted net income in the quarter came in at $57.6 million or $1.23 per share. This compares to adjusted net income of $44.8 million or 90 cents per share in the year-ago quarter.
In the recently concluded quarter, 150,300 shares were repurchased by DST Systems for an amount of $6.2 million, or around $41.25 per share. In the month of May, the board of directors authorized the repurchase of an additional 1.0 million shares under the existing share repurchase authorization plan, which will allow the company to repurchase shares through December 31, 2012. Currently, the company has slightly more than 1.0 million shares remaining under the existing repurchase authorization plan.
Balance Sheet
The balance sheet appears highly leveraged. DST Systems exited the quarter with $79.0 million in cash, down from $124.0 million reported in the previous quarter, and debt of $1.22 billion, down from $1.32 billion reported in the previous quarter. During the quarter, DST Systems repurchased senior convertible debentures of approximately $126.5 million in principal amount. Moreover, in June, DST Systems renewed its $100 million unsecured revolving loan with Boston Financial Data Services Inc. (“BFDS”), which is an unconsolidated affiliate of the company.
Acquisition
On June 30, 2010, 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 get combined with dsicmm.
The joint company will be named Innovative Output Solutions (“IOS”) and will be owned approximately 65% by DST and 35% by a group of dsicmm stockholders. DST System believes the transaction will have little impact on its earnings in 2010.
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 revenue outperformance. We believe that DST Systems’ leadership and scale in Financial Services will attract new customers based on the increasing popularity of mutual funds.
However, tough competition from Lombardi, Savvion, and TIBCO Software and a high debt burden are causes for concern.
We have a short-term Hold recommendation (Zacks #3 Rank) on DST Systems.
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