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DST Systems Inc. (DST - Analyst Report) posted fourth-quarter 2012 adjusted earnings per share (EPS) of $1.19, which surpassed the Zacks Consensus Estimate of $1.01. The results were 11.2% higher than the prior-year quarter.

Revenues

Total revenue in the fourth quarter was $658.6 million, up 5.6% from $623.4 million in the year-ago quarter. Excluding out-of-the-pocket reimbursements, consolidated operating revenue increased 6.5% year over year to $487.0 million, which was above the Zacks Consensus Estimate of $472.0 million.

Financial Services operating revenues (excluding out-of-the-pocket reimbursements) increased 8.3% year over year, primarily owing to broad-based improvements in the brokerage, global solutions, healthcare and AWD operating units as well as significant contribution from the ALPS acquisition (in Jul 2011). However, the results were partially offset by lower mutual fund shareowner processing revenues and retirement revenues.

During the quarter, total mutual fund shareowner accounts serviced decreased 1.5% sequentially to 88.1 million. Registered accounts and sub-accounts serviced by the company during the quarter were 75.7 million and 12.4 million, respectively.

The decline was mainly due to conversion of roughly 1.4 million registered accounts to DST’s competitor platform and 0.4 million accounts to its own sub-accounting platform. However, the interesting point is that the decline in total mutual fund shareowner accounts moderated from the 8.0% decline recorded in the preceding quarter.

DST Systems announced to have won a new subaccounting client with approximately 300,000 subaccounts. Also, the company confirmed conversion of 100,000 subaccounts from a new client announced earlier.

Customer Communications (previously Output Solutions) operating revenues increased 2.7% year over year. Contribution from North America was strong, which was offset by weak contribution from UK. 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 second half of 2013, resulting in revenue growth.

This apart, Investments and Other Segment operating revenues increased 28.1% year over year to $4.1 million, primarily as a result of increased rental activities.

Operating Results

Total cost and expenses increased 16.3% from the year-earlier period to $659.4 million. Consolidated operating loss was $0.8 million compared with operating income of $56.3 million in the year-ago quarter. Margin deceleration was due to weak performance by Customer Communications segment, partially offset by improvements in Financial Services and Investment and Other segments.

Financial Services operating income increased 9.8% from the year-ago period to $56.2 million. However, operating margin came below the year-ago level due to lower mutual fund processing revenues and higher conversion and business expansion costs for the retirement and brokerage business units. Customer Communications operating loss was $58.0 million compared with operating income of $4.9 million in the year-ago quarter.

Net income attributable to DST shareholders in the quarter was $37.9 million or 82 cents per share, down from $39.2 million or 88 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) and equity earnings. Excluding the one-time items included in operating income and non-operating income, adjusted net income in the quarter came in at $1.19 per share, up from $1.07 in the year-ago quarter.

Balance Sheet

DST Systems’ balance sheet appears highly leveraged. The company exited the quarter with $88.0 million in cash and equivalents, down from $103.0 million reported in the previous quarter, and debt of $1.01 billion, down from $1.10 billion reported in the previous quarter. Growing cash balance and declining debt reflects an improving net cash situation.

Share Repurchases & Dividend

During the fourth quarter, DST Systems bought back 1,250,000 common stock for a value of $73.7 million. Also, the company paid a semi-annual dividend of 40 cents a share.

On Jan 30, 2013, DST’s board authorized a $250 million share repurchase plan, replacing the previous plan under which 750,000 shares were still remaining.

DST Systems also announced that it will start paying dividends quarterly at a rate of 30 cents a share.

Guidance

For the first quarter of 2013, DST expects its existing clients to convert 5.1 million subaccounts to DST's subaccounting platform, an increase of 1.3 million from the previous projection. The company also expects 5.4 million new subaccounts to convert from non-DST subaccounting platforms by the end of the first quarter.

DST Systems signed a new mutual fund registered account client in Jan 2013, which is expected to add approximately 100,000 new accounts during the upcoming quarter.

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

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. However, year-over-year improvement in total revenue was not very encouraging due to 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), Advent Software Inc. (ADVS - Snapshot Report), Fiserv Inc. (FISV - Analyst Report), and a high debt burden remain concerns.

Currently, DST Systems has a Zacks Rank #2 (Buy).

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