DST Delivers a Decent 1Q

DST Systems Inc. (DST - Analyst Report) posted first quarter 2012 adjusted earnings per share (EPS) of $1.05, inching past the Zacks Consensus Estimate of $1.04. However, the results were 2.8% lower than $1.08 recorded in the prior-year quarter.

Revenue

Total revenue in the first quarter was $653.2 million, up 10.4% from $591.7 million in the year-ago quarter. Excluding out-of-the-pocket reimbursements, consolidated operating revenue increased 10.8% year over year to $475.9 million, which was above the Zacks Consensus Estimate of $469.0 million.

Financial Services operating revenues (excluding out-of-the-pocket reimbursements) increased 9.4% year over year, primarily owing to broad based improvements in the brokerage, retirement, healthcare and AWD operating units as well as significant contribution from the ALPS acquisition (in July 2011). However, the results were partially offset by lower mutual fund shareowner processing revenues.

Output Solutions operating revenues increased 13.1%, reflecting favorable contributions from Newkirk Products, Inc. (acquired in May 2011) and Lateral Group Limited (acquired in August 2011. During the quarter, there were four new client commitments from North America. DST Systems expects full conversion activities related to these new clients to be completed in the second half of 2012, resulting in revenue growth.

This apart, Investments and Other Segment operating revenues increased 2.1% year over year to $14.4 million, primarily as a result of increased rental activities.

During the quarter, total mutual fund shareowner accounts serviced decreased by 0.2% sequentially to 99.5 million. Registered accounts and sub-accounts serviced by the company during the quarter were 82.8 million and 16.7 million, respectively. The rate of decline moderated from 0.9% in the previous quarter.

Management expects 8 million to 10 million registered accounts to convert to sub-accounting for 2012.

Operating Results

Total cost and expenses increased 13.6% from the year-earlier period to $559.1 million. Consolidated operating income was $60.1 million, down 13.3% from $69.3 million in the year-ago quarter. The margin deceleration was due to weak performance by the Financial Services segment, partially offset by a favorable margin outcome from Output Solutions.

Financial Services operating income decreased 17.4% from the year-ago period to $52.1 million. The decrease was due to higher costs pertaining to the ALPS acquisition, new business development and compensation. Output Solutions operating income was $7.2 million, up 30.9% from the year-ago quarter. The improvement was attributable to increases in the North America operations, partially offset by higher costs due to Canadian plant expansion and new client start-up expenses.

Net income attributable to DST shareholders in the quarter was $55.3 million or $1.22 per share compared with $53.4 million or $1.14 per share in the year-ago quarter. Excluding the one-time items included in operating income and non-operating income, adjusted net income in the quarter came in at $1.05 per share, down from $1.08 in the year-ago quarter.

Balance Sheet

DST Systems’ balance sheet appears highly leveraged. The company exited the quarter with $52.0 million in cash and equivalents, up from $41.0 million reported in the previous quarter, and debt of $1.36 billion, down from $1.38 billion reported in the previous quarter.

Share Repurchases & Dividend

No share buyback was made during the quarter. The company currently has approximately 44.9 million shares remaining under its existing share repurchase authorization.

During the quarter, DST paid a cash dividend of 40 cents per share. The cash dividend was raised by 5 cents per share from the last dividend paid.

Conclusion

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

The company surpassed the Zacks Consensus Estimates on both the top and bottom lines. Total revenue improved on strong performances across the segments.

However, we are still of the opinion that, DST Systems’ business volume and massive scale of operation in Financial Services will attract new customers. Moreover, we expect steady contributions from Lateral and New Kirk to provide continued support to Output Solutions’ revenue growth.

We expect the acquisitions to be accretive in the upcoming quarters. The similar lines of businesses will make it easy for DST Systems to speed-up integration.

On the other hand, tough competition from Broadridge Financials Solutions Inc. (BR - Snapshot Report), Advent Software Inc. (ADVS - Snapshot Report) and a high debt burden remain concerns.

Currently, DST Systems has a Zacks #2 Rank, implying a short-term Buy recommendation.