UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number 1-14036
DST SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 43-1581814
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
333 West 11th Street, Kansas City, Missouri 64105
(Address of principal executive offices) (Zip Code)
(816) 435-1000
(Registrant's telephone number, including area code)
No Changes
(Former name, former address and former fiscal year, if changed since
last report)
Indicate by check mark whether the Company (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Company was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Number of shares outstanding of the Company's common stock as of July 31, 2002:
Common Stock $0.01 par value - 119,902,377
1
DST Systems, Inc.
Form 10-Q
June 30, 2002
Table of Contents
Page
----
PART I. FINANCIAL INFORMATION
- -------------------------------
Item 1. Financial Statements
Introductory Comments 3
Condensed Consolidated Balance Sheet
June 30, 2002 and December 31, 2001 4
Condensed Consolidated Statement of Income -
Three and Six Months Ended June 30, 2002 and 2001 5
Condensed Consolidated Statement of Cash Flows -
Six Months Ended June 30, 2002 and 2001 6
Notes to Condensed Consolidated Financial Statements 7-14
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15-25
Item 3. Quantitative and Qualitative Disclosures about Market Risk 25
PART II. OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings 26
Item 2. Changes in Securities and Use of Proceeds 26
Item 3. Defaults Upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 28
SIGNATURE 28
- ---------
The brand, service or product names or marks referred to in this Report are
trademarks or services marks, registered or otherwise, of DST Systems, Inc. or
its subsidiaries, affiliates or of vendors to the Company.
2
DST Systems, Inc.
Form 10-Q
June 30, 2002
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Introductory Comments
The Condensed Consolidated Financial Statements of DST Systems, Inc. ("DST" or
the "Company") included herein have been prepared by the Company, without audit,
pursuant to the rules and regulations of the United States Securities and
Exchange Commission. Certain information and note disclosures normally included
in financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed or
omitted pursuant to such rules and regulations, although the Company believes
that the disclosures are adequate to enable a reasonable understanding of the
information presented. These Condensed Consolidated Financial Statements should
be read in conjunction with the audited financial statements and the notes
thereto for the year ended December 31, 2001. Additionally, the Condensed
Consolidated Financial Statements should be read in conjunction with Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in this Form 10-Q.
The results of operations for the three and six months ended June 30, 2002, are
not necessarily indicative of the results to be expected for the full year 2002.
3
DST Systems, Inc.
Condensed Consolidated Balance Sheet
(dollars in millions, except per share amounts)
(unaudited)
June 30, December 31,
2002 2001
----------- -----------
ASSETS
Current Assets
Cash and cash equivalents $ 62.0 $ 84.4
Transfer agency investments 86.2 60.6
Accounts receivable 372.5 361.8
Other current assets 103.0 98.0
------------ -----------
623.7 604.8
Investments 1,343.3 1,436.4
Properties 506.0 455.5
Goodwill 181.4 170.5
Intangibles 26.6 27.5
Other assets 11.8 9.3
------------ -----------
Total assets $ 2,692.8 $ 2,704.0
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Debt due within one year $ 50.8 $ 63.5
Transfer agency deposits 86.2 60.6
Accounts payable 102.0 111.2
Accrued compensation and benefits 80.5 77.3
Deferred revenues and gains 54.4 54.7
Other liabilities 112.7 104.1
---------- ----------
486.6 471.4
Long-term debt 251.4 243.4
Deferred income taxes 389.0 427.2
Other liabilities 87.7 89.6
---------- ----------
1,214.7 1,231.6
---------- ----------
Commitments and contingencies
---------- ----------
Stockholders' equity
Common stock, $0.01 par; 300 million shares
authorized, 127.6 million shares issued 1.3 1.3
Additional paid-in capital 375.5 392.1
Retained earnings 1,072.7 960.2
Treasury stock (7.5 million and 7.2 million
shares, respectively), at cost (309.8) (289.3)
Accumulated other comprehensive income 338.4 408.1
---------- ----------
Total stockholders' equity 1,478.1 1,472.4
---------- ----------
Total liabilities and stockholders' equity $ 2,692.8 $ 2,704.0
========== ==========
The accompanying notes are an integral part of these financial statements.
4
DST Systems, Inc.
Condensed Consolidated Statement of Income
(in millions, except per share amounts)
(unaudited)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2002 2001 2002 2001
--------------- --------------- --------------- --------------
Operating revenues $ 402.9 $ 450.8 $ 829.5 $ 820.4
Out-of-pocket reimbursements 177.4 190.0 371.7 359.1
--------------- --------------- --------------- --------------
Total revenues 580.3 640.8 1,201.2 1,179.5
Costs and expenses 475.4 524.1 982.4 953.8
Depreciation and amortization 33.6 39.2 66.2 70.5
--------------- --------------- --------------- --------------
Income from operations 71.3 77.5 152.6 155.2
Interest expense (2.9) (1.9) (5.7) (3.1)
Other income, net 10.4 7.0 18.5 13.6
Gain on sale of PAS 32.8 32.8
Equity in earnings of unconsolidated affiliates 2.6 0.3 5.1 1.2
--------------- --------------- --------------- --------------
Income before income taxes 81.4 115.7 170.5 199.7
Income taxes 27.7 41.9 58.0 71.4
--------------- --------------- --------------- --------------
Net income $ 53.7 $ 73.8 $ 112.5 $ 128.3
=============== =============== =============== ==============
Average common shares outstanding 120.2 123.0 120.4 123.6
Diluted shares outstanding 122.1 126.3 122.4 127.4
Basic earnings per share $ 0.45 $ 0.60 $ 0.93 $ 1.04
Diluted earnings per share $ 0.44 $ 0.58 $ 0.92 $ 1.01
The accompanying notes are an integral part of these financial statements.
5
DST Systems, Inc.
Condensed Consolidated Statement of Cash Flows
(in millions)
(unaudited)
For the Six Months
Ended June 30,
2002 2001
---------------- ----------------
Cash flows -- operating activities:
Net income $ 112.5 $ 128.3
---------------- ----------------
Depreciation and amortization 66.2 70.5
Equity in earnings of unconsolidated affiliates (5.1) (1.2)
Net realized gain from sale of investments and PAS (7.4) (39.4)
Deferred taxes 6.7 (16.9)
Changes in accounts receivable (9.4) 4.0
Changes in other current assets (0.7) (4.0)
Changes in accounts payable and accrued liabilities 10.0 10.8
Other, net 6.1 (7.9)
---------------- ----------------
Total adjustments to net income 66.4 15.9
---------------- ----------------
Net 178.9 144.2
---------------- ----------------
Cash flows -- investing activities:
Proceeds from sale of property and equipment 0.2 3.9
Proceeds from sale of investments and PAS 30.0 32.0
Investments and advances to unconsolidated affiliates (18.6) (13.7)
Investments in securities (27.2) (28.1)
Capital expenditures (123.2) (106.2)
Payment for purchase of subsidiaries, net of cash acquired (5.5) (20.6)
Other, net 2.1 4.8
---------------- ----------------
Net (142.2) (127.9)
---------------- ----------------
Cash flows -- financing activities:
Proceeds from issuance of common stock 16.7 19.7
Principal payments on long-term debt (55.1) (3.2)
Net increase in revolving credit facilities and notes payable 48.9 46.2
Common stock repurchased (69.6) (93.8)
---------------- ----------------
Net (59.1) (31.1)
---------------- ----------------
Net decrease in cash and cash equivalents (22.4) (14.8)
Cash and cash equivalents at beginning of period 84.4 116.2
---------------- ----------------
Cash and cash equivalents at end of period $ 62.0 $ 101.4
================ ================
The accompanying notes are an integral part of these financial statements.
6
DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
1. Summary of Accounting Policies
The Condensed Consolidated Financial Statements of DST Systems, Inc. ("DST" or
the "Company") included herein have been prepared by the Company, without audit,
pursuant to the rules and regulations of the United States Securities and
Exchange Commission. Certain information and note disclosures normally included
in financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed or
omitted pursuant to such rules and regulations, although the Company believes
that the disclosures are adequate to enable a reasonable understanding of the
information presented. These Condensed Consolidated Financial Statements should
be read in conjunction with the audited financial statements and the notes
thereto for the year ended December 31, 2001. Additionally, the Condensed
Consolidated Financial Statements should be read in conjunction with Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in this Form 10-Q.
In the opinion of management, the accompanying unaudited condensed consolidated
financial statements contain all adjustments (consisting of normal interim
closing procedures) necessary to present fairly the financial position of the
Company and its subsidiaries at June 30, 2002 and December 31, 2001, and the
results of operations for the three and six months ended June 30, 2002 and 2001
and cash flows for the six months ended June 30, 2002 and 2001.
Certain amounts in the prior year's consolidated financial statements have been
reclassified to conform to the current year presentation.
The results of operations for the three and six months ended June 30, 2002, are
not necessarily indicative of the results to be expected for the full year 2002.
Revenue recognition
Effective January 1, 2002, the Company adopted EITF Issue No. 01-14, Income
Statement Characterization of Reimbursements received for "Out-of-Pocket"
("OOP") Expenses Incurred ("EITF No. 01-14"), formerly EITF Topic No. D-103.
Prior to the issuance of EITF No. 01-14, the Company netted the OOP expense
reimbursements from customers with the applicable OOP expenditures. The
Company's significant OOP expenses at the consolidated level include postage and
telecommunication expenditures and at the segment level include print mail
services between the Financial Services Segment and the Output Solutions
Segment. Under EITF No. 01-14, the Company is required to record the
reimbursements received for OOP expenses as revenue on an accrual basis. Because
these additional revenues are offset by the reimbursable expenses incurred,
adoption of EITF No. 01-14 did not impact income from operations or net income.
Comparative financial statements for prior periods have been reclassified to
comply with the new guidance. For each segment, total revenues are reported in
two categories, operating revenues (which correspond to amounts previously
reported) and OOP reimbursements. OOP expenses are included in costs and
expenses.
2. Subsequent Events
lock\line, LLC
On August 2, 2002, DST Systems, Inc. announced the acquisition of the operations
of lock\line, LLC ("lock\line") for cash. lock\line provides administrative
services to support insurance programs for wireless communication devices,
extended warranty programs for land line telephone and consumer equipment and
event based debt protection programs. lock\line is headquartered in the Kansas
City area. lock\line revenues for its fiscal year ended April 30, 2002 were
approximately $51 million. lock\line will be included in the Financial Services
Segment for financial reporting purposes. The transaction is expected to be
accretive to diluted earnings per share.
7
The acquisition was accounted for as a purchase and the results of lock\line's
operations will be included in DST's 2002 consolidated financial statements
beginning August 2, 2002. The minimum purchase price of $190 million was paid
in cash at closing. There are provisions in the acquisition agreement that allow
for additional consideration to be paid in cash if lock\line revenues, as
defined in the acquisition agreement, exceed certain targeted levels for 2003
and 2004. Goodwill will be increased by the amount of additional consideration
paid.
The following table, which is based upon an estimated valuation, summarizes the
allocation of the minimum purchase price to the fair values of assets acquired
and liabilities assumed at the date of the acquisition. Upon completion of the
valuation of identifiable intangible assets, such will be reclassified between
goodwill and the appropriate intangible asset categories, as applicable.
(in millions)
Current assets $ 18.0
Properties 7.8
Other non-current assets 0.5
Intangible assets 100.0
Goodwill 80.0
------------------
206.3
Current liabilities 13.6
Non-current liabilities 2.7
------------------
Net assets acquired $ 190.0
==================
The intangible assets represent customer relationships and are being amortized
over an estimated 10 year life.
lock\line's revenues for the year ended December 31, 2001 were $41.3 million and
for the six months ended June 30, 2002 were $32.5 million. Assuming the
acquisition had occurred January 1, 2001, the Company's consolidated operating
revenues for the three and six months ended June 30, 2002 would have been $419.8
million and $862.0 million, respectively, and $1,701.3 million for the year
ended December 31, 2001. Consolidated proforma net income and earnings per share
would not have been materially different from the reported amounts for 2002 and
2001. Such unaudited proforma amounts are not indicative of what actual
consolidated results of operations might have been if the acquisition had been
effective at the beginning of 2001.
Wall Street Access, LLC ("Wall Street Access")
Subsequent to quarter end, DST exercised its contractual rights to acquire
additional shares of voting common stock of Wall Street Access for approximately
$16 million. DST now has a 20% interest in Wall Street Access. Wall Street
Access is a provider of online brokerage services to individual traders and
professional money managers.
3. DST Output Restructuring
The Company plans to consolidate the operations of its domestic Output Solutions
business into three large facilities and close certain other smaller facilities,
which the Company believes will result in operational efficiencies. The Company
recorded $7.6 million in costs associated with facility consolidations in the
second quarter of 2002. The Company still expects to incur additional charges of
$6 million to $8 million in future periods related to facility consolidation
items that are required to be expensed when incurred. The estimated impact of
the facility consolidations reflects the Company's current views. There may be
material differences between these estimates and the actual costs.
4. EquiServe, Inc. ("EquiServe")
On March 30, 2001, DST completed the acquisition of a 75% interest in EquiServe
by purchasing interests held by FleetBoston Financial ("FleetBoston") and Bank
One Corporation ("Bank One"). On July 31, 2001, DST completed the acquisition of
the remaining 25%, which was owned by Boston Financial Data Services, on
8
essentially the same terms provided to FleetBoston and Bank One. EquiServe is
one of the nation's largest corporate transfer agency service providers,
maintaining and servicing the records of approximately 26.3 million shareholder
accounts for approximately 1,400 publicly traded companies.
A restructuring provision of $15.9 million was recorded for employee severances
and supplier contract termination costs related to the acquisition. The Company
utilized $0.4 million and $1.7 million in the three and six months ended June
30, 2002, respectively, related to the restructuring provision. The
restructuring provision for employee severance costs, which affected employees
across nearly all classifications and locations, was $12.5 million relating to
approximately 610 employees, of which 383 employees have been separated from the
Company as of June 30, 2002. The remaining employee severances of approximately
$8.8 million are expected to be paid in 2002. Contract termination costs of
approximately $3.4 million related to facilities that were closed were paid in
2001. The costs of transitioning the continuing business have not been accrued.
5. Investments
Investments are as follows (in millions):
Carrying Value
-----------------------------------
Ownership June 30, December 31,
Percentage 2002 2001
-------------------- ---------------- ----------------
Available-for-sale securities:
State Street Corporation 4% $ 571.8 $ 668.4
Computer Sciences Corporation 5% 412.6 422.8
Euronet Worldwide, Inc. 8% 30.1 40.5
Other available-for-sale securities 123.0 117.8
---------------- ----------------
1,137.5 1,249.5
---------------- ----------------
Unconsolidated affiliates:
Boston Financial Data Services, Inc. 50% 67.7 63.9
International Financial Data Services, U.K. 50% 10.9 10.5
International Financial Data Services, Canada 50% 14.4 12.9
Other unconsolidated affiliates 65.5 62.2
---------------- ----------------
158.5 149.5
---------------- ----------------
Other:
Net investment in leases 2.6 4.7
Other 44.7 32.7
---------------- ----------------
47.3 37.4
---------------- ----------------
Total investments $ 1,343.3 $ 1,436.4
================ ================
Certain information related to the Company's available-for-sale securities is as
follows (in millions):
June 30, December 31,
2002 2001
----------------- -----------------
Cost $ 579.3 $ 569.0
Gross unrealized gains 563.3 683.8
Gross unrealized losses (5.1) (3.3)
---------------- -----------------
Market value $ 1,137.5 $ 1,249.5
================= =================
9
The following table summarizes equity in earnings (losses) of unconsolidated
affiliates (in millions):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2002 2001 2002 2001
-------------- -------------- -------------- ---------------
Boston Financial Data Services, Inc. $ 1.8 $ 1.0 $ 3.7 $ 2.6
International Financial Data Services, U.K. (0.1) (0.2) (0.3) (0.4)
International Financial Data Services, Canada 0.5 1.1 0.7 2.0
Other 0.4 (1.6) 1.0 (3.0)
-------------- -------------- -------------- ---------------
$ 2.6 $ 0.3 $ 5.1 $ 1.2
============== ============== ============== ===============
6. Goodwill and Intangibles
Effective July 1, 2001 for goodwill and intangible assets acquired after June
30, 2001 and effective January 1, 2002 for all goodwill and intangible assets,
the Company adopted, as required, Statement of Financial Accounting Standards
("SFAS") SFAS No. 142, "Goodwill and Other Intangible Assets." This statement
addresses, among other things, how goodwill and other intangible assets should
be accounted for after they have been initially recognized in the financial
statements. Under SFAS No. 142, goodwill and intangible assets that have
indefinite useful lives will not be amortized but rather will be tested at least
annually for impairment. Intangible assets that have finite lives will continue
to be amortized over their useful lives.
If SFAS No. 142 would have been adopted at January 1, 2001, the Company would
have reported net income and diluted earnings per share as follows:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2002 2001 2002 2001
--------------- --------------- --------------- --------------
Reported net income (in millions) $ 53.7 $ 73.8 $ 112.5 $ 128.3
Add goodwill amortization (net of tax) 2.6 4.0
--------------- --------------- --------------- --------------
Adjusted net income $ 53.7 $ 76.4 $ 112.5 $ 132.3
=============== =============== =============== ==============
Basic earnings per share
Reported net income $ 0.45 $ 0.60 $ 0.93 $ 1.04
Goodwill amortization (net of tax) 0.02 0.03
--------------- --------------- --------------- --------------
Adjusted net income $ 0.45 $ 0.62 $ 0.93 $ 1.07
=============== =============== =============== ==============
Diluted earnings per share
Reported net income $ 0.44 $ 0.58 $ 0.92 $ 1.01
Goodwill amortization (net of tax) 0.02 0.03
--------------- --------------- --------------- --------------
Adjusted net income $ 0.44 $ 0.60 $ 0.92 $ 1.04
=============== =============== =============== ==============
Average common shares outstanding 120.2 123.0 120.4 123.6
Diluted potential common shares 122.1 126.3 122.4 127.4
10
The following table summarizes intangible assets (in millions):
June 30, 2002 December 31, 2001
---------------------------------- ----------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
---------------- --------------- ----------------- ---------------
Amortized intangbile assets:
Customer relationships $ 28.2 $ 1.6 $ 28.3 $ 0.9
Intellectual property 9.8 9.8
Other 0.1 0.1 2.2 2.1
---------------- --------------- ----------------- ---------------
Total $ 28.3 $ 1.7 $ 40.3 $ 12.8
================ =============== ================= ===============
Amortization of intangible assets for the three and six months ended June 30,
2002 was $0.4 million and $0.9 million, respectively. Estimated annual
amortization for intangible assets recorded as of June 30, 2002 for each of the
years 2002, 2003, 2004, 2005 and 2006 is $1.6 million.
The following table summarizes the changes in the carrying amount of goodwill
for the six months ended June 30, 2002, by segment (in millions):
December 31, June 30,
2001 Acquisitions Other 2002
--------------- ---------------- ---------------- ----------------
Financial Services $ 156.1 $ 10.5 $ 166.6
Output Solutions 8.7 1.4 (1.0) 9.1
Customer Management 5.4 5.4
Investments and Other 0.3 0.3
--------------- ---------------- ---------------- ----------------
Total $ 170.5 $ 1.4 $ 9.5 $ 181.4
=============== ================ ================ ================
Amortization of goodwill and other intangibles, net of tax, for the quarters
ended March 31, 2001, June 30, 2001, September 30, 2001 and December 31, 2001
totaled $1.4 million, $2.6 million, $2.7 million and $7.2 million, respectively.
The Company has completed its initial impairment testing of goodwill and has
concluded that no such impairment exists. The fair value of the reporting units
were estimated using the expected present value of future cash flows.
11
7. Stockholders' Equity
Earnings per share. The computation of basic and diluted earnings per share is
as follows (in millions, except per share amounts):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2002 2001 2002 2001
--------------- --------------- --------------- --------------
Net income $ 53.7 $ 73.8 $ 112.5 $ 128.3
=============== =============== =============== ==============
Average common shares outstanding 120.2 123.0 120.4 123.6
Incremental shares from assumed
conversions of stock options 1.9 3.3 2.0 3.8
--------------- --------------- --------------- --------------
Diluted potential common shares 122.1 126.3 122.4 127.4
=============== =============== =============== ==============
Basic earnings per share $ 0.45 $ 0.60 $ 0.93 $ 1.04
Diluted earnings per share $ 0.44 $ 0.58 $ 0.92 $ 1.01
Comprehensive income. Components of comprehensive income (loss) consist of the
following (in millions):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2002 2001 2002 2001
-------------- ------------- -------------- --------------
Net income $ 53.7 $ 73.8 $ 112.5 $ 128.3
-------------- ------------- -------------- --------------
Other comprehensive income (loss):
Unrealized gains (losses) on investments:
Unrealized holding gains (losses) arising
during the period (169.9) 70.5 (117.3) (344.0)
Less reclassification adjustments for gains
included in net income (3.6) (3.5) (5.0) (6.7)
Foreign currency translation adjustments 5.9 1.8 4.8 (2.8)
Deferred income taxes 67.8 (26.2) 47.8 137.0
-------------- ------------- -------------- --------------
Other comprehensive income (loss) (99.8) 42.6 (69.7) (216.5)
-------------- ------------- -------------- --------------
Comprehensive income (loss) $ (46.1) $ 116.4 $ 42.8 $ (88.2)
============== ============= ============== ==============
8. Segment Information
The Company has several operating business units that offer sophisticated
information processing and software services and products. These business units
are reported as three operating segments (Financial Services, Output Solutions
and Customer Management). In addition, investments in certain equity securities
and financial interests and the Company's real estate and computer hardware
leasing subsidiaries and affiliates have been aggregated into an Investments and
Other Segment. The Company evaluates the performance of its segments based on
income before income taxes, non-recurring items and interest expense.
Summarized financial information concerning the segments is shown in the
following tables (in millions):
12
Three Months Ended June 30, 2002
------------------------------------------------------------------------------------------
Financial Output Customer Investments/ Consolidated
Services Solutions Management Other Eliminations Total
------------- ------------- -------------- ------------- ------------- --------------
Operating revenues $ 230.7 $ 127.7 $ 41.8 $ 2.7 $ $ 402.9
Intersegment operating revenues 2.2 16.0 11.3 (29.5)
Out-of-pocket reimbursements 39.7 143.7 14.9 0.2 (21.1) 177.4
------------- ------------- -------------- ------------- ------------- --------------
272.6 287.4 56.7 14.2 (50.6) 580.3
Costs and expenses 190.1 274.3 52.8 8.8 (50.6) 475.4
Depreciation and amortization 19.4 9.4 1.9 2.9 33.6
------------- ------------- -------------- ------------- ------------- --------------
Income from operations 63.1 3.7 2.0 2.5 71.3
Other income, net 2.1 2.3 6.0 10.4
Equity in earnings of
unconsolidated affiliates 1.9 0.7 2.6
------------- ------------- -------------- ------------- ------------- --------------
Income before interest
and income taxes $ 67.1 $ 6.0 $ 2.0 $ 9.2 $ $ 84.3
============= ============= ============== ============= ============= ==============
Three Months Ended June 30, 2001
------------------------------------------------------------------------------------------
Financial Output Customer Investments/ Consolidated
Services Solutions Management Other Eliminations Total
------------- ------------- -------------- ------------- ------------- --------------
Operating revenues $ 257.7 $ 136.2 $ 54.4 $ 2.5 $ $ 450.8
Intersegment operating revenues 0.3 16.5 7.4 (24.2)
Out-of-pocket reimbursements 49.1 148.5 17.6 0.1 (25.3) 190.0
------------- ------------- -------------- ------------- ------------- --------------
307.1 301.2 72.0 10.0 (49.5) 640.8
Costs and expenses 229.1 277.1 60.9 6.5 (49.5) 524.1
Depreciation and amortization 22.7 9.3 4.5 2.7 39.2
------------- ------------- -------------- ------------- ------------- --------------
Income from operations 55.3 14.8 6.6 0.8 77.5
Other income, net 0.8 6.2 7.0
Gain on sale of PAS 32.8 32.8
Equity in earnings of
unconsolidated affiliates 0.2 0.1 0.3
------------- ------------- -------------- ------------- ------------- --------------
Income before interest
and income taxes $ 89.1 $ 14.9 $ 6.6 $ 7.0 $ $ 117.6
============= ============= ============== ============= ============= ==============
13
Six Months Ended June 30, 2002
------------------------------------------------------------------------------------------
Financial Output Customer Investments/ Consolidated
Services Solutions Management Other Eliminations Total
------------- ------------- ------------ ------------- ------------- --------------
Operating revenues $ 465.8 $ 266.5 $ 91.9 $ 5.3 $ $ 829.5
Intersegment operating revenues 4.3 31.8 21.7 (57.8)
Out-of-pocket reimbursements 85.0 300.8 30.4 0.3 (44.8) 371.7
------------- ------------- -------------- ------------- ------------- --------------
555.1 599.1 122.3 27.3 (102.6) 1,201.2
Costs and expenses 397.4 560.8 109.4 17.4 (102.6) 982.4
Depreciation and amortization 39.0 18.2 3.7 5.3 66.2
------------- ------------- -------------- ------------- ------------- --------------
Income from operations 118.7 20.1 9.2 4.6 152.6
Other income, net 4.1 3.7 10.7 18.5
Equity in earnings of
unconsolidated affiliates 3.9 1.2 5.1
------------- ------------- -------------- ------------- ------------- --------------
Income before interest
and income taxes $ 126.7 $ 23.8 $ 9.2 $ 16.5 $ $ 176.2
============= ============= ============== ============= ============= ==============
Six Months Ended June 30, 2001
------------------------------------------------------------------------------------------
Financial Output Customer Investments/ Consolidated
Services Solutions Management Other Eliminations Total
------------- ------------- ------------- -------------- ------------- --------------
Operating revenues $ 424.8 $ 287.6 $ 102.9 $ 5.1 $ $ 820.4
Intersegment operating revenues 0.7 30.6 13.9 (45.2)
Out-of-pocket reimbursements 68.3 307.3 35.3 0.2 (52.0) 359.1
------------- ------------- -------------- ------------- ------------- --------------
493.8 625.5 138.2 19.2 (97.2) 1,179.5
Costs and expenses 351.9 567.8 119.2 12.1 (97.2) 953.8
Depreciation and amortization 38.9 18.2 8.7 4.7 70.5
------------- ------------- -------------- ------------- ------------- --------------
Income from operations 103.0 39.5 10.3 2.4 155.2
Other income, net 1.6 12.0 13.6
Gain on sale of PAS 32.8 32.8
Equity in earnings (losses) of
unconsolidated affiliates 1.3 0.1 (0.2) 1.2
------------- ------------- -------------- ------------- ------------- --------------
Income before interest
and income taxes $ 138.7 $ 39.6 $ 10.3 $ 14.2 $ $ 202.8
============= ============= ============== ============= ============= ==============
The consolidated total income before interest and income taxes as shown in the
segment reporting information above less interest expense of $2.9 million and
$5.7 million for the three and six months ended June 30, 2002, respectively, and
$1.9 million and $3.1 million for the three and six months ended June 30, 2001,
respectively, is equal to the Company's income before income taxes on a
consolidated basis for the corresponding periods.
14
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The discussions set forth in this Quarterly Report on Form 10-Q contain
statements concerning potential future events. Such forward-looking statements
are based upon assumptions by the Company's management, as of the date of this
Quarterly Report, including assumptions about risks and uncertainties faced by
the Company. Readers can identify these forward-looking statements by the use of
such verbs as expects, anticipates, believes or similar verbs or conjugations of
such verbs. If any of management's assumptions prove incorrect or should
unanticipated circumstances arise, the Company's actual results could materially
differ from those anticipated by such forward-looking statements. The
differences could be caused by a number of factors or combination of factors
including, but not limited to, those factors identified in the Company's amended
Current Report on Form 8-K/A dated March 19, 2002, which is hereby incorporated
by reference. This report has been filed with the United States Securities and
Exchange Commission ("SEC") in Washington, D.C. and can be obtained by
contacting the SEC's Public Reference Branch. Readers are strongly encouraged to
obtain and consider the factors listed in the March 19, 2002 Current Report and
any amendments or modifications thereof when evaluating any forward-looking
statements concerning the Company. The Company will not update any
forward-looking statements in this Quarterly Report to reflect future events or
developments.
The information contained in this Management's Discussion and Analysis of
Financial Condition and Results of Operations should be read in conjunction with
the Condensed Consolidated Financial Statements and Notes thereto included in
this Form 10-Q and the audited financial statements and notes thereto in the
Company's Annual Report on Form 10-K for the year ended December 31, 2001.
INTRODUCTION
The Company has several operating business units that offer sophisticated
information processing and software services and products. These business units
are reported as three operating segments (Financial Services, Output Solutions
and Customer Management). In addition, investments in certain equity securities
and financial interests and the Company's real estate and computer hardware
leasing subsidiaries and affiliates have been aggregated into an Investments and
Other Segment.
Financial Services
The Financial Services Segment provides sophisticated information processing and
computer software services and products primarily to mutual funds, investment
managers, corporations, insurance companies, banks, brokers and financial
planners.
Output Solutions
The Output Solutions Segment provides complete bill and statement processing
services and solutions, including electronic presentment, which include
generation of customized statements that are produced in sophisticated automated
facilities designed to minimize turnaround time and mailing costs.
Customer Management
The Customer Management Segment provides sophisticated customer management and
open billing solutions to the video/broadband, direct broadcast satellite
("DBS"), wire-line and Internet-protocol telephony, Internet and utility markets
worldwide.
Investments and Other
The Investments and Other Segment holds investments in certain equity securities
and financial interests and the Company's real estate and computer hardware
leasing subsidiaries and affiliates.
15
RESULTS OF OPERATIONS
The following table summarizes the Company's operating results (dollars in
millions, except per share amounts):
Three months Six Months
Ended June 30, Ended June 30,
------------------------------- -------------------------------
2002 2001 2002 2001
-------------- --------------- --------------- --------------
Revenues
Operating revenues
Financial Services $ 232.9 $ 258.0 $ 470.1 $ 425.5
Output Solutions 143.7 152.7 298.3 318.2
Customer Management 41.8 54.4 91.9 102.9
Investments and Other 14.0 9.9 27.0 19.0
Eliminations (29.5) (24.2) (57.8) (45.2)
-------------- --------------- --------------- --------------
$ 402.9 $ 450.8 $ 829.5 $ 820.4
-------------- --------------- --------------- --------------
% change from prior year period (10.6%) 1.1%
Reimbursable expense revenues
Financial Services $ 39.7 $ 49.1 $ 85.0 $ 68.3
Output Solutions 143.7 148.5 300.8 307.3
Customer Management 14.9 17.6 30.4 35.3
Investments and Other 0.2 0.1 0.3 0.2
Eliminations (21.1) (25.3) (44.8) (52.0)
------------- ---------------- --------------- --------------
$ 177.4 $ 190.0 $ 371.7 $ 359.1
-------------- --------------- --------------- --------------
% change from prior year period (6.6%) 3.5%
Total revenues $ 580.3 $ 640.8 $ 1,201.2 $ 1,179.5
============== =============== =============== ==============
% change from prior year period (9.4%) 1.8%
Income from operations
Financial Services $ 63.1 $ 55.3 $ 118.7 $ 103.0
Output Solutions 3.7 14.8 20.1 39.5
Customer Management 2.0 6.6 9.2 10.3
Investments and Other 2.5 0.8 4.6 2.4
-------------- --------------- --------------- --------------
71.3 77.5 152.6 155.2
Interest expense (2.9) (1.9) (5.7) (3.1)
Other income, net 10.4 7.0 18.5 13.6
Gain on sale of PAS 32.8 32.8
Equity in earnings of unconsolidated
affiliates, net of income taxes 2.6 0.3 5.1 1.2
-------------- --------------- --------------- --------------
Income before income taxes 81.4 115.7 170.5 199.7
Income taxes 27.7 41.9 58.0 71.4
-------------- --------------- --------------- --------------
Net income $ 53.7 $ 73.8 $ 112.5 $ 128.3
============== =============== =============== ==============
Basic earnings per share $ 0.45 $ 0.60 $ 0.93 $ 1.04
Diluted earnings per share $ 0.44 $ 0.58 $ 0.92 $ 1.01
Consolidated revenues
Consolidated total revenues (including Out-of-Pocket ("OOP") reimbursements) for
the three months ended June 30, 2002 decreased $60.5 million or 9.4% over the
prior year quarter and increased $21.7 million or 1.8% over the prior year six
month period. Consolidated operating revenues (excluding OOP reimbursements) for
the three months ended June 30, 2002 decreased $47.9 million or 10.6% over the
prior year quarter and increased $9.1 million or
16
1.1% over the prior year six month period. U.S. operating revenues for the
three and six months ended June 30, 2002 were $365.8 million and $758.3
million, respectively, a decrease of 12.0% and an increase of 1.1%,
respectively, over the same periods in 2001. International operating revenues
for the three and six months ended June 30, 2002 were $37.1 million and $71.2
million, respectively, an increase of 6.3% and 1.7%, respectively, over the
same periods in 2001.
Financial Services Segment total revenues for the three and six months ended
June 30, 2002 decreased $34.5 million or 11.2% and increased $61.3 million or
12.4%, respectively, over the same periods in 2001. Financial Services operating
revenues for the three and six months ended June 30, 2002 decreased $25.1
million or 9.7% and increased $44.6 million or 10.5%, respectively, over the
same periods in 2001. U.S. Financial Services Segment operating revenues for the
three and six months ended June 30, 2002 decreased $25.2 million or 10.8% and
increased $48.5 million or 13.0%, respectively, over the same periods in 2001.
EquiServe, Inc. ("EquiServe"), acquired in March 2001, is included in both
quarters for 2002 compared to one quarter in 2001 and the Portfolio Accounting
Systems ("PAS") business was sold in June 2001. The decrease is primarily from
a decrease in EquiServe revenues from lower demutualization revenues of
approximately $15 million, as the Prudential demutualization is complete, lower
revenue from corporate actions (e.g. tenders and exchanges), lower revenues from
slower market activity and a decrease in Automated Work Distributor ("AWD")
license revenue, partially offset by an increase in mutual fund shareowner
accounts processed. U.S. mutual fund shareowner accounts serviced totaled 80.3
million at June 30, 2002, an increase of 6.2% from the 75.6 million serviced at
December 31, 2001 and an increase of 7.4% from the 74.8 million serviced at June
30, 2001.
Output Solutions Segment total revenues for the three and six months ended June
30, 2002 decreased $13.8 million and $26.4 million, respectively, or 4.6% and
4.2%, respectively, over the same periods in 2001. Output Solutions Segment
operating revenues for the three and six months ended June 30, 2002 were $143.7
million and $298.3 million, respectively, a decrease of $9.0 million and $19.9
million from the comparable periods in 2001. The revenue decline resulted from
the loss of a telecommunications customer in the fourth quarter 2001, declines
in brokerage related marketing fulfillment and trade confirmation volumes and
changes in statement presentation formats from existing customers which result
in lower revenues, partially offset by increased volumes from the insurance and
healthcare industries and the inclusion of new international operations of $3.8
million. Output Solutions Segment images produced for the three and six months
ended June 30, 2002 increased 5.0% and 7.5%, respectively to 2.1 billion and 4.3
billion, respectively, and items mailed decreased 8.7% and 7.7%, respectively,
to 422 million and 895 million, respectively, compared to the same periods in
2001.
Customer Management Segment total revenues for the three and six months ended
June 30, 2002 decreased $15.3 million or 21.3% and $15.9 million or 11.5%,
respectively, over the same periods in 2001. Customer Management Segment
operating revenues for the three and six months ended June 30, 2002 decreased
$12.6 million or 23.2% and $11.0 million or 10.7%, respectively, over the same
periods in 2001 primarily from decreased processing and software service
revenues.
Investments and Other Segment total revenues increased $4.2 million and $8.1
million, respectively, for the three and six months ended June 30, 2002, an
increase of 42.0% and 42.2%, respectively, as compared to the same periods in
2001. Investments and Other Segment operating revenues increased $4.1 million
and $8.0 million, respectively, for the three and six months ended June 30,
2002, an increase of 41.4% and 42.1%, respectively, as compared to the same
periods in 2001, primarily from increased real estate leasing activity. Segment
revenues are primarily rental income for facilities leased to the Company's
operating segments and hardware leasing activities.
Income from operations
Consolidated income from operations for the three and six months ended June 30,
2002 decreased $6.2 million and $2.6 million, respectively, or 8.0% and 1.7%,
respectively, over the same periods in 2001. U.S. income from operations for the
three and six months ended June 30, 2002 was $62.2 million and $135.8 million,
respectively, a decrease of 10.2% and 1.1%, respectively, over the same periods
in 2001. International income from operations for the three and six months ended
June 30, 2002 was $9.1 million and $16.9 million, respectively, an increase of
13.8% and a decrease of 5.6%, respectively, compared to the same periods in
2001.
17
Financial Services Segment income from operations for the three and six months
ended June 30, 2002 increased 14.1% or $7.8 million and 15.2% or $15.7 million,
respectively, over the comparable prior year periods to $63.1 million and $118.7
million, respectively. This resulted in controllable operating margins (income
from operations divided by operating revenues) of 27.1% and 25.2%, respectively,
for the three and six months ended June 30, 2002, compared to 21.4% and 24.2%
for the comparable prior year periods. The increase in controllable operating
margin resulted primarily from lower EquiServe personnel costs associated with
lower demutualization activity and other cost containment efforts. Excluding PAS
from 2001, income from operations for the three and six months ended June 30,
2002, would have increased 18.6% and 20.3%, respectively.
Output Solutions Segment income from operations for the three and six months
ended June 30, 2002 decreased $11.1 million and $19.4 million, respectively, or
75.0% and 49.1%, respectively, over the same periods in 2001. The operating
income decline resulted primarily from costs of $7.6 million associated with
facility consolidations and, to a lesser extent, decreases in revenue. Output
Solutions Segment controllable operating margin was 2.6% and 6.7%, respectively,
for the three and six months ended June 30, 2002 compared to 9.7% and 12.4%,
respectively, for the same periods in 2001. Excluding the facility consolidation
costs, income from operations for three and six months ended June 30, 2002 would
have decreased $3.5 million or 23.6% and $11.8 million or 29.9%, respectively,
and controllable operating margin would have been 7.9% and 9.3% for the three
and six months ended June 30, 2002, respectively.
Customer Management Segment income from operations totaled $2.0 million and $9.2
million for the three and six months ended June 30, 2002, respectively, a
decrease of 69.7% and 10.7%, respectively, over the comparable prior year
periods. Controllable operating margin was 4.8% and 10.0% for the three and six
months ended June 30, 2002, compared to 12.1% and 10.0% for the comparable prior
year periods.
Investments and Other Segment income from operations totaled $2.5 million and
$4.6 million for the three and six months ended June 30, 2002, as compared to
$0.8 million and $2.4 million for the three and six months ended June 30, 2001.
Interest expense
Interest expense totaled $2.9 million and $5.7 million, respectively, for the
three and six months ended June 30, 2002, an increase from $1.9 million and $3.1
million recorded in the comparable periods in 2001. Average debt balances were
higher in 2002 compared to 2001, primarily as a result of common stock
repurchases and the EquiServe acquisition.
Other income, net
Other income was $10.4 million for the three months ended June 30, 2002,
compared to $7.0 million recorded in the prior year quarter. Second quarter 2002
results include $4.2 million primarily related to interest and dividend income,
$3.9 million related primarily to net gains on securities and a $2.3 million
gain from the sale of the DST Output presort business. Second quarter 2001
results include $3.5 million primarily related to interest and dividend income
and $3.5 million related primarily to net gains on securities.
Other income was $18.4 million for the six months ended June 30, 2002, compared
to $13.6 million recorded in the prior year. Year to date 2002 results include
$8.4 million primarily related to interest and dividend income, $7.8 million
related primarily to net gains on securities and a $2.3 million gain from the
sale of the DST Output presort business. Year to date 2001 results include $6.8
million primarily related to interest and dividend income and $6.8 million
related primarily to net gains on securities.
Gain on sale of PAS
On June 29, 2001, DST sold its PAS business to State Street Corporation ("State
Street"). DST offered PAS services primarily to the U.S. mutual fund industry on
a remote processing basis. DST received, in a taxable transaction, proceeds of
$75.0 million, comprised of approximately 1.5 million shares of State Street
common stock
18
and cash. In conjunction with the transaction, DST agreed to
provide data processing services for PAS and agreed to a non-compete agreement
for a period of five years, for which elements a portion of the purchase price
has been deferred. DST recognized a one-time gain of $20.0 million after taxes,
deferrals and other expenses. DST recorded revenue related to PAS of $9.8
million for the six months ended June 30, 2001.
Equity in earnings of unconsolidated affiliates
Equity in earnings of unconsolidated affiliates totaled $2.6 million and $5.1
million, respectively, for the three and six months ended June 30, 2002 as
compared to $0.3 million and $1.2 million, respectively, for the three and six
months ended June 30, 2001. Increased earnings were recorded at Boston Financial
Data Services due to higher revenues from client additions and reduced operating
expenses obtained from cost containment efforts. International Financial Data
Services, U.K. losses were lower as revenue growth from higher account service
levels were partially offset by higher costs related to the relocation to new
facilities. International Financial Data Services, U.K. results reflect an
increase in accounts serviced to 3.2 million at June 30, 2002, which is 0.1
million or 3.2% above year end 2001 levels and 0.3 million or 10.3% over June
30, 2001 levels. International Financial Data Services, Canada earnings
decreased from lower revenues from client funded development work and increased
costs from operations.
Income taxes
DST's effective tax rate was 34.0% for the quarter and six months ended June 30,
2002, compared to 36.2% for the prior year quarter and 35.8% for the six months
ended June 30, 2001. Excluding the taxes provided on the PAS transaction, the
effective tax rate would have been 35.1% for the quarter and six months ended
June 30, 2001. The 2002 and 2001 tax rates were affected by tax benefits
relating to certain international operations and recognition of state tax
benefits associated with income apportionment rules.
Business Segment Comparisons
FINANCIAL SERVICES SEGMENT
Revenues
Financial Services Segment total revenues for the three and six months ended
June 30, 2002 decreased 11.2% and increased 12.4%, respectively, over the same
periods in 2001 to $272.6 million and $555.1 million, respectively. Financial
Services Segment operating revenues for the three and six months ending June 30,
2002 were $232.9 million and $470.1 million, respectively, a decrease of $25.1
million or 9.7% and an increase of $44.6 million or 10.5%, respectively, over
the prior year periods. U.S. Financial Services operating revenue decreased
10.8% to $207.1 million and increased 13.0% to $423.0 million, respectively, for
the three and six months ended June 30, 2002. EquiServe, acquired in March 2001,
is included in both quarters for 2002 compared to only the second quarter in
2001 and the PAS business, sold in June 2001, is included only in 2001.
Excluding PAS from 2001, operating revenues for three and six months ended would
have decreased 8.0% and increased 13.1%, respectively, over the same periods in
2001. The decrease is primarily from a decrease in EquiServe revenues from lower
demutualization revenues of approximately $15 million, as the Prudential
demutualization is complete, lower revenue from corporate actions (e.g. tenders
and exchanges), lower revenues from slower market activity and a decrease in
Automated Work Distributor ("AWD") license revenue, partially offset by an
increase in mutual fund shareowner accounts processed. U.S. mutual fund
processing revenues for the three and six months ended June 30, 2002 increased
4.0% and 2.9%, respectively, over the prior year periods as shareowner accounts
serviced increased 7.4% from 74.8 million at June 30, 2001 to 80.3 million at
June 30, 2002.
Financial Services Segment operating revenues from international operations for
the three and six months ended June 30, 2002 increased 0.4% to $25.8 million and
decreased 7.6% to $47.1 million, respectively. The changes are primarily from an
increase in investment management processing, AWD license and AWD maintenance
revenues partially offset by lower investment accounting license revenues.
19
Costs and expenses
Segment costs and expenses for the three and six months ended June 30, 2002
decreased 17.0% to $190.1 million and increased 12.9% to $397.4 million over the
comparable periods in 2001. Personnel costs for the three and six months ended
June 30, 2002 decreased 10.6% and increased 13.8%, respectively, over the
comparable prior year periods. Excluding PAS from 2001, costs and expenses would
have decreased 16.0% and increased 13.8%, respectively, and personnel costs
would have decreased 9.5% and increased 15.5%, respectively, for the three and
six months ended June 30, 2002. Costs and expenses decreased for the three month
period, primarily from lower EquiServe personnel costs associated with lower
demutualization activity, other cost containment efforts and the absence of the
PAS business. Costs and expenses increased for the six month period, principally
from the inclusion of EquiServe for both quarters of 2002 partially offset by
lower demutualization costs and cost containment activities.
Depreciation and amortization
Segment depreciation and amortization decreased 14.5% or $3.3 million and
increased 0.3% and $0.1 million, respectively, for the three and six months
ended June 30, 2002 over the comparable periods in 2001. The decrease over prior
year quarter is primarily the result of the required cessation of goodwill
amortization. The increase for the six month period is primarily attributable to
the inclusion of EquiServe for both quarters of 2002, partially offset by the
required cessation of goodwill amortization.
Income from operations
Segment income from operations for the three and six months ended June 30, 2002
increased 14.1% to $63.1 million and 15.2% to $118.7 million, respectively, over
the comparable prior year periods. The Segment's controllable operating margins
were 27.1% and 25.2% for the three and six months ended June 30, 2002 as
compared to 21.4% and 24.2% for the three and six months ended June 30, 2001,
respectively. The increase in controllable operating margin resulted primarily
from cost containment efforts. Excluding PAS from 2001, income from operations
for the three and six months ended June 30, 2002 would have increased 18.6% and
20.3%, respectively.
OUTPUT SOLUTIONS SEGMENT
Revenues
Output Solutions Segment total revenues for the three and six months ended June
30, 2002 decreased 4.6% to $287.4 million and 4.2% to $599.1 million,
respectively, as compared to the same periods in 2001. Output Solutions Segment
operating revenues for the three and six months ended June 30, 2002 decreased
5.9% to $143.7 million and 6.3% to $298.3 million, respectively, as compared to
the same periods in 2001. The revenue decline resulted from the loss of a
telecommunications customer in the fourth quarter 2001, declines in brokerage
related marketing fulfillment and trade confirmation volumes and changes in
statement presentation formats from existing customers which result in lower
revenues, partially offset by increased volumes from the insurance and
healthcare industries and the inclusion of new international operations of $3.8
million.
Costs and expenses
Segment costs and expenses for the three and six months ended June 30, 2002
decreased 1.0% to $274.3 million and 1.2% to $560.8 million, respectively, over
the comparable periods in 2001. Personnel costs for the three and six months
ended June 30, 2002 decreased 10.3% and 9.5% over the comparable prior year
periods. Excluding costs of $7.6 million associated with facility
consolidations, costs and expenses would have decreased 3.8% and 2.6%,
respectively, primarily due to decreased personnel and purchased material costs.
As previously announced, the Company plans to consolidate its operations into
three large facilities and close certain other smaller facilities, which the
Company believes will result in operational efficiencies. The Company recorded
$7.6 million in costs related to the consolidations in the second quarter of
2002. The Company still expects to incur additional charges in future periods
related to facility consolidations at approximately $6 million to $8 million
related to items that are required to be expensed when incurred. The estimated
impact of the facility consolidations reflect the Company's current views. There
may be material differences between these estimates and the actual costs.
20
Depreciation and amortization
Segment depreciation and amortization increased $0.1 million to $9.4 million for
the three months ended June 30, 2002 compared to the prior year. There was no
change for the six months ended June 30, 2002 compared to the same period in
2001.
Income from operations
Segment income from operations for the three and six months ended June 30, 2002
decreased $11.1 million or 75.0% and $19.4 million or 49.1%, respectively, over
the same periods in 2001. Segment controllable operating margins were 2.6% and
6.7% for the three and six months ended June 30, 2002, respectively, as compared
to 9.7% and 12.4% for the three and six months ended June 30, 2001,
respectively. The operating income decline resulted primarily from costs of $7.6
million associated with facility consolidations and, to a lesser extent,
decreases in revenue. Excluding these costs, income from operations for three
and six months ended June 30, 2002 would have decreased $3.5 million or 23.6%
and $11.8 million or 29.9%, respectively, and controllable operating margin
would have been 7.9% and 9.3% for the three and six months ended June 30, 2002,
respectively.
CUSTOMER MANAGEMENT SEGMENT
Revenues
Customer Management Segment total revenues for the three and six months ended
June 30, 2002 decreased 21.3% to $56.7 million and 11.5% to $122.3 million,
respectively, as compared to the same periods in 2001. Customer Management
Segment operating revenues for the three and six months ended June 30, 2002 were
$41.8 million, a decrease of $12.6 million or 23.2%, and $91.9 million, a
decrease of $11.0 million or 10.7%, respectively, over the comparable periods in
2001. Processing and software service revenues decreased to $40.9 million and
$87.2 million, respectively, for the three and six months ended June 30, 2002
from $50.8 million and $97.7 million for the three and six months ended June 30,
2001, respectively. Processing and software service revenues decreased as a
result of the loss of a customer in late 2001, the recognition of certain AWD
license revenue in the second quarter of 2001 and the deferral of approximately
$4.2 million of revenue in the second quarter of 2002 relating to a customer
filing for protection under Chapter 11 of the Bankruptcy Code. Equipment sales
decreased to $0.9 million and $4.7 million for the three and six months ended
June 30, 2002, respectively, from $3.6 million and $5.2 million for the three
and six months ended June 30, 2001, respectively. Total cable and satellite
subscribers serviced were 41.3 million at June 30, 2002, an increase of 1.0%
compared to year end 2001 levels, principally from an increase in U.S. satellite
and international cable subscribers serviced.
As previously announced, the Company has been advised that a customer, Charter
Communications Inc. ("Charter") plans to discontinue its processing agreement.
It is not expected that any substantial portion of Charter's subscribers will be
removed during 2002. At June 30, 2002, the Company serviced approximately 4
million Charter subscribers.
Costs and expenses
Segment costs and expenses for the three and six months ended June 30, 2002
decreased $8.1 million or 13.3% and $9.8 million or 8.2%, respectively, compared
to the same periods in 2001, primarily attributable to lower processing and
hardware costs.
Depreciation and amortization
Segment depreciation and amortization for the three and six months ended June
30, 2002 decreased 57.8% to $1.9 million and 57.5% to $3.7 million,
respectively, compared to the same periods in 2001. The decrease is primarily
from lower capitalized software amortization and the elimination of goodwill
amortization.
Income from operations
Customer Management Segment income from operations for the three and six months
ended June 30, 2002 decreased $4.6 million and $1.1 million, respectively, or
69.7% and 10.7%, respectively, compared to the prior year periods, resulting in
a controllable operating margin of 4.8% and 10.0% for the three and six months
ended June 30, 2002, respectively, as compared to 12.1% and 10.0% for three and
six months ended June 30, 2001, respectively.
21
INVESTMENTS AND OTHER SEGMENT
Revenues
Investments and Other Segment total revenues were $14.2 million and $27.3
million for the three and six months ended June 30, 2002, respectively, an
increase of $4.2 million and $8.1 million, respectively, as compared to the
prior year periods. Investments and Other Segment operating revenues were $14.0
million and $27.0 million for the three and six months ended June 30, 2002,
respectively, an increase of $4.1 million and $8.0 million, respectively, as
compared to prior year periods. The increase is primarily attributable to
increased real estate leasing activity.
Costs and expenses
Segment costs and expenses increased $2.3 million and $5.3 million for the three
and six months ended June 30, 2002, respectively, as compared to the three and
six months ended June 30, 2001 primarily as a result of additional real estate
activities.
Depreciation and amortization
Segment depreciation and amortization increased $0.2 million and $0.6 million
for the three and six months ended June 30, 2002, respectively, over the same
periods in 2001.
Income from operations
The Segment's income from operations totaled $2.5 million and $4.6 million for
the three and six months ended June 30, 2002, respectively, as compared to $0.8
million and $2.4 million for the three and six months ended June 30, 2001,
principally from higher revenues.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash flow from operating activities totaled $178.9 million for the
six months ended June 30, 2002. Operating cash flows for the six months ended
June 30, 2002 were primarily caused by net income of $112.5 million and
depreciation and amortization of $66.2 million.
Cash flows used in investing activities totaled $142.2 million for the six
months ended June 30, 2002. The Company expended $123.2 million during the six
months ended June 30, 2002 for capital additions. The Company made $27.2 million
of investments in available-for-sale securities and other investments. During
the six months ended June 30, 2002, the Company received $23.5 million from the
sale of investments in available-for-sale securities and $6.5 million from the
sale of investment in unconsolidated affiliates and other.
Cash flows used in financing activities totaled $59.1 million for the six months
ended June 30, 2002. The Company received proceeds from the issuance of common
stock of $16.7 million for the six months ended June 30, 2002. In December 2001,
the Company entered into a $285 million (increased to $315 million in February
2002) unsecured revolving credit facility with a syndicate of U.S. and
international banks. The $315 million facility is comprised of a $210 million
three-year facility and a $105 million 364-day facility. The $315 million
revolving credit facility replaced the Company's previous $125 million five year
revolving credit facility and $120 million 364-day revolving credit facility. At
June 30, 2002, there was $160.0 million outstanding under the $315 million
revolving credit facility, and net borrowings totaled $47.0 million for the six
months ended June 30, 2002.
One of the Company's subsidiaries maintains a 364-day $50 million line of credit
for working capital requirements and general corporate purposes. The line of
credit is scheduled to mature May 2003. Net additional borrowings under this
facility totaled $1.9 million for the six months ended June 30, 2002, bringing
total net borrowings under this facility to $44.9 million at June 30, 2002.
On August 2, 2002, DST Systems, Inc. announced the acquisition of the operations
of lock\line, LLC ("lock\line") for cash. lock\line provides administrative
services to support insurance programs for wireless communication devices,
extended warranty programs for land line telephone and consumer equipment and
event based debt protection programs. lock\line is headquartered in the Kansas
City area. lock\line revenues for its fiscal year ended April 30,
22
2002 were approximately $51 million. lock\line will be included in the
Financial Services Segment for financial reporting purposes. The transaction
is expected to be accretive to diluted earnings per share.
The acquisition was accounted for as a purchase and the results of lock\line's
operations will be included in DST's 2002 consolidated financial statements
beginning August 2, 2002. The minimum purchase price of $190 million was paid
in cash at closing. The purchase price was funded by the Company's $315 million
syndicated line of credit and a $100 million term bridge loan, which expires on
December 30, 2002, and has essentially the same terms and financial covenants as
the $315 million syndicated line of credit. There are provisions in the
acquisition agreement that allow for additional consideration to be paid in cash
if lock\line revenues, as defined in the acquisition agreement, exceed certain
targeted levels for 2003 and 2004. Goodwill will be increased by the amount of
additional consideration paid. This goodwill will not be subject to amortization
per Statement of Financial Accounting Standard ("SFAS") No. 142.
lock\line's revenues for the year ended December 31, 2001 were $41.3 million and
for the six months ended were $32.5 million. Assuming the acquisition had
occurred January 1, 2001, the Company's consolidated operating revenues for the
three and six months ended June 30, 2002 would have been $419.8 million and
$862.0 million, respectively, and $1,701.3 million for the year ended December
31, 2001. Consolidated proforma net income and earnings per share would not have
been materially different from the reported amounts for 2002 and 2001. Such
unaudited proforma amounts are not indicative of what actual consolidated
results of operations might have been if the acquisition had been effective at
the beginning of 2001.
Subsequent to quarter end, DST exercised its contractual rights to acquire
additional shares of voting common stock of Wall Street Access for approximately
$16 million. DST now has a 20% interest in Wall Street Access.
On March 30, 2001, DST completed the acquisition of a 75% interest in EquiServe
by purchasing interests held by FleetBoston Financial ("FleetBoston") and Bank
One Corporation ("Bank One"). On July 31, 2001, DST completed the acquisition of
the remaining 25%, which was owned by Boston Financial Data Services, on
essentially the same terms provided to FleetBoston and Bank One. EquiServe is
one of the nation's largest corporate transfer agency service providers,
maintaining and servicing the records of approximately 26.3 million shareholder
accounts for approximately 1,400 publicly traded companies.
The acquisitions were accounted for as a purchase and the results of EquiServe's
operations are included in DST's 2001 consolidated financial statements
beginning March 30, 2001. The minimum purchase price of $186.7 million is to be
paid in four installments. The first installments of approximately $58.5 million
were paid at the closings. The second installments of $55.8 million were paid on
March 8, 2002. The remaining two minimum installments, which total approximately
$72.4 million (discounted to $65.2 million for accounting purposes) are payable
on February 28, 2003 and February 28, 2004. The remaining minimum purchase price
installments can increase pursuant to a formula that provides for additional
consideration to be paid in cash if EquiServe's revenues, as defined in the
agreements, for the years ending 2000, 2001, 2002 and 2003 exceed certain
targeted levels. The minimum purchase price (discounted to $177.3 million for
accounting purposes) has been allocated to the net assets acquired based upon
their fair values as determined by a valuation. Goodwill will be increased by
the amount of contingent consideration paid. This goodwill will not be subject
to amortization in accordance with SFAS No. 142.
Assuming the acquisition had occurred January 1, 2001, consolidated total
revenues would have been $723.5 million or $1,262.2 million, respectively, and
consolidated operating revenues would have been $533.5 million or $903.1
million, respectively, for the three and six months ended June 30, 2001.
Consolidated proforma net income and earnings per share would not have been
materially different from the reported amounts for 2001. The unaudited proforma
amounts are not indicative of what actual consolidated results of operations
might have been if the acquisition had been effective at the beginning of 2001.
In December 2001, the Company entered into a $285 million (increased to $315
million in February 2002) unsecured revolving credit facility with a syndicate
of U.S. and international banks. The $315 million facility is comprised of a
$210 million three-year facility and a $105 million 364-day facility. Borrowings
under the facility are available at rates based on the offshore (LIBOR), Federal
Funds or prime rates. An annual facility fee of 0.1%
23
to 0.125% is required on the total facility. An additional utilization fee
of 0.125% is required if the aggregate principal amount outstanding plus letter
of credit obligations exceeds 33% of the total facility. The revolving credit
facility has a grid that adjusts borrowing costs up or down based upon
applicable credit ratings. The Company has not obtained a credit rating and,
accordingly, is not subject to the grid. In the event the Company obtains a
credit rating, the grid would become operable and may result in fluctuations
in borrowing costs. Among other provisions, the revolving credit facility
limits consolidated indebtedness, subsidiary indebtedness, asset dispositions
and requires certain coverage ratios to be maintained. In addition, the Company
is limited, on an annual basis, to making dividends or repurchasing its capital
stock in any fiscal year in an amount not to exceed 20% of consolidated net
tangible assets. In the event of default, which includes, but is not limited
to, a default in performance of covenants, default in payment of principal of
loans or change of control, as defined, the syndicated lenders may elect to
declare the principal and interest under the syndicated line of credit as due
and payable and in certain situations automatically terminate the syndicated
line of credit. In the event the Company experiences a material adverse change,
as defined in the revolving credit facility, the lenders may not be required to
make additional loans under the facility.
One of the Company's subsidiaries maintains a 364-day $50 million line of credit
for working capital requirements and general corporate purposes. The line of
credit is scheduled to mature May 2003. Borrowings under the facility are
available at rates based on the Euro dollar, fed funds or LIBOR rates.
Commitment fees of 0.1% to 0.2% per annum on the unused portions are payable
quarterly. Among other provisions, the agreement requires the subsidiary to
maintain unencumbered liquid assets and stockholder's equity of at least $300
million and to maintain certain interest coverage ratios. In the event of
non-compliance, an event of default may occur, which could result in the loan
become immediately due and payable.
During the second quarter and six months ended June 30, 2002, the Company
purchased 1.3 million and 1.4 million shares, respectively, of its common stock
under previously announced share repurchase programs for $55.4 million and $56.4
million, respectively. The purchase of the shares was financed from cash flow
from operations and borrowings under the Company's syndicated line of credit.
The shares purchased will be utilized for DST's stock award, employee stock
purchase and stock option programs and for general corporate purposes. As of
June 30, 2002, DST has purchased 14.8 million shares since the programs
commenced.
The Company has entered into forward stock purchase agreements for the
repurchase of its common stock as a means of securing potentially favorable
prices for future purchases of its stock. As of June 30, 2002, the Company had
one outstanding forward stock purchase agreement; the cost to settle the
agreement would be approximately $57.9 million for approximately 1.3 million
shares of common stock. The agreement, which expires in June 2003,
allows the Company to elect net cash or net share settlement in lieu of
physical settlement of the shares.
Subsequent to June 30, 2002, the Company entered into an additional forward
stock purchase agreement. This agreement, which expires in September 2002,
allows the Company to elect net cash or net share settlement in lieu of physical
settlement of the shares. The cost to settle this agreement would be
approximately $100.1 million for approximately 3.0 million shares of common
stock.
The Company believes that its existing cash balances and other current assets,
together with cash provided by operating activities and, as necessary, the
Company's bank and revolving credit facilities, will suffice to meet the
Company's operating and debt service requirements and other current liabilities
for at least the next 12 months. Further, the Company believes that its longer
term liquidity and capital requirements will also be met through cash provided
by operating activities and bank credit facilities.
OTHER
Comprehensive income. The Company's comprehensive losses totaled $46.1 million
and comprehensive income totaled $42.8 million for the three and six months
ended June 30, 2002, respectively, compared to comprehensive income of $116.4
million and comprehensive losses of $88.2 million, respectively, for the
comparable periods in 2001. Comprehensive income consists of net income of $53.7
million and $112.5 million and other comprehensive losses of $99.8 million and
$69.7 million for the three and six months ended June 30, 2002, respectively,
and net income
24
of $73.8 million and $128.3 million and other comprehensive income of $42.6 and
other comprehensive losses of $216.5 million for the three and six months ended
June 30, 2001, respectively. Other comprehensive income consists of unrealized
gains (losses) on available-for-sale securities, net of deferred taxes,
reclassifications for gains included in net income and foreign currency
translation adjustments. The principal difference between net income and
comprehensive net income is the net change in unrealized gains (losses) on
available-for-sale securities.
Seasonality. Generally, the Company does not have significant seasonal
fluctuations in its business operations. Processing and output volumes for
mutual fund customers are usually highest during the quarter ended March 31 due
primarily to processing year-end transactions and printing and mailing of
year-end statements and tax forms during January. The Company has historically
added operating equipment in the last half of the year in preparation for
processing year-end transactions which has the effect of increasing costs for
the second half of the year. Software license revenues and operating results are
dependent upon the timing, size and terms of the license.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
In the operations of its businesses, the Company's financial results can be
affected by changes in equity pricing, interest rates and currency exchange
rates. Changes in interest rates and exchange rates have not materially impacted
the consolidated financial position, results of operations or cash flows of the
Company. Changes in equity values of the Company's investments have had a
material effect on the Company's comprehensive income and financial position.
Available-for-sale equity price risk
The Company's investments in available-for-sale equity securities are subject to
price risk. The fair value of the Company's available-for-sale investments as of
June 30, 2002 was approximately $1,138 million. The impact of a 10% change in
fair value of these investments would be approximately $69 million to
comprehensive income. As discussed under "Comprehensive Income" above, net
unrealized gains on the Company's investments in available-for-sale securities
have had a material effect on the Company's comprehensive income and financial
position.
Interest rate risk
The Company derives a certain amount of its service revenues from investment
earnings related to cash balances maintained in transfer agency customer bank
accounts that the Company is agent to. The balances maintained in the bank
accounts are subject to fluctuation. At June 30, 2002, there was approximately
$1.3 billion of cash balances maintained in such accounts. The Company estimates
that a 50 basis point change in interest earnings rate would be approximately
$4.2 million of net income.
At June 30, 2002, the Company had $302.2 million of debt, of which $210.2
million was subject to variable interest rates (Federal Funds rates, LIBOR
rates, Prime rates). The Company estimates that a 10% increase in interest rates
would not be material to the Company's consolidated pretax earnings or to the
fair value of its debt.
Foreign currency exchange rate risk
The operation of the Company's subsidiaries in international markets results
in exposure to movements in currency exchange rates. The principal currencies
involved are the British pound, Canadian dollar and Australian dollar. Currency
exchange rate fluctuations have not historically materially affected the
consolidated financial results of the Company.
The Company's international subsidiaries use the local currency as the
functional currency. The Company translates all assets and liabilities at
year-end exchange rates and income and expense accounts at average rates during
the year. While it is generally not the Company's practice to enter into
derivative contracts, from time to time the Company and its subsidiaries do
utilize forward foreign currency exchange contracts to minimize the impact of
currency movements.
25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is from time to time a party to litigation arising in the ordinary
course of its business. Currently, there are no legal proceedings that
management believes would have a material adverse effect upon the consolidated
results of operations or financial condition of the Company.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Stockholders on May 14, 2002. Proxies for
the meeting were solicited pursuant to Regulation 14A; there was no solicitation
in opposition to management's nominees for directors as listed in such Proxy
Statement and all such nominees were elected. Listed below is each matter voted
on at the Company's Annual Meeting. Each of these matters is fully described in
the Company's Definitive Proxy Statement dated March 28, 2002. A total of
115,811,916 shares of Common Stock, or 96.0% of the shares of Common Stock
outstanding on the record date, were present in person or by proxy at the annual
meeting. These shares were voted on the following matters as follows:
1) Election of two directors for terms ending in 2005:
Thomas A. M. Jeannine
McDonnell Strandjord
---------------- ----------------
For 115,370,617 115,189,527
Withheld 441,299 622,389
---------------- ----------------
Total 115,811,916 115,811,916
================ ================
The terms of office of Directors Thomas A. McCullough, William C. Nelson and
Travis E. Reed will expire at the Annual Meeting of Stockholders in 2003. The
terms of office of Directors A. Edward Allinson and Michael G. Fitt will expire
at the Annual Meeting of Stockholders in 2004.
2) Approval of amendment of DST Systems, Inc. 1995 Stock Option and
Performance Award Plan:
For 79,989,398
Against 35,627,181
Withheld 195,337
----------------
Total 115,811,916
================
Based upon votes required for approval, each of these matters passed.
If a stockholder desires to have a proposal included in DST's Proxy Statement
for the annual meeting of stockholders to be held in 2003, the Corporate
Secretary of DST must receive such proposal on or before November 28, 2002, and
the proposal must comply with the applicable SEC laws and rules and the
procedures set forth in the DST By-laws.
26
Item 5. Other Information
The following table presents operating data for the Company's operating business
segments:
June 30, December 31,
2002 2001
--------------- ---------------
Financial Services Operating Data
Mutual fund shareowner accounts processed (millions)
U.S.
Non-retirement accounts 50.8 49.0
IRA mutual fund accounts 19.5 18.5
TRAC mutual fund accounts 8.6 7.4
Section 529 savings plan accounts 1.4 0.7
--------------- ---------------
80.3 75.6
=============== ===============
International
United Kingdom (1) 3.2 3.1
Canada (2) 1.7 1.7
Security transfer processed accounts (millions) 27.1 27.8
TRAC participants (millions) 2.5 2.5
Automated Work Distributor workstations (thousands) 90.6 85.5
Customer Management Operating Data
Video/broadband/satellite TV subscribers processed (millions)
U.S. 33.0 32.7
International 8.3 8.2
For the Six Months
Ended June 30,
2002 2001
--------------- ---------------
Output Solutions Operating Data
Images produced (millions) 4,304 3,989
Items mailed (millions) 895 970
(1) Processed by International Financial Data Services, U.K., an unconsolidated
affiliate of the Company.
(2) Processed by International Financial Data Services, Canada, an
unconsolidated affiliate of the Company.
27
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
10.6 The Company's Supplemental Executive Retirement Plan effective
January 1, 1999 as amended and restated as of May 14, 2002, is
attached hereto as Exhibit 10.6.
(b) Reports on Form 8-K:
The Company furnished under Item 9 of Form 8-K, the Company's Form 8-K
dated April 24, 2002, reporting the announcement of financial results
for the quarter ended March 31, 2002.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized, and in the capacities indicated, on August 14, 2002.
DST Systems, Inc.
/s/ Kenneth V. Hager
- ---------------------------------------------
Kenneth V. Hager
Vice President, Chief Financial Officer and Treasurer
(Principal Financial Officer)
28