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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 September 30, 2002

OR

o   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.

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    o  

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.

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 September 30, 2002 and December 31, 2001, and the results of operations for the three and nine months ended September 30, 2002 and 2001 and cash flows for the nine months ended September 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 nine months ended September 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. Recent Acquisitions

lock\line, LLC
On August 2, 2002, DST Systems, Inc. acquired lock\line, LLC and certain of its affiliates (“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 is 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 are 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 which was financed by debt. There are provisions in the acquisition agreement that

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allow for additional consideration to be paid in cash if lock\line’s 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. The following amounts are subject to adjustment upon completion of the valuation of identifiable intangible assets.

The intangible assets principally represent customer relationships, which will be amortized over 20 years.

lock\line’s operating revenues for the year ended December 31, 2001 were $41.3 million and for the nine months ended September 30, 2002 were $51.7 million. Assuming the acquisition had occurred January 1, 2001, the Company’s consolidated operating revenues for the three and nine months ended September 30, 2002 would have been $411.0 million and $1,273.0 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”)
In July 2002, 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

As previously announced, the Output Solutions segment is consolidating its operations into three primary facilities and is closing certain other smaller facilities, which it believes will result in operational efficiencies. The segment recorded costs associated with facility consolidations of $1.4 million and $9.0 million, respectively, for the three and nine months ended September 30, 2002. Additional charges of $4 million to $6 million related to facility consolidations will be expensed when incurred. The Company estimates that when fully implemented, the annualized savings will be approximately $12 million. There may be material differences between these estimates and actual costs.

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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 essentially the same terms provided to FleetBoston and Bank One.

A restructuring provision of $15.9 million was recorded for employee severances and supplier contract termination costs related to the acquisition. The Company utilized $3.9 million and $5.6 million in the three and nine months ended September 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 400 employees have been separated from the Company as of September 30, 2002. The remaining employee severances of approximately $4.9 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.

5. Investments

Investments are as follows (in millions):

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Certain information related to the Company’s available-for-sale securities is as follows (in millions):

The Company realized $3.3 million and $3.5 million of investment impairments for the three and nine months ended September 30, 2002. Investment impairments for the 2001 comparable periods were not significant. A decline in a security’s net realizable value that is other than temporary is treated as a realized loss in the statement of operations and the cost basis of the security is reduced to its estimated fair value.

The following table summarizes equity in earnings (losses) of unconsolidated affiliates (in millions):

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”) 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.

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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 (in millions, except per share amounts):