Attached files

file filename
EX-32.0 - EXHIBIT 32.0 - DST SYSTEMS INCdstex32-9302016.htm
EX-31.2 - EXHIBIT 31.2 - DST SYSTEMS INCdstex312-9302016.htm
EX-31.1 - EXHIBIT 31.1 - DST SYSTEMS INCdstex311-9302016.htm


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, 2016
 
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
 dstlogoa04.jpg
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 registrant (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 registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
 
Number of shares outstanding of the Company’s common stock as of October 31, 2016:
Common Stock $0.01 par value — 31,986,430





DST Systems, Inc.
Form 10-Q
September 30, 2016
Table of Contents
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The brand, service or product names or marks referred to in this Report are trademarks or service marks, registered or otherwise, of DST Systems, Inc. or its consolidated subsidiaries.


2


PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements
DST Systems, Inc.
Condensed Consolidated Balance Sheet
(in millions, except per share amounts)
(unaudited)
 
September 30,
2016
 
December 31,
2015
Assets
 

 
 

Current assets
 

 
 

Cash and cash equivalents
$
180.9

 
$
79.5

Funds held on behalf of clients
312.3

 
480.2

Client funding receivable
60.7

 
53.2

Accounts receivable
204.0

 
214.8

Other assets
48.1

 
49.8

Current assets held for sale
95.2

 
178.0

 
901.2

 
1,055.5

 
 
 
 
Investments
372.1

 
418.2

Unconsolidated affiliates
338.2

 
312.2

Properties, net
236.7

 
256.7

Intangible assets, net
146.9

 
135.8

Goodwill
518.0

 
458.3

Other assets
52.2

 
57.0

Noncurrent assets held for sale

 
119.5

Total assets
$
2,565.3

 
$
2,813.2

 
 
 
 
Liabilities
 

 
 

Current liabilities
 

 
 

Current portion of debt
$
194.1

 
$
5.6

Client funds obligations
373.0

 
533.4

Accounts payable
60.6

 
51.2

Accrued compensation and benefits
95.4

 
126.5

Deferred revenues and gains
25.9

 
50.4

Income taxes payable
77.0

 

Other liabilities
74.6

 
66.2

Current liabilities held for sale
27.9

 
115.4

 
928.5

 
948.7

 
 
 
 
Long-term debt
234.6

 
556.5

Income taxes payable
70.9

 
73.8

Deferred income taxes
129.8

 
104.7

Other liabilities
22.6

 
23.9

Noncurrent liabilities held for sale

 
44.5

Total liabilities
1,386.4

 
1,752.1

 
 
 
 
Commitments and contingencies (Note 11)


 


 
 
 
 
Redeemable Non-controlling Interest
21.4

 
15.1

 
 
 
 
Stockholders’ Equity
 

 
 

Preferred stock, $0.01 par; 10 million shares authorized and unissued

 

Common stock, $0.01 par; 400 million shares authorized, 50.0 million shares issued
0.5

 
0.5

Additional paid-in capital
128.9

 
136.7

Retained earnings
2,347.2

 
1,996.6

Treasury stock (17.3 million and 15.7 million shares, respectively), at cost
(1,336.2
)
 
(1,129.7
)
Accumulated other comprehensive income
17.1

 
41.9

Total stockholders’ equity
1,157.5

 
1,046.0

Total liabilities, redeemable non-controlling interest and stockholders’ equity
$
2,565.3

 
$
2,813.2

 

The accompanying notes are an integral part of these financial statements.
3


DST Systems, Inc.
Condensed Consolidated Statement of Income
(in millions, except per share amounts)
(unaudited)
 
 
 
 
 
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Operating revenues
$
365.5

 
$
353.4

 
$
1,100.7

 
$
1,042.7

Out-of-pocket reimbursements
21.2

 
18.2

 
57.2

 
48.1

Total revenues
386.7

 
371.6

 
1,157.9

 
1,090.8

 
 
 
 
 
 
 
 
Costs and expenses
289.6

 
287.1

 
916.9

 
854.3

Depreciation and amortization
22.8

 
22.9

 
69.1

 
66.0

Operating income
74.3

 
61.6

 
171.9

 
170.5

 
 
 
 
 
 
 
 
Interest expense
(5.4
)
 
(5.8
)
 
(18.0
)
 
(17.7
)
Other income, net
6.7

 
14.4

 
20.0

 
189.9

Equity in earnings of unconsolidated affiliates
7.0

 
11.8

 
23.9

 
39.2

Income from continuing operations before income taxes and non-controlling interest
82.6

 
82.0

 
197.8

 
381.9

 
 
 
 
 
 
 
 
Income taxes
31.6

 
15.9

 
73.8

 
127.2

Income from continuing operations before non-controlling interest
51.0

 
66.1

 
124.0

 
254.7

 
 
 
 
 
 
 
 
Income from discontinued operations, net of tax
222.8

 
9.0

 
260.0

 
35.7

Net income
273.8

 
75.1

 
384.0

 
290.4

 
 
 
 
 
 
 
 
Net (income) loss attributable to non-controlling interest
(0.5
)
 

 
0.4

 

Net income attributable to DST Systems, Inc.
$
273.3

 
$
75.1

 
$
384.4

 
$
290.4

 
 
 
 
 
 
 
 
Weighted average common shares outstanding
32.7

 
35.7

 
33.3

 
36.5

Weighted average diluted shares outstanding
33.0

 
36.2

 
33.6

 
36.9

 
 
 
 
 
 
 
 
Basic earnings per share:
 
 
 
 
 
 
 
Continuing operations attributable to DST Systems, Inc.
$
1.54

 
$
1.85

 
$
3.74

 
$
6.98

Discontinued operations
6.81

 
0.25

 
7.82

 
0.98

Basic earnings per share
$
8.35

 
$
2.10

 
$
11.56

 
$
7.96

 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
Continuing operations attributable to DST Systems, Inc.
$
1.53

 
$
1.83

 
$
3.70

 
$
6.90

Discontinued operations
6.75

 
0.25

 
7.73

 
0.97

Diluted earnings per share
$
8.28

 
$
2.08

 
$
11.43

 
$
7.87

 
 
 
 
 
 
 
 
Cash dividends per share of common stock
$
0.33

 
$
0.30

 
$
0.99

 
$
0.90

 
The accompanying notes are an integral part of these financial statements.


4


DST Systems, Inc.
Condensed Consolidated Statement of Comprehensive Income
(in millions)
(unaudited)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Net income attributable to DST Systems, Inc.
$
273.3

 
$
75.1

 
$
384.4

 
$
290.4

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax and reclassifications to earnings, derived from:
 

 
 

 
 

 
 

Available-for-sale securities
21.7

 
(20.3
)
 
(0.7
)
 
(123.8
)
Cash flow hedges

 
(0.3
)
 
0.2

 
(0.1
)
Foreign currency translation adjustments
(1.1
)
 
(6.4
)
 
(24.3
)
 
(10.8
)
Other comprehensive income (loss)
20.6

 
(27.0
)
 
(24.8
)
 
(134.7
)
 
 
 
 
 
 
 
 
Comprehensive income
$
293.9

 
$
48.1

 
$
359.6

 
$
155.7

 
The accompanying notes are an integral part of these financial statements.


5


DST Systems, Inc.
Condensed Consolidated Statement of Cash Flows
(in millions)
(unaudited)
 
Nine Months Ended
 
September 30,
 
2016
 
2015
Cash flows — operating activities:
 

 
 

Net income
$
384.0

 
$
290.4

Less: income from discontinued operations
260.0

 
35.7

Income from continuing operations
124.0

 
254.7

Depreciation and amortization
69.1

 
66.0

Net gains on investments
(2.8
)
 
(161.1
)
Gain on sale of properties

 
(3.5
)
Amortization of share-based compensation
11.0

 
18.8

Equity in earnings of unconsolidated affiliates
(23.9
)
 
(39.2
)
Cash dividends from unconsolidated affiliates
0.3

 
3.4

Deferred income taxes
(0.1
)
 
(6.3
)
Changes in accounts receivable
1.3

 
(13.1
)
Changes in other assets
(0.9
)
 
5.5

Changes in accounts payable and accrued liabilities
11.6

 
(7.4
)
Changes in income taxes payable
8.2

 
(34.9
)
Changes in deferred revenues and gains
(10.0
)
 
(7.9
)
Changes in accrued compensation and benefits
(32.4
)
 
(25.8
)
Other, net
(7.8
)
 
18.5

Net cash provided from continuing operating activities
147.6

 
67.7

Net cash provided from discontinued operating activities
14.1

 
64.5

Net cash provided from operating activities
161.7

 
132.2

 
 
 
 
Cash flows — investing activities:
 

 
 

Cash paid for capital expenditures
(42.7
)
 
(74.3
)
Investments in securities
(198.3
)
 
(67.4
)
Proceeds from (advances to) unconsolidated affiliates
(25.0
)
 
10.4

Proceeds from sales/maturities of investments
257.5

 
264.5

Net change in funds held to satisfy client funds obligations
167.9

 
157.2

Proceeds from sale of properties
5.7

 
4.9

Acquisition of businesses, net of cash and cash equivalents acquired
(93.5
)
 
(117.4
)
Proceeds from sale of business, net of cash and cash equivalents sold
9.5

 
7.9

Other, net
1.0

 
0.2

Net cash provided from continuing investing activities
82.1

 
186.0

Net cash provided from (used in) discontinued investing activities
409.4

 
(19.4
)
Net cash provided from investing activities
491.5

 
166.6

 
 
 
 
Cash flows — financing activities:
 

 
 

Proceeds from issuance of common stock
4.6

 
8.1

Principal payments on debt
(4.9
)
 
(44.8
)
Net borrowings (repayments) on revolving credit facilities
(216.1
)
 
233.3

Net borrowings on accounts receivable securitization program
88.6

 
30.0

Net change in client funds obligations
(167.9
)
 
(157.2
)
Common stock repurchased
(240.7
)
 
(330.2
)
Payment of cash dividends
(32.8
)
 
(32.8
)

The accompanying notes are an integral part of these financial statements.
6


DST Systems, Inc.
Condensed Consolidated Statement of Cash Flows (continued)
(in millions)
(unaudited)
 
Nine Months Ended
 
September 30,
 
2016
 
2015
Excess tax benefits from share-based compensation
3.7

 
3.9

Receipt of third party capital in investment fund
6.7

 

Other, net

 
(2.2
)
Net cash used for continuing financing activities
(558.8
)
 
(291.9
)
Net cash used for discontinued financing activities

 
(6.1
)
Net cash used for financing activities
(558.8
)
 
(298.0
)
 
 
 
 
Net increase in cash and cash equivalents, including cash within assets held for sale
94.4

 
0.8

Cash and cash equivalents, beginning of period
89.6

 
151.7

Cash and cash equivalents, end of period
184.0

 
152.5

 
 
 
 
Less: cash and cash equivalents held for sale
3.1

 
9.1

Cash and cash equivalents of continuing operations, end of period
$
180.9

 
$
143.4





The accompanying notes are an integral part of these financial statements.
7

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)


1. Summary of Accounting Policies
 
The Condensed Consolidated Financial Statements of DST Systems, Inc. and consolidated subsidiaries (“we,” “our,” “us,” the “Company” or “DST”) 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 (“GAAP”) have been condensed or omitted pursuant to such rules and regulations, although we believe 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 our audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
 
Certain amounts in the 2015 financial statements have been reclassified to conform to the 2016 presentation. On July 1, 2016, we completed the sale of our North American Customer Communications business. Additionally, during the second quarter 2016, our Board of Directors approved a plan for management to pursue the divestiture of our United Kingdom Customer Communications business. As a result, beginning in the second quarter 2016, the Customer Communications segment, as well as certain businesses previously reported within the Financial Services segment that were part of the July 1, 2016 sale, have been reported as discontinued operations. Prior period amounts have been adjusted to be consistent with the current discontinued operations presentation. See Note 3, Discontinued Operations, for additional information.

In the opinion of management, the accompanying unaudited Condensed Consolidated Financial Statements contain all adjustments (consisting only of normal recurring adjustments) necessary to fairly state the consolidated financial position and the results of operations, comprehensive income and cash flows for the periods presented. The results of operations for the three and nine months ended September 30, 2016 are not necessarily indicative of the results to be expected for the full year 2016.

New authoritative accounting guidance
 
In October 2016, the Financial Accounting Standards Board (“FASB”) issued guidance which requires the recognition of income tax consequences for intra-entity transfers of assets other than inventory. The guidance is effective January 1, 2018 and requires modified retrospective application. Early adoption is permitted. We are currently evaluating the standard and the impact it will have on our consolidated financial statements.
In August 2016, the FASB issued guidance which reduces diversity in practice in how certain transactions are presented and classified in the statement of cash flows. The guidance is effective January 1, 2018 with early adoption permitted. We do not expect the adoption of this new standard to have a material impact on our consolidated financial statements.
In March 2016, the FASB issued guidance which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification of related amounts within the statement of cash flows. The guidance is effective January 1, 2017, with early adoption permitted. We are currently evaluating the standard and the impact it will have on our consolidated financial statements; however, we do expect increased volatility in earnings as the excess tax benefits driven by changes in our stock price will be recorded to the Consolidated Statement of Income upon adoption.
In February 2016, the FASB issued its final lease accounting standard which requires lessees to reflect most leases on their balance sheet as assets and obligations. The guidance is effective January 1, 2019 with early adoption permitted. The standard is to be applied under the modified retrospective method, with elective reliefs, which requires application of the new guidance for all periods presented. We are currently evaluating the standard and the impact it will have on our consolidated financial statements and related disclosures.

In January 2016, the FASB issued guidance which updates the reporting model for certain financial instruments, including the requirement for equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. The guidance is effective January 1, 2018 and requires a cumulative-effective adjustment as of the beginning of the fiscal year of adoption. Early adoption is permitted as of the beginning of the fiscal year of adoption. We are currently evaluating the standard and the impact it will have on our consolidated financial statements.



8

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


In September 2015, the FASB issued guidance which requires that an acquirer recognize adjustments to provisional amounts in a business combination that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. Effects on earnings as a result of the change to the provisional amounts should be recorded in the same period’s financial statements and calculated as if the accounting had been completed at the acquisition date. The guidance was adopted on January 1, 2016 and did not have a material impact on our consolidated financial statements.

In February 2015, the FASB issued guidance which changes the way reporting enterprises evaluate whether (a) they should consolidate limited partnerships and similar entities, (b) fees paid to a decision maker or service provider are variable interests in a Variable Interest Entity (“VIE”), and (c) variable interests in a VIE held by related parties of the reporting enterprise require the reporting enterprise to consolidate the VIE. It also eliminates the VIE consolidation model based on majority exposure to variability that applied to certain investment companies and similar entities. In connection with the adoption of the guidance on January 1, 2016, the Company reevaluated all of its investment products for consolidation and determined that certain of its investments in private equity funds met the definition of a VIE as our equity interests lacked the characteristics of a controlling financial interest. The revised consolidation guidance did not result in consolidation of any of our investments. See Note 4, Investments, for additional details regarding our investments in variable interest entities.

In May 2014, the FASB issued guidance which requires companies to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration it expects to be entitled in exchange for those goods or services. The new standard and subsequently issued amendments will become effective for us beginning with the first quarter 2018 and may be adopted either retrospectively to each prior reporting period presented or as a cumulative effect adjustment as of the date of adoption. Early adoption of this standard is permitted as of January 2017. We are currently evaluating the standard, including which transition approach will be applied and the estimated impact it will have on our consolidated financial statements.

2. Significant Business Acquisitions

Acquisition of Kaufman Rossin Fund Services LLC

On February 24, 2016, we acquired all of the membership interests of Kaufman Rossin Fund Services LLC (“KRFS”) for $94.7 million in cash, after giving effect to a $0.3 million adjustment agreed upon in June 2016 to settle working capital under the provisions of the purchase agreement. DST financed the acquisition through cash-on-hand and available lines of credit. KRFS is a full-service provider of specialized hedge fund administration services to the global financial community. KRFS’ hedge fund services include accounting and valuation, back-office outsourcing, investor services, treasury services and customized reporting. We expect the acquisition to provide us with additional opportunities within the alternative investment marketplace and to expand our asset administration service offerings. KRFS is included within the Financial Services segment.

The factors described above, combined with the synergies expected from combining our operations with the acquired entity and the resulting expansion of the service offerings available to our clients, are the basis for the acquisition price paid resulting in $61.0 million of goodwill recorded, all of which is expected to be deductible for tax purposes.
The transaction was accounted for using the acquisition method of accounting, and as such, assets acquired, liabilities assumed, and consideration transferred were recorded at their estimated fair values on the acquisition date.



9

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


The following table summarizes the aggregate acquisition-date fair value of the consideration transferred for the acquisition of KRFS and the amounts recognized as of the acquisition date for the assets acquired and liabilities assumed (in millions):

Consideration
 
Cash paid
$
94.7

 
 
Recognized amounts of identifiable assets acquired and liabilities assumed
 
Cash and cash equivalents
$
1.0

Accounts receivable
2.9

Other current assets
0.1

Investments
0.5

Properties (1)
6.8

Intangible assets
23.4

Goodwill
61.0

Total assets
95.7

 
 
Deferred revenue
0.6

Other current liabilities
0.4

Total liabilities
1.0

Net assets acquired
$
94.7

_____________________________________________________
(1) Includes $6.5 million of acquired software with a weighted-average useful life of 6 years.

The following table summarizes the intangible assets acquired and estimated weighted-average useful lives as of the acquisition date (in millions):
 
Fair Value
 
Weighted-Average Useful Life
Customer relationships
$
22.5

 
10 years
Other
0.9

 
3 years
 
$
23.4

 
 

The operating results of KRFS were combined with our operating results subsequent to the acquisition date. Approximately $6.1 million and $14.8 million of revenues and $0.2 million net pretax loss and $0.5 million net pretax income of the acquired business is included in the Condensed Consolidated Statement of Income for the three and nine months ended September 30, 2016, respectively. Pro-forma results of operations, assuming the acquisition was made at the beginning of the earliest period presented, have not been presented because the effect of this acquisition is not material to our results.

3. Discontinued Operations

On July 1, 2016, pursuant to the Purchase Agreement dated June 14, 2016, we completed the sale of our North American Customer Communications business for cash consideration of $410.0 million, subject to customary working capital and other post-closing adjustments. We recorded an estimated pretax gain of $340.1 million on the sale during the third quarter 2016, which has been presented as a component of discontinued operations. Additionally, during the second quarter 2016, our Board of Directors approved a plan for management to pursue the divestiture of our United Kingdom Customer Communications business, which we anticipate will be completed within the required one year period. As a result of this significant shift in the strategic direction of our operations, we have classified the results of the businesses sold or being sold as discontinued operations in our Condensed Consolidated Statement of Income and Statement of Cash Flows for all periods presented. Additionally, the related assets and liabilities associated with the discontinued operations are classified as held for sale in our Condensed Consolidated Balance Sheet.


10

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)



Pursuant to the terms of the transaction, the Company will continue to provide certain information technology and operations processing activities to the North American Customer Communications business for an estimated period of 12 to 18 months from the transaction date. Additionally, we will continue to incur costs for certain print-related services received from the disposed business for an estimated period of 3 to 5 years from the transaction date. The revenues previously eliminated in consolidation that have continued post-transaction were approximately $5.7 million and $13.8 million for the three and nine months ended September 30, 2016, as compared to $3.1 million and $10.0 million for the three and nine months ended September 30, 2015. The expenses previously eliminated in consolidation that have continued post-transaction were approximately $12.9 million and $21.4 million for the three and nine months ended September 30, 2016, as compared to $4.9 million and $13.8 million for the three and nine months ended September 30, 2015. The revenues and expenses associated with these continued activities have been classified within continuing operations for all periods presented. The offsetting costs and revenues previously recorded within Customer Communications and eliminated in consolidation have been reclassified to discontinued operations for all periods presented.

The following table summarizes the assets and liabilities classified as held for sale in our Condensed Consolidated Balance Sheet (in millions):
 
September 30,
2016
 
December 31,
2015
Assets
 

 
 

Cash and cash equivalents
$
3.1

 
$
10.1

Accounts receivable
43.6

 
140.1

Investments

 
0.3

Unconsolidated affiliates
0.3

 
0.4

Properties, net
14.9

 
64.5

Intangible assets, net
17.7

 
20.6

Goodwill
5.3

 
24.8

Other assets
10.3

 
36.7

Total assets held for sale
$
95.2

 
$
297.5

 
 
 
 
Liabilities
 

 
 

Current portion of debt
$
0.5

 
$

Accounts payable
11.9

 
33.7

Accrued compensation and benefits
3.2

 
26.7

Deferred revenues and gains
1.3

 
5.5

Long-term debt
1.9

 

Income taxes payable
0.4

 

Other liabilities
8.7

 
94.0

Total liabilities held for sale
$
27.9

 
$
159.9




11

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


The following table summarizes the comparative financial results of discontinued operations which are presented as Income from discontinued operations, net of tax on our Condensed Consolidated Statement of Income (in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Operating revenues
$
38.2

 
$
149.3

 
$
349.7

 
$
456.0

Out-of-pocket reimbursements
9.9

 
184.1

 
399.3

 
555.0

Total revenues
48.1

 
333.4

 
749.0

 
1,011.0

 
 
 
 
 
 
 
 
Costs and expenses
53.7

 
311.1

 
703.5

 
933.3

Depreciation and amortization

 
8.1

 
11.9

 
24.2

Operating income (loss)
(5.6
)
 
14.2

 
33.6

 
53.5

 
 
 
 
 
 
 
 
Interest expense

 

 

 
(0.3
)
Other income, net

 

 

 
0.1

Equity in earnings of unconsolidated affiliates
0.1

 

 
0.3

 
0.3

Net gain on business disposition
340.1

 

 
340.1

 

Income before income taxes
334.6

 
14.2

 
374.0

 
53.6

 
 
 
 
 
 
 
 
Income taxes
111.8

 
5.2

 
114.0

 
17.9

Income from discontinued operations, net of tax
$
222.8

 
$
9.0

 
$
260.0

 
$
35.7


In April 2016, we completed the sale of our United Kingdom Customer Communications’ Bristol production facilities for pretax proceeds totaling approximately $16.0 million. Concurrent with this sale, we leased back approximately two-thirds of the facilities under a 12-year lease. The rent payments and associated rent expense of the Bristol production facilities are approximately $0.7 million per year over the 12-year lease term.

4. Investments
 
Investments are as follows (in millions): 
 
 
Carrying Value
 
 
September 30,
2016
 
December 31,
2015
Available-for-sale securities:
 
 

 
 

State Street Corporation
 
$
151.9

 
$
144.8

Other available-for-sale securities
 
11.8

 
74.7

 
 
163.7

 
219.5

Other:
 
 

 
 

Trading securities
 
13.3

 
14.8

Seed capital investments, at fair value
 
66.2

 
50.7

Cost method, private equity and other investments
 
128.9

 
133.2

 
 
208.4

 
198.7

Total investments
 
$
372.1

 
$
418.2

 


12

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


Certain information related to our available-for-sale securities is as follows (in millions):
 
September 30,
2016
 
December 31,
2015
Book cost basis
$
28.9

 
$
83.4

Gross unrealized gains
134.8

 
136.2

Gross unrealized losses

 
(0.1
)
Market value
$
163.7

 
$
219.5

 
At September 30, 2016 and December 31, 2015, the carrying value of our available-for-sale investments was $163.7 million and $219.5 million, respectively. Deferred tax liabilities associated with the available-for-sale investments were approximately $54.7 million and $54.8 million at September 30, 2016 and December 31, 2015, respectively. During the nine months ended September 30, 2016 and 2015, we received $61.2 million and $249.3 million, respectively, from the sale of investments in available-for-sale securities.  Gross realized gains of $0.2 million and $2.5 million and gross realized losses of $0.1 million and $1.5 million were recorded during the three months ended September 30, 2016 and 2015, respectively, from the sale of available-for-sale securities. Gross realized gains of $6.0 million and $165.8 million and gross realized losses of $3.8 million and $3.9 million were recorded during the nine months ended September 30, 2016 and 2015, respectively, from the sale of available-for-sale securities.

We consolidate the investments of open-end funds in which we own a controlling interest as a result of our seed capital investments. The seed capital investments of $66.2 million and $50.7 million at September 30, 2016 and December 31, 2015, respectively, are comprised primarily of equity securities as well as $12.7 million and $10.8 million of cash collateral deposited with a broker for securities sold short at September 30, 2016 and December 31, 2015, respectively.

We are a limited partner in various private equity funds which are primarily accounted for using the cost method. Our involvement in financing the operations of the private equity fund investments is generally limited to our investments in the entities. At September 30, 2016 and December 31, 2015, our carrying value of these private equity fund investments was approximately $112.2 million and $117.2 million, respectively.  At September 30, 2016, we had future capital commitments related to these private equity fund investments of approximately $4.0 million. Additionally, we have other investments with a carrying value of $16.7 million and $16.0 million at September 30, 2016 and December 31, 2015, respectively.

We record lower of cost or market valuation adjustments on cost method and other investments when impairment conditions, such as adverse market conditions or poor performance of the underlying investment, are present. We had no impairments on cost method and other investments during the three and nine months ended September 30, 2016 and 2015.

As a result of the revised consolidation guidance, we determined that our investments in private equity funds meet the definition of a VIE; however, the private equity fund investments were not consolidated as we do not have the power to direct the entities’ most significant economic activities. The maximum risk of loss related to our private equity fund investments is limited to the carrying value of our investments in the entities plus any future capital commitments. At September 30, 2016 and December 31, 2015, our maximum risk of loss associated with these VIE’s, which is comprised of our investment and required future capital commitments, was $116.2 million and $120.9 million, respectively. 

5. Unconsolidated Affiliates
 
Investments in unconsolidated affiliates are as follows (in millions):
 
 
 
Carrying Value
 
Ownership
Percentage
 
September 30,
2016
 
December 31,
2015
International Financial Data Services (U.K. and L.P.)
50%
 
$
216.7

 
$
199.5

Boston Financial Data Services, Inc.
50%
 
88.4

 
82.9

Unconsolidated real estate and other affiliates
 
 
33.1

 
29.8

Total
 
 
$
338.2

 
$
312.2




13

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


Equity in earnings of unconsolidated affiliates are as follows (in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
International Financial Data Services (U.K. and L.P.)
$
4.3

 
$
8.6

 
$
12.1

 
$
25.6

Boston Financial Data Services, Inc.
1.2

 
1.4

 
5.5

 
3.9

Unconsolidated real estate and other affiliates
1.5

 
1.8

 
6.3

 
9.7

Total
$
7.0

 
$
11.8

 
$
23.9

 
$
39.2

 
On March 29, 2016, we and our joint venture partner, State Street, each provided a subordinated loan of approximately $15.0 million to IFDS U.K. in which the principal plus accrued and unpaid interest is payable in full at maturity in March 2021. Additionally, we and State Street each provided an additional subordinated loan of approximately $13.0 million to IFDS U.K. on September 30, 2016. The principal plus accrued and unpaid interest is payable in full at maturity in September 2021.

6. Fair Value Measurements
 
Authoritative accounting guidance on fair value measurements establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value.  These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
 
As of September 30, 2016 and December 31, 2015, we held certain investment assets and certain liabilities that are required to be measured at fair value on a recurring basis.  These investments include our money market funds, available-for-sale equity securities, trading securities, seed capital investments and securities sold short whereby fair value is determined using quoted prices in active markets.  Accordingly, the fair value measurements of these investments have been classified as Level 1 in the tables below.  Fair value for deferred compensation liabilities that are credited with deemed gains or losses of the underlying hypothetical investments, primarily equity securities, have been classified as Level 1 in the tables below.  In addition, we have interest rate and foreign currency derivative instruments that are required to be reported at fair value. Fair value for the derivative instruments was determined using inputs from quoted prices for similar assets and liabilities in active markets that are directly or indirectly observable. Accordingly, our derivative instruments have been classified as Level 2 in the tables below.
 
The following tables present assets and liabilities measured at fair value on a recurring basis (in millions):
 
 
 
Fair Value Measurements at Reporting Date Using
 
September 30,
2016
 
Quoted prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Money market funds (1)
$
336.3

 
$
336.3

 
$

 
$

Equity securities (2)
177.0

 
177.0

 

 

Seed capital investments (2)
66.2

 
66.2

 

 

Deferred compensation liabilities (3)
(13.3
)
 
(13.3
)
 

 

Securities sold short (3)
(12.7
)
 
(12.7
)
 

 

Derivative instruments (3)
(0.1
)
 

 
(0.1
)
 

Total
$
553.4

 
$
553.5

 
$
(0.1
)
 
$

 


14

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


 
 
 
Fair Value Measurements at Reporting Date Using
 
December 31,
2015
 
Quoted prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Money market funds (1)
$
210.1

 
$
210.1

 
$

 
$

Equity securities (2)
234.3

 
234.3

 

 

Seed capital investments (2)
50.7

 
50.7

 

 

Deferred compensation liabilities (3)
(14.8
)
 
(14.8
)
 

 

Securities sold short (3)
(10.7
)
 
(10.7
)
 

 

Derivative instruments (3)
(0.3
)
 

 
(0.3
)
 

Total
$
469.3

 
$
469.6

 
$
(0.3
)
 
$

_____________________________________________________
(1) Included in Cash and cash equivalents, Funds held on behalf of clients, and Other current assets on the Condensed Consolidated
Balance Sheet.
(2) Included in Investments on the Condensed Consolidated Balance Sheet.
(3) Included in Other assets or Other liabilities on the Condensed Consolidated Balance Sheet.  

At September 30, 2016 and December 31, 2015, we held approximately $12.0 million and $6.1 million, respectively, of investments in pooled funds, which are measured using net asset value as a practical expedient for fair value and therefore excluded from the table above. The investments in pooled funds are included within the $128.9 million and $133.2 million of cost method and other investments at September 30, 2016 and December 31, 2015, respectively, disclosed within Note 4, Investments.

7. Intangible Assets and Goodwill
 
Intangible assets
 
The following table summarizes intangible assets (in millions):
 
September 30, 2016
 
December 31, 2015
 
Carrying
Amount
 
Accumulated
Amortization
 
Carrying
Amount
 
Accumulated
Amortization
Amortizable intangible assets
 

 
 

 
 

 
 

Customer relationships
$
203.6

 
$
67.5

 
$
181.1

 
$
57.5

Other
28.5

 
17.7

 
27.6

 
15.4

Total
$
232.1

 
$
85.2

 
$
208.7

 
$
72.9

 


15

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


Amortization expense of intangible assets for the three and nine months ended September 30, 2016 was approximately $4.3 million and $12.3 million as compared to $3.3 million and $8.9 million for the three and nine months ended September 30, 2015. The following table summarizes the estimated annual amortization for intangible assets recorded as of September 30, 2016 (in millions):
Remainder of 2016
$
4.2

2017
16.8

2018
16.6

2019
15.5

2020
13.1

Thereafter
80.7

Total
$
146.9


Goodwill
 
The following table summarizes the changes in the carrying amount of goodwill for the nine months ended September 30, 2016, by segment (in millions):
 
December 31,
2015
 
Acquisitions
 
Disposals
 
Other
 
September 30,
2016
Financial Services
$
303.3

 
$
61.0

 
$

 
$
(1.3
)
 
$
363.0

Healthcare Services
155.0

 

 

 

 
155.0

Total
$
458.3

 
$
61.0

 
$

 
$
(1.3
)
 
$
518.0


8. Debt
 
We are obligated under notes and other indebtedness as follows (in millions):
 
September 30,
2016
 
December 31,
2015
Accounts receivable securitization program
$
88.6

 
$

Revolving credit facilities
10.0

 
226.1

Senior notes
330.0

 
330.0

Related party credit agreements

 
1.5

Other indebtedness
0.1

 
4.5

 
428.7

 
562.1

Less current portion of debt
194.1

 
5.6

Long-term debt
$
234.6

 
$
556.5

 
Accounts receivable securitization program
 
We securitize certain of our domestic accounts receivable through an accounts receivable securitization program with a third-party bank.  The maximum amount that can be outstanding under this program is $150.0 million. The facility will expire by its terms in May 2018, unless renewed. As a result of the business sale, the North American Customer Communications business was removed from the accounts receivable securitization program resulting in a reduction in the receivables eligible to be borrowed against beginning in the third quarter of 2016.
 
The outstanding amount under the program was $88.6 million at September 30, 2016. There was no outstanding amount under the program at December 31, 2015.  During the nine months ended September 30, 2016 and 2015, total proceeds from the accounts receivable securitization program were approximately $746.8 million and $812.0 million, respectively, and total repayments were approximately $658.2 million and $782.0 million, respectively, which comprise the net cash flows presented within the financing section of the Condensed Consolidated Statement of Cash Flows.



16

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


Revolving credit facilities

Our syndicated credit facility provides for revolving unsecured credit in an aggregate principal amount of up to $850.0 million. The outstanding amount under this syndicated credit facility was $10.0 million and $226.1 million at September 30, 2016 and December 31, 2015, respectively.  We also have various other unsecured revolving lines of credit to support our consolidated subsidiaries’ operations that provide total borrowings of up to $30.0 million. There were no borrowings outstanding under these lines of credit at September 30, 2016 or December 31, 2015.

During the nine months ended September 30, 2016 and 2015, total proceeds from our revolving credit facilities were approximately $768.7 million and $851.1 million, respectively, and total repayments were approximately $984.8 million and $617.8 million, respectively, which comprise the net cash flows presented within the financing section of the Condensed Consolidated Statement of Cash Flows.

Fair value

Based upon the borrowing rates currently available to us for indebtedness with similar terms and average maturities, the carrying value of long-term debt, with the exception of the privately placed senior notes, (collectively, the “Senior Notes”), is considered to approximate fair value.  The estimated fair values of the Senior Notes were derived principally from quoted prices for similar financial instruments (Level 2 in the fair value hierarchy). 

As of September 30, 2016 and December 31, 2015, the carrying values and estimated fair values of the Senior Notes were as follows (in millions):
 
September 30, 2016
 
December 31, 2015
 
Carrying
Value
 
Estimated
Fair Value
 
Carrying
Value
 
Estimated
Fair Value
Senior notes - Series B
$
105.0

 
$
107.3

 
$
105.0

 
$
108.5

Senior notes - Series C
65.0

 
68.2

 
65.0

 
68.2

Senior notes - Series D
160.0

 
176.4

 
160.0

 
172.8

Total
$
330.0

 
$
351.9

 
$
330.0

 
$
349.5

 
9. Income Taxes
 
We record income tax expense during interim periods based on our best estimate of the full year’s tax rate as adjusted for discrete items, if any, that are taken into account in the relevant interim period.  Each quarter, we update our estimate of the annual effective tax rate and any change in the estimated rate is recorded on a cumulative basis. Our tax rate on income from continuing operations was 38.3% and 37.3% for the three and nine months ended September 30, 2016 compared to 19.4% and 33.3% for the three and nine months ended September 30, 2015. The Company’s tax rate for the three and nine months ended September 30, 2016 was higher than the statutory federal income tax rate of 35% primarily attributable to state income taxes and transaction related taxes, partially offset by dividends received deductions and a change in the proportional mix of domestic and international income. The Company’s tax rate for the three and nine months ended September 30, 2015 was lower than the statutory federal income tax rate of 35% primarily due to benefits realized from the release of certain liabilities for uncertain tax positions that were settled, effectively settled, or otherwise remeasured during the period.
 
Our estimated annual effective full year 2016 tax rate will vary from the statutory federal rate primarily as a result of variances among the estimates and actual amounts of full year sources of taxable income (e.g., domestic consolidated, joint venture and/or international), the realization of tax credits (e.g., research and experimentation, foreign tax and state incentive), adjustments which may arise from the resolution of tax matters under review and our assessment of our liability for uncertain tax positions.



17

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


10. Equity
 
Earnings per share
 
The computation of basic and diluted earnings per share is as follows (in millions, except per share amounts): 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Income from continuing operations attributable to DST Systems, Inc.
$
50.5

 
$
66.1

 
$
124.4

 
$
254.7

Income from discontinued operations
222.8

 
9.0

 
260.0

 
35.7

Net income attributable to DST Systems, Inc.
$
273.3

 
$
75.1

 
$
384.4

 
$
290.4

 
 
 
 
 
 
 
 
Weighted average common shares outstanding
32.7

 
35.7

 
33.3

 
36.5

Incremental shares from restricted stock units and stock options
0.3

 
0.5

 
0.3

 
0.4

Weighted average diluted shares outstanding
33.0

 
36.2

 
33.6

 
36.9

 
 
 
 
 
 
 
 
Basic earnings per share
 
 
 
 
 
 
 
Continuing operations attributable to DST Systems, Inc.
$
1.54

 
$
1.85

 
$
3.74

 
$
6.98

Discontinued operations
6.81

 
0.25

 
7.82

 
0.98

Basic earnings per share
$
8.35

 
$
2.10

 
$
11.56

 
$
7.96

 
 
 
 
 
 
 
 
Diluted earnings per share
 
 
 
 
 
 
 
Continuing operations attributable to DST Systems, Inc.
$
1.53

 
$
1.83

 
$
3.70

 
$
6.90

Discontinued operations
6.75

 
0.25

 
7.73

 
0.97

Diluted earnings per share
$
8.28

 
$
2.08

 
$
11.43

 
$
7.87

 
We had approximately 32.7 million and 34.9 million common shares outstanding at September 30, 2016 and 2015, respectively. No shares from options to purchase common stock were excluded from the diluted earnings per share calculation because they were anti-dilutive for the three and nine months ended September 30, 2016 and 2015.

Share based compensation
 
We have share based compensation plans covering our employees and non-employee directors.  During the nine months ended September 30, 2016, we granted approximately 0.4 million restricted stock units (“RSU’s”), of which approximately 0.3 million are performance stock units.  Additionally, during the nine months ended September 30, 2016, we had 0.4 million RSU’s vest as the result of the completion of the service requirements or achievement of the service and performance features of the awards, as applicable. At September 30, 2016, we had 0.9 million unvested RSU’s and 0.3 million stock options outstanding.
 
We recognized share based compensation expense of $1.4 million and $16.7 million during the three and nine months ended September 30, 2016 as compared to $7.3 million and $21.7 million during the three and nine months ended September 30, 2015. These amounts are inclusive of discontinued operations. At September 30, 2016, we had $65.2 million of unrecognized compensation expense related to our share based compensation arrangements, net of estimated forfeitures.  We estimate that compensation expense recognition attributable to currently outstanding stock option and RSU grants will be approximately $5.0 million for the remainder of 2016, $12.7 million for 2017, $7.0 million for 2018 and $1.4 million for 2019. Future expense recognition is not projected on approximately $39.1 million of unrecognized compensation expense as the related awards are not currently expected to achieve their required performance features and therefore not expected to vest. 



18

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


Other comprehensive income (loss)
 
Accumulated other comprehensive income balances consist of the following (in millions), net of tax:
 
Unrealized Gain on Available-for-Sale Securities
 
Unrealized Gain (Loss) on Cash Flow Hedges
 
Foreign Currency
Translation
Adjustments
 
Accumulated
Other
Comprehensive
Income
Balance, December 31, 2015
$
84.0

 
$
(0.1
)
 
$
(42.0
)
 
$
41.9

Net current period other comprehensive income (loss)
(0.7
)
 
0.2

 
(24.3
)
 
(24.8
)
Balance, September 30, 2016
$
83.3

 
$
0.1

 
$
(66.3
)
 
$
17.1


Additions to and reclassifications out of accumulated other comprehensive income attributable to the Company are as follows (in millions):
 
Three Months Ended
 
September 30,
 
2016
 
2015
 
Pretax
 
Net of Tax
 
Pretax
 
Net of Tax
Available-for-sale securities
 
 
 
 
 
 
 
Unrealized gains (losses) on available-for-sale securities
$
35.0

 
$
21.7

 
$
(33.1
)
 
$
(20.0
)
Reclassification of (gains) losses into net earnings on available-for-sale securities (1)
(0.1
)
 

 
(0.4
)
 
(0.3
)
Net change in available-for-sale securities
34.9

 
21.7

 
(33.5
)
 
(20.3
)
Cash flow hedges
 
 
 
 
 
 
 
Unrealized gains (losses) on cash flow hedges
(0.1
)
 
(0.1
)
 
(0.2
)
 
(0.1
)
Reclassification of (gains) losses into net earnings on foreign currency cash flow hedges (2)
0.2

 
0.1

 
(0.3
)
 
(0.2
)
Net change in cash flow hedges
0.1

 

 
(0.5
)
 
(0.3
)
Cumulative translation adjustments (3)
(1.1
)
 
(1.1
)
 
(6.4
)
 
(6.4
)
Total other comprehensive income (loss)
$
33.9

 
$
20.6

 
$
(40.4
)
 
$
(27.0
)
 
Nine Months Ended
 
September 30,
 
2016
 
2015
 
Pretax
 
Net of Tax
 
Pretax
 
Net of Tax
Available-for-sale securities
 
 
 
 
 
 
 
Unrealized gains (losses) on available-for-sale securities
$
0.8

 
$
0.5

 
$
(39.5
)
 
$
(23.8
)
Reclassification of (gains) losses into net earnings on available-for-sale securities (1)
(2.0
)
 
(1.2
)
 
(161.3
)
 
(100.0
)
Net change in available-for-sale securities
(1.2
)
 
(0.7
)
 
(200.8
)
 
(123.8
)
Cash flow hedges
 
 
 
 
 
 
 
Unrealized gains (losses) on cash flow hedges
0.4

 
0.2

 
(0.2
)
 
(0.1
)
Reclassification of (gains) losses into net earnings on foreign currency cash flow hedges (2)

 

 
(0.1
)
 

Net change in cash flow hedges
0.4

 
0.2

 
(0.3
)
 
(0.1
)
Cumulative translation adjustments (3)
(24.3
)
 
(24.3
)
 
(10.8
)
 
(10.8
)
Total other comprehensive loss
$
(25.1
)
 
$
(24.8
)
 
$
(211.9
)
 
$
(134.7
)
_______________________________________________________________    
(1)
Realized gains and losses on available-for-sale securities are recognized in Other income, net on the Condensed Consolidated Statement of Income.
(2)
Reclassification to net earnings of foreign currency cash flow hedges are recognized in Costs and expenses on the Condensed Consolidated Statement of Income.
(3) Cumulative translation adjustments are inclusive of amounts derived from assets and liabilities held for sale.



19

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


One of our unconsolidated affiliates had an interest rate swap liability with a fair market value of $44.0 million and $44.7 million at September 30, 2016 and December 31, 2015, respectively.  The unconsolidated affiliate used inputs from quoted prices for similar assets and liabilities in active markets that are directly or indirectly observable relating to the measurement of the interest rate swap.  Our 50% proportionate share of this interest rate swap liability was $22.0 million and $22.4 million at September 30, 2016 and December 31, 2015, respectively.  We record our proportionate share of this liability in an amount not to exceed the carrying value of our investment in this unconsolidated affiliate. Because the carrying value of this unconsolidated affiliate investment balance was zero at both September 30, 2016 and December 31, 2015, no change in the interest rate swap liability was recorded in the Condensed Consolidated Financial Statements.
 
Stock repurchases
 
During the nine months ended September 30, 2016, we repurchased approximately 2.0 million shares of DST common stock for $225.0 million. On June 13, 2016, our Board of Directors authorized a new $300.0 million share repurchase plan, which allows, but does not require, the repurchase of common stock in open market transactions and private transactions. The plan does not have an expiration date. During October 2016, we spent $75.0 million to repurchase approximately 0.7 million shares. As of October 31, 2016, there was approximately $150.0 million remaining under our new share repurchase plan.

Shares received in exchange for satisfaction of the option exercise price and for tax withholding obligations arising from the exercise of options to purchase the Company’s stock or from the vesting of restricted stock are included in common stock repurchased in the Condensed Consolidated Statement of Cash Flows.  The amount of such share receipts and withholdings for option exercises and restricted stock vesting was $15.7 million and $5.2 million during the nine months ended September 30, 2016 and 2015, respectively.
 
Dividends

Total dividends for the nine months ended September 30, 2016 and 2015 were $33.8 million and $33.9 million, respectively. Cash dividends paid during both the nine months ended September 30, 2016 and 2015 were $32.8 million. The remaining amount of dividends represents dividend equivalent shares of restricted stock units in lieu of cash dividends.

On October 28, 2016, our Board of Directors declared a quarterly cash dividend of $0.33 per share on our common stock, payable on December 15, 2016, to shareholders of record at the close of business on November 23, 2016.

11. Commitments and Contingencies
 
Agreements

We have letters of credit and bank guarantees of $10.7 million and $10.6 million outstanding at September 30, 2016 and December 31, 2015, respectively.  Letters of credit are secured by our debt facilities.

We have entered into agreements with certain officers whereby upon defined circumstances constituting a change in control of the Company, certain benefit entitlements are automatically funded and such officers are entitled to specific cash payments upon termination of employment. Additionally, we have adopted the DST Systems, Inc. Executive Severance Plan, which provides certain benefits to participants in the event of a qualifying termination under the plan.   
 
In the normal course of business, to facilitate transactions of services and products and other business assets, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, data and confidentiality obligations, intellectual property infringement or other claims made by third parties. These agreements may limit the time period in which an indemnification claim can be made and the amount of the claim. At September 30, 2016 and December 31, 2015, except for certain immaterial items, there were no liabilities for guarantees or indemnifications as it is not possible to determine either the maximum potential amount under these indemnification agreements or the timing of any such payments due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made under these agreements have not had a material impact on our consolidated financial position, results of operations or cash flows.




20

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


Legal Proceedings

We are involved in various other legal proceedings arising in the normal course of our businesses. While the ultimate outcome of these legal proceedings cannot be predicted with certainty, it is the opinion of management, after consultation with legal counsel, that the final outcome in such proceedings, in the aggregate, would not have a material adverse effect on our consolidated financial condition, results of operations or cash flows.

12. Segment Information
 
Our operating business units offer sophisticated information processing and software services and products. We present these businesses as two operating segments, Financial Services and Healthcare Services.  During the second quarter of 2016, we entered into a definitive agreement to sell our North American Customer Communications business and announced our intent to sell our United Kingdom Customer Communications business. As a result, beginning in the second quarter 2016, the Customer Communications segment, as well as certain businesses previously reported within the Financial Services segment that were part of the July 1, 2016 sale, have been reported as discontinued operations. Prior periods have also been adjusted to be consistent with the current presentation. Investments in our equity securities, private equity investments, real estate and certain financial interests are included in the Investments and Other segment.

Information concerning total assets by reporting segment is as follows (in millions): 
 
September 30,
2016
 
December 31,
2015
Financial Services
$
1,566.9

 
$
1,611.2

Healthcare Services
429.7

 
405.3

Investments and Other
476.0

 
502.7

Assets held for sale
95.2

 
297.5

Elimination Adjustments
(2.5
)
 
(3.5
)
 
$
2,565.3

 
$
2,813.2


We evaluate the performance of our operating segments based on income before interest expense, income taxes and non-controlling interest.  Intersegment revenues are reflected at rates determined by us and may not be reflective of market rates. Summarized financial information concerning our segments is shown in the following tables (in millions):
 
Three Months Ended September 30, 2016
 
Financial
Services
 
Healthcare
Services
 
Investments /
Other
 
Elimination
Adjustments
 
Consolidated
Total
Operating revenues
$
259.4

 
$
106.1

 
$

 
$

 
$
365.5

Intersegment operating revenues
10.8

 

 

 
(10.8
)
 

Out-of-pocket reimbursements
19.4

 
1.8

 

 

 
21.2

Total revenues
289.6

 
107.9

 

 
(10.8
)
 
386.7

 
 
 
 
 
 
 
 
 
 
Costs and expenses
213.7

 
86.0

 
0.7

 
(10.8
)
 
289.6

Depreciation and amortization
19.0

 
3.8

 

 

 
22.8

Operating income (loss)
56.9

 
18.1

 
(0.7
)
 

 
74.3

 
 
 
 
 
 
 
 
 
 
Other income, net
3.1

 
0.1

 
3.5

 

 
6.7

Equity in earnings of unconsolidated affiliates
5.7

 
0.1

 
1.2

 

 
7.0

 
 
 
 
 
 
 
 
 
 
Earnings from continuing operations before interest, income taxes and non-controlling interest
$
65.7

 
$
18.3

 
$
4.0

 
$

 
$
88.0




21

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


 
Three Months Ended September 30, 2015
 
Financial
Services
 
Healthcare
Services
 
Investments /
Other
 
Elimination
Adjustments
 
Consolidated
Total
Operating revenues
$
258.5

 
$
94.0

 
$
0.9

 
$

 
$
353.4

Intersegment operating revenues
9.2

 

 

 
(9.2
)
 

Out-of-pocket reimbursements
15.9

 
2.4

 

 
(0.1
)
 
18.2

Total revenues
283.6

 
96.4

 
0.9

 
(9.3
)
 
371.6

 
 
 
 
 
 
 
 
 
 
Costs and expenses
217.6

 
78.4

 
0.4

 
(9.3
)
 
287.1

Depreciation and amortization
17.9

 
4.8

 
0.2

 

 
22.9

Operating income
48.1

 
13.2

 
0.3

 

 
61.6

 
 
 
 
 
 
 
 
 
 
Other income (loss), net
(0.3
)
 
(0.2
)
 
14.9

 

 
14.4

Equity in earnings of unconsolidated affiliates
10.1

 
0.1

 
1.6

 

 
11.8

 
 
 
 
 
 
 
 
 
 
Earnings from continuing operations before interest, income taxes and non-controlling interest
$
57.9

 
$
13.1

 
$
16.8

 
$

 
$
87.8


Earnings from continuing operations before interest, income taxes and non-controlling interest in the segment reporting information above less interest expense of $5.4 million and $5.8 million for the three months ended September 30, 2016 and 2015 is equal to our income from continuing operations before income taxes and non-controlling interest on a consolidated basis for the corresponding periods.

 
Nine Months Ended September 30, 2016
 
Financial
Services
 
Healthcare
Services
 
Investments /
Other
 
Elimination
Adjustments
 
Consolidated
Total
Operating revenues
$
785.6

 
$
314.3

 
$
0.8

 
$

 
$
1,100.7

Intersegment operating revenues
31.9

 

 

 
(31.9
)
 

Out-of-pocket reimbursements
51.0

 
6.3

 

 
(0.1
)
 
57.2

Total revenues
868.5

 
320.6

 
0.8

 
(32.0
)
 
1,157.9

 
 
 
 
 
 
 
 
 
 
Costs and expenses
688.4

 
258.1

 
2.4

 
(32.0
)
 
916.9

Depreciation and amortization
56.4

 
12.0

 
0.7

 

 
69.1

Operating income (loss)
123.7

 
50.5

 
(2.3
)
 

 
171.9

 
 
 
 
 
 
 
 
 
 
Other income (loss), net
(0.4
)
 
0.1

 
20.3

 

 
20.0

Equity in earnings of unconsolidated affiliates
18.3

 
0.2

 
5.4

 

 
23.9

 
 
 
 
 
 
 
 
 
 
Earnings from continuing operations before interest, income taxes and non-controlling interest
$
141.6

 
$
50.8

 
$
23.4

 
$

 
$
215.8




22

DST Systems, Inc.
Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)


 
Nine Months Ended September 30, 2015
 
Financial
Services
 
Healthcare
Services
 
Investments /
Other
 
Elimination
Adjustments
 
Consolidated
Total
Operating revenues
$
762.4

 
$
278.0

 
$
2.3

 
$

 
$
1,042.7

Intersegment operating revenues
28.8

 

 

 
(28.8
)
 

Out-of-pocket reimbursements
42.9

 
5.9

 

 
(0.7
)
 
48.1

Total revenues
834.1

 
283.9

 
2.3

 
(29.5
)
 
1,090.8

 
 
 
 
 
 
 
 
 
 
Costs and expenses
647.6

 
237.6

 
(1.4
)
 
(29.5
)
 
854.3

Depreciation and amortization
51.4

 
14.0

 
0.6

 

 
66.0

Operating income
135.1

 
32.3

 
3.1

 

 
170.5

 
 
 
 
 
 
 
 
 
 
Other income (loss), net
(1.3
)
 
(0.1
)
 
191.3

 

 
189.9

Equity in earnings of unconsolidated affiliates
29.6

 
0.2

 
9.4

 

 
39.2

 
 
 
 
 
 
 
 
 
 
Earnings from continuing operations before interest, income taxes and non-controlling interest
$
163.4

 
$
32.4

 
$
203.8

 
$

 
$
399.6


Earnings from continuing operations before interest, income taxes and non-controlling interest in the segment reporting information above less interest expense of $18.0 million and $17.7 million for the nine months ended September 30, 2016 and 2015 is equal to our income from continuing operations before income taxes and non-controlling interest on a consolidated basis for the corresponding periods.

13. Restructuring Charges

As a result of market changes that have impacted DST’s service offerings to clients, including lower registered account processing, DST completed a restructuring in June 2016 to reduce our workforce and consolidate certain facilities to enhance operational efficiency within the Financial Services segment. During the nine months ended September 30, 2016, we incurred pretax restructuring charges related to employee termination costs of $9.9 million and lease termination costs of $0.5 million related to this restructuring event. As of September 30, 2016, we had a liability of $0.6 million associated with these restructuring activities.

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
FORWARD LOOKING STATEMENTS
This report contains “forward-looking statements” - that is, statements related to future, not past, events. In this context, forward-looking statements often address our expected future business and financial performance and financial condition, and often contain words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “see,” “will,” “would,” or “target.” Forward-looking statements by their nature address matters that are, to different degrees, uncertain.
For us, particular risks and uncertainties that could cause our actual results to be materially different than those expressed in our forward-looking statements include:
the effects of competition in the businesses in which we operate;
changes in customer demand and our ability to provide products and services on terms that are favorable to us;
changes in law, economic and financial conditions;
the impacts of breaches or potential breaches of network, information technology or data security, natural disasters, terrorist attacks or acts of war or significant litigation and any resulting financial impact not covered by insurance;
our investments in joint ventures or other unconsolidated affiliates; for example, some of our joint venture investments are subject to contractual obligations which could restrict us from selling such interests;
the effectiveness of our risk management framework;
the impact of regulation and regulatory, investigative and legal proceedings and legal compliance risks, including the impact of financial services regulation and litigation and SEC or DOL regulations impacting third-party distributors of mutual funds;
our investments in funds and other companies may decline;


23


our ability to successfully complete acquisitions or integrate acquired businesses;
the other factors that are described in Item 1A, “Risk Factors” within this Form 10-Q and within “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015.

These or other uncertainties may cause our actual future results to be materially different than those expressed in our forward-looking statements. We do not undertake to update our forward-looking statements. This document includes certain forward-looking projected financial information that is based on current estimates and forecasts. Actual results could differ materially.
Future economic and industry trends that could potentially impact our financial statements or results of operations are difficult to predict. These forward-looking statements are based on information as of the date of this report and we assume no obligation to publicly update or revise our forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized. 
INTRODUCTION
 
DST Systems, Inc. and our consolidated subsidiaries (“we,” “our,” “us,” the “Company” or “DST”) use proprietary software applications to provide specialized technology, strategic advisory, and business operations outsourcing primarily to the financial and healthcare industries. Our wholly-owned data centers provide the secure technology infrastructure support necessary to support our solution offerings. In order to position the company to take advantage of new and emerging technologies, we are embarking on an IT transformation effort which will increase our operating expenses for the next three to four years. We expect the result of these investments to be lower centralized infrastructure costs and a more agile platform on which to deliver future capabilities.
We manage our business through two operating segments, Financial Services and Healthcare Services.  Our investments in equity securities, private equity investments, real estate and certain financial interests have been aggregated into an Investments and Other segment.
In connection with the execution of our strategic plan, which focuses on the Financial Services and Healthcare Services markets, we sold our North American Customer Communications business for cash consideration of $410.0 million, subject to customary working capital and other adjustments, on July 1, 2016. We recorded an estimated pretax gain of $340.1 million on the sale during the third quarter 2016, which has been presented as a component of discontinued operations. Additionally, during the second quarter 2016, our Board of Directors approved a plan for management to divest of our United Kingdom Customer Communications business. As a result of this significant shift in the strategic direction of our operations, we have classified the results of the businesses sold or being sold as discontinued operations in our Condensed Consolidated Statement of Income for all periods presented.
Financial Services Segment
Through the Financial Services segment, we provide investor, investment, advisor/intermediary and asset distribution services to companies within the Financial Services industry. DST’s proprietary software applications enable us to offer our customers information processing solutions that enable them to capture, analyze and report their investors’ transactions. Examples of the services we provide include tracking of purchases, redemptions, exchanges and transfers of shares; maintaining investor identification and ownership records; reconciling cash and share activity; processing dividends; reporting sales; performing tax and other compliance functions; and providing information for printing of investor trade confirmations, statements and year-end tax forms.
Services are provided either under a remote processing (“Remote”) model or on a business process outsourcing (“BPO”) basis. Our BPO service offerings are enhanced by our proprietary workflow software, AWD®, which is also licensed separately to third parties.
In the U.S., we provide services to mutual funds, brokerage firms, retirement plans and alternative investment funds (such as real estate investment trusts) either directly or through Boston Financial Data Services, Inc. (“BFDS”), our domestic joint venture with State Street Corporation (“State Street”). In Australia and the U.K., we license software solutions to funds and fund managers, who perform participant accounting and recordkeeping for the wealth management and retirement savings market. We also provide investor services on a Remote and BPO basis internationally (U.K., Canada, Ireland and Luxembourg) solely through IFDS U.K. and IFDS L.P., which are also joint ventures with State Street.
Financial Services fees are primarily charged to the client based on the number of accounts, participants or transactions processed. For subaccounts, a portion of the services we provide for registered accounts are provided directly by the broker/dealer. As a result, our revenue per account is generally higher for registered accounts than for subaccounts. On a more limited


24


basis, we also generate revenue through asset-based fee arrangements and from investment earnings related to cash balances maintained in our full service transfer agency bank accounts. We typically have multi-year agreements with our clients. We receive revenues for processing services and products provided under various agreements with unconsolidated affiliates. We believe that the terms of our contracts with unconsolidated affiliates are fair to us and are no less favorable to us than those obtained from unaffiliated parties.

We continue to evaluate the products and services we offer within the Financial Services segment and have identified certain current offerings in which the increased risk and required investment resulting from recent regulations outweighs the benefit we expect to receive. As a result of this evaluation, during third quarter 2016 we made the decision to exit certain non-core products and services. We expect the exiting of these businesses will result in approximately $8.6 million less operating revenue and $3.8 million less operating income on an annual basis. Additionally, in November 2016, we sold a wholly-owned foreign subsidiary that provides water billing software and services solutions for cash consideration of approximately $6.1 million, subject to customary working capital post-closing adjustments. This business had approximately $5.4 million of operating revenue and $1.2 million of operating income on an annual basis. As these decisions were the result of a tactical review of our products and services, and not the result of a significant shift in strategic direction, the revenue and operating income from these products and services are included within our continuing operations.

On February 24, 2016, we acquired all of the membership interests of Kaufman Rossin Fund Services LLC (“KRFS”) for $94.7 million in cash, after giving effect to a $0.3 million adjustment agreed upon in June 2016 to settle working capital under the provisions of the purchase agreement. KRFS is a full-service provider of specialized hedge fund administration services to the global financial community. KRFS’ hedge fund services include accounting and valuation, back-office outsourcing, investor services, treasury services, and customized reporting. We expect the acquisition to provide us with additional opportunities within the alternative investment marketplace and expand our asset administration service offerings.
Healthcare Services Segment
The Healthcare Services segment uses our proprietary software applications to provide healthcare organizations a variety of pharmacy, healthcare administration, and health outcomes optimization solutions to satisfy their information processing, quality of care, cost management concerns and payment integrity programs, while achieving compliance and improving operational efficiencies. Our healthcare solutions include claims administration, benefit management, care management, business intelligence and other ancillary services. We also continue to expand and enhance our Healthcare Services’ offerings to ensure we are able to address the changing needs of our clients within the complex and highly regulated health industries which we serve. For example, our pharmacy management business continues to make investments to expand our clinical, network, and analytic capabilities to help our customers and prospective customers achieve the best possible outcomes for their members and to allow us to more effectively compete in the broader competitive pharmacy benefit manager (“PBM”) market. Historically, we have acted as an agent within our pharmacy-solutions business and, accordingly, recognized revenue on a net basis. As our enhanced products evolve and we expand our pharmacy-solutions service offerings, we will evaluate the provisions within our new customer contracts to determine whether we are acting as a principal or an agent in the transactions.  If we determine that we are acting as a principal in the transactions, we will report the transactions on a gross basis, resulting in significantly higher revenues and costs reflected within our consolidated financial statements.
We generally derive revenue from our pharmacy-solutions business on a transactional fee basis. Fees are earned on pharmacy claims processing and payments services, pharmacy and member call center services, pharmaceutical rebate administration, administration or management of clinical programs, pharmacy network management, member and plan web services and management information and reporting. Further, revenues include investment earnings related to client cash balances maintained in our bank accounts. Healthcare administration and health outcomes optimization revenues are generally derived from fees charged based on a per member/per month basis and transactional basis. We also realize revenue from fixed-fee license agreements that include provisions for ongoing support and maintenance and for additional license payments in the event that usage or members increase. Additionally, we derive professional service revenues from fees for implementation services, custom programming and data center operations.
During the third quarter of 2016, two of our Healthcare Services customers notified us that they would be transitioning their services off our systems effective in the first quarter of 2017. We continue to expect our Healthcare Segment to achieve strong revenue growth through a combination of new client wins and organic growth. However, we now expect this growth will derive from a smaller revenue base, which will result in lower overall segment revenue growth during 2017 as compared to 2016.


25


Investments and Other Segment
The Investments and Other segment is comprised of our real estate subsidiaries and joint ventures, investments in equity securities, private equity investments and other financial interests. The assets held by this segment are primarily passive in nature.
The Investments and Other segment’s revenues are derived from rental income from third-party real estate leases. Rental income is recorded as revenue when, based on lease terms, it is earned. The Investments and Other segment records investment income (dividends, interest and net gains or losses on investment securities) within Other income, net. The Investments and Other segment derives part of its income from its pro rata share in the earnings or losses of certain unconsolidated affiliates. We make lease payments to certain real estate joint ventures.
Seasonality
Generally, we do not have significant seasonal fluctuations in our business operations.  Processing volumes for mutual fund customers within our Financial Services segment are usually highest during the three months ended March 31 due primarily to processing year-end transactions during January.  Revenues and operating results from individual license sales vary depending on the timing and size of the contract.
RESULTS OF OPERATIONS
 
The following table summarizes our operating results (in millions). Additional information regarding each of our segments operating results is included below under the caption, “Business Segment Comparisons.”
 
Three Months Ended
 
Change
 
September 30,
 
2016 vs 2015
 
2016
 
2015
 
$
 
%
Operating revenues
$
365.5

 
$
353.4

 
$
12.1

 
3.4
 %
Out-of-pocket reimbursements
21.2

 
18.2

 
3.0

 
16.5
 %
Total revenues
386.7

 
371.6

 
15.1

 
4.1
 %
 
 
 
 
 
 
 
 
Costs and expenses
289.6

 
287.1

 
2.5

 
0.9
 %
Depreciation and amortization
22.8

 
22.9

 
(0.1
)
 
(0.4
)%
Operating income
74.3

 
61.6

 
12.7

 
20.6
 %
 
 
 
 
 
 
 
 
Interest expense
(5.4
)
 
(5.8
)
 
0.4

 
6.9
 %
Other income, net
6.7

 
14.4

 
(7.7
)
 
(53.5
)%
Equity in earnings of unconsolidated affiliates
7.0

 
11.8

 
(4.8
)
 
(40.7
)%
Income from continuing operations before income taxes and non-controlling interest
82.6

 
82.0

 
0.6

 
0.7
 %
 
 
 
 
 
 
 
 
Income taxes
31.6

 
15.9

 
15.7

 
98.7
 %
Income from continuing operations before non-controlling interest
51.0

 
66.1

 
(15.1
)
 
(22.8
)%
 
 
 
 
 
 
 
 
Income from discontinued operations, net of tax
222.8

 
9.0

 
213.8

 
2,375.6
 %
Net income
273.8

 
75.1

 
198.7

 
264.6
 %
 
 
 
 
 
 
 
 
Net income attributable to non-controlling interest
(0.5
)
 

 
(0.5
)
 
 %
Net income attributable to DST Systems, Inc.
$
273.3

 
$
75.1

 
$
198.2

 
263.9
 %



26


 
Nine Months Ended
 
Change
 
September 30,
 
2016 vs 2015
 
2016
 
2015
 
$
 
%
Operating revenues
$
1,100.7

 
$
1,042.7

 
$
58.0

 
5.6
 %
Out-of-pocket reimbursements
57.2

 
48.1

 
9.1

 
18.9
 %
Total revenues
1,157.9

 
1,090.8

 
67.1

 
6.2
 %
 
 
 
 
 
 
 
 
Costs and expenses
916.9

 
854.3

 
62.6

 
7.3
 %
Depreciation and amortization
69.1

 
66.0

 
3.1

 
4.7
 %
Operating income
171.9

 
170.5

 
1.4

 
0.8
 %
 
 
 
 
 
 
 
 
Interest expense
(18.0
)
 
(17.7
)
 
(0.3
)
 
(1.7
)%
Other income, net
20.0

 
189.9

 
(169.9
)
 
(89.5
)%
Equity in earnings of unconsolidated affiliates
23.9

 
39.2

 
(15.3
)
 
(39.0
)%
Income from continuing operations before income taxes and non-controlling interest
197.8

 
381.9

 
(184.1
)
 
(48.2
)%
 
 
 
 
 
 
 
 
Income taxes
73.8

 
127.2

 
(53.4
)
 
(42.0
)%
Income from continuing operations before non-controlling interest
124.0

 
254.7

 
(130.7
)
 
(51.3
)%
 
 
 
 
 
 
 
 
Income from discontinued operations, net of tax
260.0

 
35.7

 
224.3

 
628.3
 %
Net income
384.0

 
290.4

 
93.6

 
32.2
 %
 
 
 
 
 
 
 
 
Net loss attributable to non-controlling interest
0.4

 

 
0.4

 
 %
Net income attributable to DST Systems, Inc.
$
384.4

 
$
290.4

 
$
94.0

 
32.4
 %

Revenues
 
Consolidated total revenues (including out-of-pocket (“OOP”) reimbursements) for the three and nine months ended September 30, 2016 were $386.7 million and $1,157.9 million, an increase of $15.1 million or 4.1% and $67.1 million or 6.2% compared to the three and nine months ended September 30, 2015.  Consolidated operating revenues for the three and nine months ended September 30, 2016 increased $12.1 million or 3.4% and $58.0 million or 5.6% as compared to the same periods in 2015

The increase in consolidated operating revenues during the three and nine months ended September 30, 2016 was attributable to increased operating revenues across both the Financial Services and Healthcare Services operating segments.
 
Consolidated OOP reimbursements for the three and nine months ended September 30, 2016 increased $3.0 million or 16.5% and $9.1 million or 18.9% as compared to the same periods in 2015.  The increase in OOP reimbursements is primarily attributable to increased client volumes in the Financial Services segment. 

Operating income
 
Consolidated operating income for the three and nine months ended September 30, 2016 was $74.3 million and $171.9 million, an increase of $12.7 million or 20.6% and $1.4 million or 0.8% as compared to the same periods in 2015.  The increase in operating income during the three months ended September 30, 2016 was primarily due to increases within both the Financial Services segment and the Healthcare Services segment. The increase in operating income during the nine months ended September 30, 2016 was primarily due to increases within the Healthcare Services segment, partially offset by decreases within the Financial Services segment.



27


Interest expense
 
Interest expense for the three and nine months ended September 30, 2016 was $5.4 million and $18.0 million, respectively, a decrease of $0.4 million and an increase of $0.3 million as compared to the three and nine months ended September 30, 2015, respectively. The decrease in interest expense during the three months ended September 30, 2016 was primarily due to lower average outstanding borrowings. The increase in interest expense during the nine months ended September 30, 2016 was primarily due to an increase in average outstanding borrowings.

Other income, net
 
The components of other income, net are as follows (in millions): 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Net realized gains from sale of available-for-sale securities
$
0.1

 
$
1.0

 
$
2.2

 
$
161.9

Net gain on other investments
4.7

 
14.5

 
19.0

 
25.3

Dividend income
1.4

 
1.8

 
3.9

 
5.5

Miscellaneous items
0.5

 
(2.9
)
 
(5.1
)
 
(2.8
)
Other income, net
$
6.7

 
$
14.4

 
$
20.0

 
$
189.9

 
We recorded no gains from the sale of State Street available-for-sale securities as we did not sell any State Street securities during the nine months ended September 30, 2016, as compared to a gain of $157.3 million from the sale of approximately 2.3 million shares of State Street during the nine months ended September 30, 2015.

Equity in earnings of unconsolidated affiliates
 
Equity in earnings of unconsolidated affiliates is as follows (in millions): 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
IFDS (U.K. and L.P.)
$
4.3

 
$
8.6

 
$
12.1

 
$
25.6

BFDS
1.2

 
1.4

 
5.5

 
3.9

Other
1.5

 
1.8

 
6.3

 
9.7

 
$
7.0

 
$
11.8

 
$
23.9

 
$
39.2


Additional condensed financial information of our significant operating unconsolidated affiliates, BFDS and IFDS, is presented below (in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Total revenues
$
258.7

 
$
272.6

 
$
802.2

 
$
808.5

Costs and expenses
232.4

 
237.4

 
724.0

 
704.8

Depreciation and amortization
10.3

 
10.0

 
31.0

 
28.2

Operating income
16.0

 
25.2

 
47.2

 
75.5

Non-operating income
0.1

 
1.0

 
0.4

 
2.3

Income before income taxes
16.1

 
26.2

 
47.6

 
77.8

Income taxes
5.0

 
6.0

 
12.4

 
18.7

Net income
$
11.1

 
$
20.2

 
$
35.2

 
$
59.1


DST’s equity in earnings of IFDS decreased $4.3 million and $13.5 million during the three and nine months ended September 30, 2016 as compared to the same periods in 2015. The decrease is primarily the result of lower revenues recognized related to the ongoing client conversion activities and higher operating costs as IFDS expands its infrastructure to address increasing regulatory, compliance and security needs.


28



The multi-year implementation efforts for the two IFDS wealth management platform clients are progressing, however the scope and timing continues to be adjusted as client requirements evolve. In 2014, IFDS began capitalizing a significant portion of the software development costs incurred to develop the new wealth management platform for the U.K. market resulting in approximately £130.6 million (£65.3 million at DST’s 50% ownership) of capitalized costs through September 30, 2016.  These costs will continue to be incurred as the platform is completed. As the projects are completed and the underlying modules are placed into production, we expect that IFDS’ earnings will decrease due to the amortization of the capitalized software costs coupled with the decline in implementation revenue.
 
DST’s equity in earnings of BFDS decreased $0.2 million and increased $1.6 million during the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The increase in equity in earnings of BFDS during the nine months ended September 30, 2016 was due to higher ancillary revenues and reduced operating costs.

Our equity in earnings of other unconsolidated affiliates decreased $0.3 million and $3.4 million during the three and nine months ended September 30, 2016, as compared to the same periods in 2015. The decrease for the nine months ended September 30, 2016 was primarily due to lower gains from the sale of real estate investments in 2015.
 
Income taxes
 
We record income tax expense for interim periods based on our best estimate of the annual tax rate as adjusted for discrete items, if any, that are taken into account in the relevant period. Our tax rate was 38.3% and 37.3% for the three and nine months ended September 30, 2016, compared to 19.4% and 33.3% for the three and nine months ended September 30, 2015. The change in the Company’s tax rate for the three and nine months ended September 30, 2016 as compared to the three and nine months ended September 30, 2015 was primarily a result of benefits realized for the release of certain liabilities for uncertain tax positions settled, effectively settled or otherwise remeasured during 2015 that did not recur in 2016 as well as a change in the proportional mix of domestic and international income.

Excluding the effect of discrete period items, we expect our annual tax rate to be approximately 36.0% for full year 2016.  The full year 2016 tax rate can be affected as a result of variances among the estimates and amounts of full year sources of taxable income (e.g., domestic consolidated, joint venture and/or international), the realization of tax credits (e.g., research and experimentation, foreign tax and state incentive), adjustments which may arise from the resolution of tax matters under review and our assessment of our liability for uncertain tax positions.

Income from discontinued operations, net of tax
Income from discontinued operations, net of tax, for the three and nine months ended September 30, 2016 was $222.8 million and $260.0 million, respectively, an increase of $213.8 million and $224.3 million as compared to the same periods in 2015. The increase is primarily attributable to an estimated $233.6 million gain, net of tax, from the sale of our North American Customer Communications business.

Business Segment Comparisons

FINANCIAL SERVICES SEGMENT

The following table presents the financial results of the Financial Services segment (in millions):
 
 
Three Months Ended

Change
 
 
September 30,

2016 vs 2015
 
 
2016
 
2015

$

%
Operating revenues
 
$
270.2

 
$
267.7


$
2.5


0.9
 %
Out-of-pocket reimbursements
 
19.4

 
15.9


3.5


22.0
 %
Total revenues
 
289.6

 
283.6


6.0


2.1
 %
Costs and expenses
 
213.7

 
217.6


(3.9
)

(1.8
)%
Depreciation and amortization
 
19.0

 
17.9


1.1


6.1
 %
Operating income
 
$
56.9

 
$
48.1


$
8.8


18.3
 %
 
 
 
 
 




Operating margin
 
21.1
%
 
18.0
%






29



 
 
Nine Months Ended
 
Change
 
 
September 30,
 
2016 vs 2015
 
 
2016
 
2015
 
$
 
%
Operating revenues
 
$
817.5

 
$
791.2

 
$
26.3

 
3.3
 %
Out-of-pocket reimbursements
 
51.0

 
42.9

 
8.1

 
18.9
 %
Total revenues
 
868.5

 
834.1

 
34.4

 
4.1
 %
Costs and expenses
 
688.4

 
647.6

 
40.8

 
6.3
 %
Depreciation and amortization
 
56.4

 
51.4

 
5.0

 
9.7
 %
Operating income
 
$
123.7

 
$
135.1

 
$
(11.4
)
 
(8.4
)%
 
 
 
 
 
 
 
 
 
Operating margin
 
15.1
%
 
17.1
%
 
 
 
 


The following tables summarize the Financial Services segment’s statistical results (in millions, except as noted):
 
 
September 30,
 
 
2016
 
2015
U.S. mutual fund shareowner accounts processed:
 
 
 
 
Registered accounts - non tax-advantaged
 
26.4

 
28.0

IRA mutual fund accounts
 
21.3

 
22.0

Other retirement accounts
 
8.1

 
8.0

Section 529 and Educational IRAs
 
7.6

 
8.5

Registered accounts - tax-advantaged
 
37.0

 
38.5

Total registered accounts
 
63.4

 
66.5

Subaccounts
 
41.3

 
30.3

Total U.S. mutual fund shareowner accounts processed
 
104.7

 
96.8

 
 
 
 
 
International mutual fund shareowner accounts processed:
 
 
 
 
IFDS U.K.
 
9.0

 
11.7

IFDS L.P. (Canada)
 
13.4

 
12.9

Total international mutual fund shareowner accounts processed
 
22.4

 
24.6

 
 
 
 
 
Defined contribution participant accounts
 
6.5

 
6.7

 
 
 
 
 
ALPS (in billions of U.S. dollars):
 
 
 
 
Assets Under Management
 
$
16.1

 
$
14.1

Assets Under Administration
 
$
176.1

 
$
134.8

 
 
 
 
 
Automatic Work Distributor workstations (in thousands)
 
212.2

 
210.9



30


 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
Changes in registered accounts:
 
 
 
 
 
 
 
 
Beginning balance
 
64.2

 
67.4

 
65.4

 
68.8

Subaccounting conversions to DST platforms
 

 
(0.4
)
 
(0.1
)
 
(1.3
)
Subaccounting conversions to non-DST platforms
 

 
(0.1
)
 
(0.4
)
 
(0.7
)
Conversions to non-DST platforms
 
(0.4
)
 
(0.2
)
 
(0.6
)
 
(0.3
)
Organic growth (decline)
 
(0.4
)
 
(0.2
)
 
(0.9
)
 

Ending balance
 
63.4

 
66.5

 
63.4

 
66.5

 
 
 
 
 
 
 
 
 
Changes in subaccounts:
 
 
 
 
 
 
 
 
Beginning balance
 
30.4

 
30.0

 
31.3

 
28.6

New client conversions
 
10.5

 

 
10.7

 

Conversions from non-DST registered platforms
 

 
0.2

 

 
0.4

Conversions from DST’s registered accounts
 

 
0.4

 
0.1

 
1.3

Organic growth (decline)
 
0.4

 
(0.3
)
 
(0.8
)
 

Ending balance
 
41.3

 
30.3

 
41.3

 
30.3

 
 
 
 
 
 
 
 
 
Changes in defined contribution participant accounts:
 
 
 
 
 
 
 
 
Beginning balance
 
6.4

 
6.4

 
7.0

 
7.2

Organic growth (decline)
 
0.1

 
0.3

 
(0.5
)
 
(0.5
)
Ending balance
 
6.5

 
6.7

 
6.5

 
6.7


Operating revenues
 
Financial Services segment operating revenues for the three and nine months ended September 30, 2016 were $270.2 million and $817.5 million, respectively, an increase of $2.5 million or 0.9% and $26.3 million or 3.3% as compared to the same periods in 2015. The increase in operating revenues for the three and nine months ended September 30, 2016 is primarily driven from the businesses acquired during 2015 and 2016, which contributed $9.0 million and $27.8 million of incremental operating revenues during the three and nine months ended September 30, 2016, and increased professional services revenues associated with our international wealth management platform business. In September 2016, we also completed the conversion of approximately 10.0 million subaccounts associated with the previously announced client contracts, which resulted in incremental revenue. These increases were partly offset by a decline in mutual fund registered shareowner account processing revenue due to lower registered accounts, primarily as a result of subaccounting conversions, and approximately $0.6 million and $4.6 million of negative foreign currency movements for the three and nine months ended September 30, 2016, respectively. Lower revenue due to extending certain long-term contracts at lower pricing also partially offset the increase in operating revenues for the three months ended September 30, 2016 in comparison to the three months ended September 30, 2015. Software license revenues for the three and nine months ended September 30, 2016 were $6.9 million and $22.8 million, respectively, a decrease of $1.1 million and $2.0 million as compared to the same periods in 2015.

Costs and expenses
 
Financial Services segment costs and expenses were $213.7 million and $688.4 million for the three and nine months ended September 30, 2016, respectively, a decrease of $3.9 million or 1.8% and an increase $40.8 million or 6.3% as compared to the same periods in 2015. Costs and expenses in the Financial Services segment are primarily comprised of compensation and benefits costs as well as technology-related expenditures and reimbursable operating expenses.  Reimbursable operating costs, included in costs and expenses, were $19.4 million and $51.0 million for the three and nine months ended September 30, 2016, respectively, an increase of $3.5 million or 22.0% and $8.1 million or 18.9% as compared to the same periods in 2015.
 
Excluding reimbursable operating costs, costs and expenses for the three and nine months ended September 30, 2016 were $194.3 million and $637.4 million, respectively, a decrease of $7.4 million or 3.7% and an increase of $32.7 million or 5.4% as compared to the same periods in 2015. The decrease in costs and expenses during the three months ended September 30, 2016 was primarily impacted by the reversal of approximately $6.5 million of accrued performance-related contingent consideration, as well as increased cost savings resulting from previously implemented restructuring and other cost containment initiatives


31


and $0.8 million of foreign currency movements. Partly offsetting the decrease in costs and expenses were the acquisitions completed during 2015 and 2016, which resulted in incremental operating expenses during the three months ended September 30, 2016.

The increase in costs and expenses during the nine months ended September 30, 2016 was primarily associated with the acquisitions completed during 2015 and 2016, which resulted in approximately $28.5 million of incremental operating expenses. Also contributing to the increase in costs and expenses were the restructuring activities, which resulted in $10.4 million of employee and lease termination costs during the nine months ended September 30, 2016 to enhance operational efficiency within the Financial Services segment, increased costs incurred to enhance the network infrastructure utilized across all of our operating businesses and incremental costs to service new and existing clients. During the nine months ended September 30, 2016, we also recognized a $6.0 million software impairment. These increases were partly offset by continued cost containment efforts and $6.0 million of foreign currency movements during the nine months ended September 30, 2016.

Depreciation and amortization
 
Financial Services segment depreciation and amortization expense for the three and nine months ended September 30, 2016 was $19.0 million and $56.4 million, respectively, an increase of $1.1 million or 6.1% and $5.0 million or 9.7% as compared to the same periods in 2015. The increase during the three and nine months ended September 30, 2016 was primarily attributable to incremental amortization associated with acquired intangibles from the acquisitions completed in 2015 and 2016 as well as increased depreciation from capitalized costs incurred to enhance our network infrastructure and increase security and regulatory compliance.

Operating income
 
Financial Services segment operating income for the three and nine months ended September 30, 2016 was $56.9 million and $123.7 million, respectively, an increase of $8.8 million or 18.3% and a decrease of $11.4 million or 8.4% as compared to the same periods in 2015. Financial Services segment operating income increased for the three months ended September 30, 2016 primarily due to the reversal of accrued performance-related contingent consideration, higher revenues and cost savings resulting from the previously implemented restructuring and other cost containment initiatives.

Financial Services segment operating income for the nine months ended September 30, 2016 decreased due to restructuring costs incurred during 2016 and increased costs to enhance our network infrastructure, maintain security and regulatory compliance. Additionally, during the nine months ended September 30, 2016, we recognized a $6.0 million software impairment. These decreases were partly offset by the reversal of accrued performance-related contingent consideration, higher operating revenues and cost containment efforts during 2016. The impacts on operating income from foreign currency movements were not significant.

HEALTHCARE SERVICES SEGMENT

The following table presents the financial results of the Healthcare Services segment (in millions):
 
 
Three Months Ended
 
Change
 
 
September 30,
 
2016 vs 2015
 
 
2016
 
2015
 
$
 
%
Operating revenues
 
$
106.1

 
$
94.0

 
$
12.1

 
12.9
 %
Out-of-pocket reimbursements
 
1.8

 
2.4

 
(0.6
)
 
(25.0
)%
Total revenues
 
107.9

 
96.4

 
11.5

 
11.9
 %
Costs and expenses
 
86.0

 
78.4

 
7.6

 
9.7
 %
Depreciation and amortization
 
3.8

 
4.8

 
(1.0
)
 
(20.8
)%
Operating income
 
$
18.1

 
$
13.2

 
$
4.9

 
37.1
 %
 
 
 
 
 
 
 
 
 
Operating margin
 
17.1
%
 
14.0
%
 
 
 
 


32


 
 
Nine Months Ended
 
Change
 
 
September 30,
 
2016 vs 2015
 
 
2016
 
2015
 
$
 
%
Operating revenues
 
$
314.3

 
$
278.0

 
$
36.3

 
13.1
 %
Out-of-pocket reimbursements
 
6.3

 
5.9

 
0.4

 
6.8
 %
Total revenues
 
320.6

 
283.9

 
36.7

 
12.9
 %
Costs and expenses
 
258.1

 
237.6

 
20.5

 
8.6
 %
Depreciation and amortization
 
12.0

 
14.0

 
(2.0
)
 
(14.3
)%
Operating income
 
$
50.5

 
$
32.3

 
$
18.2

 
56.3
 %
 
 
 
 
 
 
 
 
 
Operating margin
 
16.1
%
 
11.6
%
 
 
 
 

The following tables summarize the Healthcare Services segment’s statistical results (in millions):
 
 
September 30,
 
 
2016
 
2015
DST Health Solutions covered lives
 
23.9

 
25.3

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
Argus pharmacy paid claims
 
125.7

 
123.7

 
379.3

 
365.9


Operating revenues

Healthcare Services segment operating revenues for the three and nine months ended September 30, 2016 were $106.1 million and $314.3 million, respectively, an increase of $12.1 million or 12.9% and $36.3 million or 13.1% as compared to the same periods in 2015.  Operating revenues for the three and nine months ended September 30, 2016 were higher as compared to the same periods in 2015 primarily from new medical claims processing clients implemented in January 2016, organic growth and expansion of the high-value services we are offering to existing clients in both the medical and pharmacy businesses. Operating revenues include approximately $1.7 million and $5.5 million of software license fee revenues for the three and nine months ended September 30, 2016, respectively, an increase of $0.4 million and a decrease of $1.8 million over the same periods in 2015
 
Costs and expenses
 
Healthcare Services segment costs and expenses were $86.0 million and $258.1 million for the three and nine months ended September 30, 2016, respectively, an increase of $7.6 million or 9.7% and $20.5 million or 8.6% as compared to the same periods in 2015. Healthcare Services costs and expenses are primarily comprised of compensation and benefits costs but also include technology-related expenditures.

The increase in costs and expenses for the three and nine months ended September 30, 2016 was primarily attributable to a combination of increased staffing costs incurred to support the higher medical transaction volumes due to growth in business process outsourcing services and higher restructuring costs as we consolidate our operations.

Depreciation and amortization
 
Healthcare Services segment depreciation and amortization expense for the three and nine months ended September 30, 2016 was $3.8 million and $12.0 million, respectively, a decrease of $1.0 million or 20.8% and $2.0 million or 14.3% as compared to the same periods in 2015, attributable to lower capital expenditures. 



33


Operating income
 
Healthcare Services segment operating income for the three and nine months ended September 30, 2016 was $18.1 million and $50.5 million, respectively, an increase of $4.9 million and $18.2 million as compared to the same periods in 2015.  The increase is primarily attributable to higher revenues from new medical claims processing clients implemented in January 2016 and enhanced economies of scale, partially offset by increased staffing costs associated with supporting new and existing client growth and higher restructuring costs as we consolidate our operations.

INVESTMENTS AND OTHER SEGMENT
 
The Investments and Other segment recorded an operating loss of $0.7 million and $2.3 million during the three and nine months ended September 30, 2016, respectively, a decrease of $1.0 million and $5.4 million as compared to the same periods in 2015.  The decrease in operating income is primarily related to a $3.1 million gain on the sale of real estate during the nine months ended September 30, 2015 that did not recur in 2016 as well as incremental expense associated with the charitable contributions of marketable securities to a donor-advised fund during 2016. These were partially offset by lower occupancy costs for the three and nine months ended September 30, 2016.


LIQUIDITY AND CAPITAL RESOURCES

Company’s assessment of short-term and long-term liquidity
 
We believe that our existing cash balances and other current assets, together with cash provided by operating activities and, as necessary, our revolving credit facilities, will meet our operating and debt service requirements and other current liabilities for at least the next 12 months.  Further, we believe that our short-term liquidity may be increased by monetizing available-for-sale securities owned by our domestic subsidiaries (which were $163.7 million at September 30, 2016) and other assets, and that our longer term liquidity and capital requirements will be met through cash provided by operating activities and bank credit facilities.  At September 30, 2016, we had approximately $860.1 million of availability under our domestic revolving credit facilities.

Sources and uses of cash
 
We had $180.9 million and $79.5 million of cash and cash equivalents at September 30, 2016 and December 31, 2015, respectively. Our primary source of liquidity has historically been cash provided by operations.  In addition, we have used proceeds from the sale of investments to fund other investing and financing activities.  Principal uses of cash are operations, reinvestment in our proprietary technologies, capital expenditures, investment purchases, business acquisitions, payments on debt, stock repurchases and dividend payments.  Information on our consolidated cash flows for the nine months ended September 30, 2016 and 2015 is presented in the Condensed Consolidated Statement of Cash Flows, categorized by operating activities, investing activities, and financing activities.

The sale of our North American Customer Communications business on July 1, 2016 resulted in cash consideration of $410.0 million, subject to customary working capital and other adjustments. During the fourth quarter of 2016, we expect to make a tax payment of approximately $75.0 million associated with the gain on the sale. We expect to use the after-tax proceeds from the sale to continue to advance our strategic priorities, including ongoing investments in our remaining businesses, acquisitions and shareholder returns.
 
Operating activities
 
Cash flows provided from operating activities from continuing operations were $147.6 million during the nine months ended September 30, 2016 compared to cash flows from operating activities of $67.7 million for the nine months ended September 30, 2015, an increase of $79.9 million.

Operating cash flows from continuing operations during the nine months ended September 30, 2016 resulted principally from net income of $124.0 million, adjusted for non-cash or non-operating items including equity in earnings of unconsolidated affiliates of $23.9 million and depreciation and amortization expense of $69.1 million, and a use of cash due to changes in operating assets and liabilities of $30.0 million. Significant changes in operating assets and liabilities during the period include a $32.4 million decrease in accrued compensation and benefits primarily due to the annual payments for incentive compensation and other employee benefits.



34


Operating cash flows from continuing operations during the nine months ended September 30, 2015 resulted principally from net income of $254.7 million, adjusted for non-cash or non-operating items including net gains on investments of $161.1 million, equity in earnings of unconsolidated affiliates of $39.2 million, and depreciation and amortization expense of $66.0 million, as well as a use of cash due to changes in operating assets and liabilities of $65.1 million. Significant changes in operating assets and liabilities during the period include a $25.8 million use of cash for accrued compensation and benefits primarily due to the annual payments for incentive compensation and other employee benefits and a $34.9 million decrease in income taxes payable primarily driven by the timing of tax payments on investment sales.

Investing activities
 
Cash flows provided from investing activities from continuing operations were $82.1 million during the nine months ended September 30, 2016, as compared to $186.0 million for the nine months ended September 30, 2015, a decrease of $103.9 million

Investing cash flows from continuing operations during the nine months ended September 30, 2016 resulted principally from $167.9 million of net changes in funds held to satisfy client funds obligations and $257.5 million of proceeds from sales/maturities of investments. These sources of cash were partially offset by cash used to acquire Kaufman Rossin Fund Services LLC, purchase capital assets, and invest in securities (principally seed capital investments) of $93.5 million, $42.7 million, and $198.3 million, respectively, as well as approximately $28.0 million of cash loaned to IFDS U.K. during 2016.
Investing cash flows from continuing operations during the nine months ended September 30, 2015 resulted principally from $264.5 million of proceeds from sales/maturities of investments and $157.2 million of net changes in funds held to satisfy client fund obligations. These sources of cash were partially offset by cash used to purchase capital assets, invest in securities, and acquire businesses of $74.3 million, $67.4 million, and $117.4 million, respectively.
Capital expenditures
 
The following table summarizes capital expenditures by segment (in millions):
 
Nine Months Ended
 
September 30,
 
2016
 
2015
Financial Services
$
39.2

 
$
68.7

Healthcare Services
3.5

 
5.6

 
$
42.7

 
$
74.3

 
Future capital expenditures are expected to be funded primarily by cash flows from operating activities or borrowings from our bank credit facilities.

Financing activities
 
Cash flows used in financing activities from continuing operations were $558.8 million during the nine months ended September 30, 2016 as compared to $291.9 million for the nine months ended September 30, 2015.

Financing cash flows used for continuing operations during the nine months ended September 30, 2016 resulted principally from net changes in client funds obligations of $167.9 million, $240.7 million of share repurchases and $127.5 million of decreased borrowings on our accounts receivable securitization program and revolving credit facilities during 2016.
Financing cash flows used for continuing operations during the nine months ended September 30, 2015 resulted principally from $330.2 million of share repurchases, net changes in client fund obligations of $157.2 million and $263.3 million of net repayments of our accounts receivable securitization program and revolving credit facilities during 2015.


35


Common stock repurchases
 
During the nine months ended September 30, 2016, we repurchased approximately 2.0 million shares of DST common stock for $225.0 million, which completed the existing share repurchase plan. On June 13, 2016, our Board of Directors authorized a new $300.0 million share repurchase plan. During October 2016, we spent $75.0 million to repurchase approximately 0.7 million shares. As of October 31, 2016, there was approximately $150.0 million remaining under our new share repurchase plan. During the nine months ended September 30, 2015, we repurchased approximately 3.0 million shares of DST common stock for $325.0 million under previous share repurchase programs from 2014 and 2015.

Shares received in exchange for satisfaction of the option exercise price and for tax withholding obligations arising from the exercise of options to purchase the Company’s stock or from the vesting of restricted stock are included in common stock repurchased in the Condensed Consolidated Statement of Cash Flows.  The amount of such share receipts and withholdings for option exercises and restricted stock vesting was $15.7 million and $5.2 million during the nine months ended September 30, 2016 and 2015, respectively.

Client funds obligations

Client funds obligations represent our contractual obligations to remit funds to satisfy client pharmacy claim obligations and are recorded on the balance sheet when incurred, generally after a claim has been processed by us. In addition, client funds obligations include transfer agency and other client balances invested overnight. We had $373.0 million and $533.4 million of client funds obligations at September 30, 2016 and December 31, 2015, respectively.

Debt activity
 
We have used the following primary sources of financing: our syndicated revolving credit facility; subsidiary line of credit facilities; accounts receivable securitization program; privately placed senior notes; and secured borrowings.  We had $428.7 million and $562.1 million of debt outstanding at September 30, 2016 and December 31, 2015, respectively, a decrease of $133.4 million during the nine months ended September 30, 2016, primarily resulting from the utilization of the proceeds from the sale of our North American Customer Communications business to pay down outstanding balances, partially offset by borrowings to fund the KRFS business acquisition, share repurchases and working capital uses.

Our debt agreements contain customary restrictive covenants, including limitations on consolidated indebtedness, liens, investments, subsidiary indebtedness, asset dispositions and restricted payments (including stock repurchases and cash dividends), and require certain consolidated leverage and interest coverage ratios to be maintained. We are currently in compliance with these covenants. An event of default under certain of our borrowings could trigger defaults under certain of our other debt obligations, which in turn could result in their maturities being accelerated. Our debt arrangements are described in Note 8 to the Condensed Consolidated Financial Statements included in Item 1 of this Quarterly Report on Form 10-Q.

Guarantees

In the normal course of business, to facilitate transactions of services and products and other business assets, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, data and confidentiality obligations, intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. At September 30, 2016 and December 31, 2015, except for certain immaterial items, there were no liabilities for guarantees or indemnifications as it is not possible to determine either the maximum potential amount under these indemnification agreements or the timing of any such payments due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made under these agreements have not had a material impact on our consolidated financial position, results of operations or cash flows.

Off balance sheet obligations
 
As of September 30, 2016, we had no material off balance sheet arrangements.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk
 
The operations of our businesses and our financial results can be affected by changes in equity pricing, interest rates and currency exchange rates. 
 


36


Available-for-sale equity price risk
 
Our investments in available-for-sale equity securities are subject to price risk.  The fair value of our available-for-sale investments as of September 30, 2016 was approximately $163.7 million.  The impact on comprehensive income of a 10% change in fair value of these investments would be approximately $10.1 million.  Net unrealized gains and losses on our investments in available-for-sale securities have had a material effect on our comprehensive income and financial position.

Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s current carrying value, thereby requiring an impairment charge in the future.  Such a charge could have a material effect on the Company’s financial position and results of operations.
 
Interest rate risk
 
We and certain of our joint ventures derive service revenues from investment earnings related to cash balances maintained in bank accounts on which we are the agent for our clients.  The balances maintained in the bank accounts are subject to fluctuation.  For the nine months ended September 30, 2016, DST and BFDS had average daily cash balances of approximately $1.8 billion maintained in such accounts, of which approximately $1.1 billion were maintained at BFDS.  We estimate that a 100 basis point change in the interest earnings rate would equal approximately $6.5 million of net income (loss) on an annual basis. The effect of changes in interest rates attributable to earnings derived from cash balances we hold for clients is partially offset by changes in interest rates on our variable rate debt.
 
At September 30, 2016, we had $428.7 million of debt, of which $98.6 million was subject to variable interest rates (Federal Funds rates, LIBOR rates, Prime rates).  Included in this amount are program fees incurred on proceeds from the sale of receivables under our accounts receivable securitization program, which are determined based on variable interest rates associated with LIBOR.  We estimate that a 10% increase in interest rates would not have a material effect on our consolidated results of operations or to the fair value of our debt.
 
Foreign currency exchange rate risk
 
The operation of our subsidiaries in international markets results in exposure to movements in currency exchange rates.  The principal currencies involved are the British pound, Canadian dollar, Australian dollar, Thai baht and Indian rupee.  Our international subsidiaries use the local currency as the functional currency.  We translate our assets and liabilities at period-end exchange rates, and translate income and expense accounts at average rates during the year.  Currency exchange rate fluctuations have not historically materially affected our consolidated financial results. 

At September 30, 2016, our international subsidiaries had approximately $219.1 million in total assets, and for the three and nine months ended September 30, 2016, these international subsidiaries recorded net income of approximately $5.5 million and $17.7 million, respectively.  We estimate that a 10% change in exchange rates would change total consolidated assets by approximately $21.9 million.  Furthermore, a 10% change in exchange rates would change consolidated reported net income by approximately $1.8 million and $0.6 million for the three and nine months ended September 30, 2016.
 
We have entered into foreign currency cash flow and economic hedging programs to mitigate the impact of movements in foreign currency (principally British pound and Thai baht) on our operations. The total notional value of our foreign currency derivatives is $115.9 million at September 30, 2016. The fair value of the contracts that qualify for hedge accounting resulted in a net asset of $0.2 million at September 30, 2016. We estimate that a 10% change in exchange rates would result in a $0.2 million change in other comprehensive income. The fair value of the contracts that do not qualify for hedge accounting resulted in a net liability of $0.3 million at September 30, 2016. We estimate a 10% change in exchange rates on these contracts would result in a $6.7 million change to consolidated net income. Substantially all gains and losses on the derivative instruments are offset by changes in the underlying hedged items, resulting in no net material impact on earnings.

Item 4.  Controls and Procedures
 
Disclosure controls and procedures
 
The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in the reports it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, including without limitation, controls and procedures designed to ensure that information required to be disclosed in reports that it files under the Exchange Act is


37


accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on an evaluation of the Company’s disclosure controls and procedures as of the end of the period covered by this report conducted by the Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, the Chief Executive Officer and Chief Financial Officer concluded that these controls and procedures were effective as of September 30, 2016.
 
Internal control over financial reporting
 
There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13(a)-15 and 15(d)-15 under the Exchange Act) during the quarter ended September 30, 2016, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings
 
The information required by this item is included in Note 11, “Commitments and Contingencies, - Legal Proceedings” of the Notes to the Condensed Consolidated Financial Statements in this Quarterly Report and is incorporated herein by reference.
 
Item 1A. Risk Factors
 
The only material changes to our risk factors as described in our Annual Report on Form 10-K for the year ended December 31, 2015 are as follows:

The SEC or other regulatory agencies may issue regulations impacting third-party distributors of mutual funds, which could adversely affect our business. The Department of Labor recently issued fiduciary regulations that are likely to impact our business.
The SEC or other regulatory agencies may issue regulations impacting third-party distributors of mutual funds and other fund- types products (collectively referred to as “mutual funds”), which could adversely affect our business. The SEC may issue additional regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) or other legislative authority that would require brokers and financial intermediaries that distribute mutual funds to make more detailed fee disclosures at the point-of-sale. Additionally, brokers and financial intermediaries will become, in some instances, subject to a new DOL-imposed fiduciary standard-of-care that, if applicable, could cause them to alter their methods of distribution and/or wholesaling activities. The new DOL fiduciary regulations were recently issued and it is not yet clear what impact they may have on such activities. We cannot predict the requirements the SEC or FINRA may propose and finally adopt in this area. Regulations that would cause current distribution channels or interest in mutual fund investing to change could decrease the number of accounts on our systems as a result of changes in client offerings or the attractiveness of offerings to customers of our clients. The biggest impact of the fiduciary regulations will fall on brokers and registered investment advisers (“RIAs”) who give individualized non-discretionary advice in the “retail” marketplace, discretionary investment managers in the “institutional” space will also be affected, primarily in connection with sales of investment products and services. To the extent that our business units, clients, unaffiliated intermediary partners and retirement plan service providers fit into these categories, this could adversely affect our business and operating results. Additionally, to the extent the Dodd- Frank Act and/or DOL regulations impact the operations, financial condition, liquidity and capital requirements of unaffiliated financial institutions with whom we transact business, those institutions may seek to pass on increased costs, reduce their capacity to transact, or otherwise present inefficiencies in their interactions with us.
We have made and may continue to make acquisitions and divestitures that involve numerous risks and uncertainties.

Our business strategy anticipates that we will supplement internal growth by pursuing acquisitions of complementary businesses. We may be unable to identify suitable businesses to acquire. We compete with other potential buyers for the acquisition of other complementary businesses. Information we obtain about an acquisition target may be limited and there can be no assurance that an acquisition will perform as expected or positively impact our financial performance. Potential acquisitions involve risk, including the risk we would be unable to effectively integrate the acquired technologies, operations and personnel into our business, and the risk that management’s attention and our capital would be diverted from other areas of our business. The anticipated benefits of our acquisitions may not materialize. Future acquisitions or dispositions could result in the issuance of capital stock, incurrence of debt, contingent liabilities or expenses, or write-offs of goodwill and other intangible assets, any of which could harm our financial condition. If we cannot complete acquisitions, our growth may be limited and our financial condition may be adversely affected.


38



In addition, we have divested, and may in the future divest, businesses that are no longer a part of our ongoing strategic plan. These divestitures similarly require significant investment of time and resources, may disrupt our business, distract management from other responsibilities and may result in continued responsibility for the divested business, including through indemnification, for a period of time following the transaction, which could adversely affect our financial results.

We depend on information technology, and any failures of or damage to, attack on or unauthorized access to our information technology systems could result in significant costs and reputational damage. 

We have developed and maintained, and our businesses depend on, information technology infrastructure, including elements both internal and external, to record and process a large volume of complex transactions and other data, including personally identifiable information regarding financial and health matters. In certain circumstances, vendors have access to such data in order to assist us with responsibilities, such as producing benefit plan identification cards, maintaining software we license on our own behalf or resell to others, or helping clients comply with anti-money laundering regulations. Any interruptions, delays, breakdowns or breach, including as a result of cybersecurity breaches or breaches of security systems and procedures of ours or those of our vendors could result in significant data losses or theft of our or our customers’ intellectual property, proprietary business information or personally identifiable information.  In recent years, several health care and financial services firms were victims of computer systems hacking attacks, resulting in the disruption of services to clients, loss or misappropriation of sensitive or private data, and reputational harm. Rapid advances in technology, and the limits and costs of technology, skills and manpower, may prevent us from anticipating, identifying, preventing or addressing all potential security threats and breaches. A cybersecurity breach could negatively affect our reputation as a trusted product and service provider by adversely affecting the market’s perception of the security or reliability of our products or services. In addition, a system breach could result in other negative consequences, including remediation costs, disruption of internal operations, increased cybersecurity protection costs, lost revenues, regulatory penalties, and litigation. 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
 
Stock repurchases
 
The following table sets forth information with respect to shares of our common stock purchased by us during the three months ended September 30, 2016.
Period
 
Total Number
of Shares
Purchased 
 
 
Average Price
Paid Per Share
 
Total $ Amount of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Maximum Amount That May Yet
Be Purchased Under
the Plans or 
Programs
 
July 1 — July 31
 
640,558

(1)
 
$
119.58

 
$
74,999,987

 
$
225,000,013

(2)
August 1 — August 31
 
380

(1)
 
122.76

 

 
225,000,013

(2)
September 1 — September 30
 
1,228

(1)
 
118.13

 

 
225,000,013

(2)
Total
 
642,166

 
 
$
122.50

 
$
74,999,987

 
$
225,000,013

(2)
__________________________________________________
(1)
For the three months ended September 30, 2016, we purchased, in accordance with the applicable equity compensation plan, 15,328 shares of our common stock for participant income tax withholding in conjunction with stock option exercises or from the vesting of restricted shares, as requested by the participants, or from shares surrendered in satisfaction of option exercise price.  These purchases were not made under the publicly announced repurchase plans or programs, but were allowed by the rules of the Compensation Committee of the DST Board of Directors.  Of these shares, 13,720 shares were purchased in July 2016, 380 shares were purchased in August 2016 and 1,228 shares were purchased in September 2016.

(2)
On June 13, 2016, our Board of Directors authorized $300.0 million of share repurchases. This plan allows, but does not require, the repurchase of common stock in open market transactions and private transactions. The plan does not have an expiration date. We may enter into one or more plans with our brokers or banks for pre-authorized purchases within defined limits pursuant to Rule 10b5-1 to effect all or a portion of such share repurchases.

Item 3.  Defaults Upon Senior Securities
 
None.
 


39


Item 4.  Mine Safety Disclosures
 
None.
 
Item 5.  Other Information
 
(a)                                 Disclosure of Unreported 8-K Information
 
None.

 (b)                                 Material Changes to Director Nominee Procedures
 
None.



40


Item 6.  Exhibits

The Exhibit Index to this Quarterly Report on Form 10-Q is hereby incorporated by reference.
 


 
SIGNATURE
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
November 2, 2016
 
DST Systems, Inc.
 
 
 
/s/ Gregg Wm. Givens
 
 
 
Gregg Wm. Givens
 
Senior Vice President, Chief Financial Officer and Treasurer
 
(Principal Financial Officer)






41



Exhibit Index
 
 
 
 
 
 
Incorporated by Reference
 
Filed/Furnished Herewith
Exhibit no.
 
Exhibit Description
 
Form
 
SEC File No.
 
Exhibit
 
Filing Date
 
(3) Articles of Incorporation and Bylaws
 
 
 
 
 
 
 
 
 
 
3.1
 
Restated Certificate of Incorporation, dated May 12, 2015
 
8-K
 
001-14036
 
3.3
 
5/14/2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
3.2
 
Amended and Restated Bylaws, dated February 29, 2016
 
8-K
 
001-14036
 
3.1
 
2/29/2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(31) and (32) Officer Certifications
 
 
 
 
 
 
 
 
 
 
31.1
 
Certification of Chief Executive Officer Pursuant to Securities Exchange Act of 1934 Rule 13a-14(a)
 
 
 
 
 
 
 
 
 
*
 
 
 
 
 
 
 
 
 
 
 
 
 
31.2
 
Certification of Chief Financial Officer Pursuant to Securities Exchange Act of 1934 Rule 13a-14(a)
 
 
 
 
 
 
 
 
 
*
 
 
 
 
 
 
 
 
 
 
 
 
 
32.0
 
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes Oxley Act of 2002
 
 
 
 
 
 
 
 
 
*
 
 
 
 
 
 
 
 
 
 
 
 
 
(101) Formatted in XBRL (Extensible Business Reporting Language)
 
 
 
 
 
 
 
 
The following financial information from DST’s Quarterly Report on Form 10-Q for the period ended September 30, 2016, filed with the SEC on November 2, 2016, formatted in Extensible Business Reporting Language (“XBRL”): (i) the Condensed Consolidated Balance Sheet at September 30, 2016 and December 31, 2015, (ii) the Condensed Consolidated Statement of Income for the three and nine months ended September 30, 2016 and 2015, (iii) the Condensed Consolidated Statement of Comprehensive Income for the three and nine months ended September 30, 2016 and 2015, (iv) the Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2016 and 2015, and (v) Notes to Condensed Consolidated Financial Statements.




42