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DST Systems Inc. (DST - Analyst Report) posted third quarter 2012 adjusted earnings per share (EPS) of 96 cents, surpassing the Zacks Consensus Estimate of 93 cents. The results were 6.7% higher than 90 cents recorded in the prior-year quarter.

Revenue

Total revenue in the third quarter was $632.0 million, up 6.9% from $591.4 million in the year-ago quarter. Excluding out-of-the-pocket reimbursements, consolidated operating revenue increased 7.1% year over year to $464.0 million, which was below the Zacks Consensus Estimate of $472.0 million.

Financial Services operating revenues (excluding out-of-the-pocket reimbursements) increased 10.2% 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 1.5% year over year. Contribution from North America was strong, which was offset by weak contribution from the U.K. During the quarter, there were new client commitments from North America. DST Systems expects full conversion activities related to these new clients to be completed in the first quarter of 2013, resulting in revenue growth.

This apart, Investments and Other Segment operating revenues increased 19.4% year over year to $3.7 million, primarily as a result of increased rental activities.

During the quarter, total mutual fund shareowner accounts serviced decreased by 8.0% sequentially to 89.4 million. Registered accounts and sub-accounts serviced by the company during the quarter were 80.2 million and 17.0 million, respectively.

The decline was mainly due to conversion of roughly 6.1 registered accounts to DST’s competitor platform.

Operating Results

Total cost and expenses increased 10.3% from the year-earlier period to $584.9 million. Consolidated operating income was $47.1 million, down 23.0% from $61.2 million in the year-ago quarter. Margin deceleration was due to weak performances by Financial Services and Investment and Other segments, partially offset by improvement in Output Solutions segment.

Financial Services operating income decreased 12.8% from the year-ago period to $52.0 million. The decrease was due to higher costs pertaining to the ALPS acquisition, new business development and compensation. Output Solutions operating income was $10.6 million, significantly up from $1.9 million in the year-ago quarter. The improvement was attributable to lower costs from facility consolidations and improvements in operations.

Net income attributable to DST shareholders in the quarter was $85.9 million or $1.87 per share compared with $35.3 million or 76 cents per share in the year-ago quarter. Despite a lackluster operating performance, the improvement in net income was attributable to higher non-operating income (sale of assets). Excluding the one-time items included in operating income and non-operating income, adjusted net income in the quarter came in at 96 cents per share, up from 90 cents in the year-ago quarter.

Balance Sheet

DST Systems’ balance sheet appears highly leveraged. The company exited the quarter with $103.0 million in cash and equivalents, up from $93.0 million reported in the previous quarter, and debt of $1.10 billion, down from $1.21 billion reported in the previous quarter. Growing cash balance and declining debt reflects an improving net cash situation.

Share Repurchases & Dividend

No share buyback was made during the quarter. But 100,000 shares were issued under share-based compensation plans, due to which the company currently has approximately 45.2 million shares remaining under its existing share repurchase authorization.

DST will pay a dividend of 40 cents a share in November.

Guidance

For fiscal 2012, the company forecasts 2-3 million conversions of registered accounts to subaccounts and a total loss of 9 million to 10 million accounts. But the company expects roughly 25.0% of these accounts to convert to DST's subaccounting platform.

For 2013, DST expects total conversions to subaccounts to approximate 5-6 million, of which approximately 30% will convert to DST's subaccounting platform.

DST signed a contract with a new subaccounting client with approximately 3.9 million subaccounts. The conversion of the subaccounts to DST's platform is expected to be completed in the second quarter of 2013, impacting revenue growth.

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 Estimate on the bottom line, but missed the top-line projection. Total revenue improved on modest performances across the segments.

We remain encouraged by DST’s exposure in the insurance vertical. Currently, the company has tie-ups with more than 20 of the top 25 insurance companies in America, which is expected to drive decent revenue growth.

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 the recent acquisitions to support revenue growth.

On the other hand, tough competition from Broadridge Financials Solutions Inc. (BR - Snapshot Report), and 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” rating.

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