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DST Systems, Inc. (NYSE:DST)

Q4 2006 Earnings Conference Call

January 24, 2007 11:00 am ET

Executives

Tom McDonnell - President & CEO

Tom McCullough - COO

Ken Hager - CFO

Analysts

Pat Burton - Citigroup

Charlie Murphy - Morgan Stanley

Greg Smith - Merrill Lynch

Jim Kissane - Bear Stearns

Murali Gopal - KBW

Pete Heckmann - A.G. Edwards

Glenn Greene - ThinkEquity Partners

Bryan Keane - Prudential

Dave Koning - Robert W. Baird

Paul [Goldschmid] - King Street Capital

Phil Mickelson - JP Morgan

Peggy [Corsillo] - Meridian

Steve Balog - Cedar Creek Management

Presentation

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the fourth quarter earnings release conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. [Operator Instructions]. As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Tom McDonnell. Please go ahead.

Tom McDonnell

Good morning. I'm joined here in Kansas City today by Tom McCullough, our COO, and Ken Hager, our CFO.

But before starting today, I need to make a statement under the SEC procedures and rules. If in the course of our conference call today we make forward-looking statements respecting DST and its businesses, such statements would be based on our views as of today and actual results could differ. There could be a number of factors affecting future results, including those set forth in DST's latest periodic report, which we file with the SEC. All such factors should be considered in evaluating any forward-looking statements which we might make today.

Turning to the overall fourth quarter results, the comments that we'll address today on our financial results are based on the results that exclude certain items that we set forth in our press release under the section "Use of non-GAAP Financial Information." A reconciliation of the reported GAAP results to the income that was adjusted for those items is accompanying the press release, so you can refer to that for specifics.

Kind of up front, I should mention that in the fourth quarter, and we'll discuss it further, but we had a significant decline in license -- software license revenue from the fourth quarter of 2005; a decline of roughly $13 million. In the fourth quarter last year, we had about $29.5 million of license revenue. This year, we had 16.6.

So we had reasonable license revenue. But it was substantially less than what we had in the fourth quarter of '05. And also as we'll discuss further, our Output division, based on its continuing investment in technology and certain volume and pricing issues, did report a loss for the quarter.

So turning to the numbers on the non-GAAP basis that I discussed. Income for the fourth quarter of 2006 totaled $65.5 million, or $0.93 per diluted share. And that compares to $58.1 million, $0.78 per diluted share, for the fourth quarter of 2005. It's an increase of 12 -- a little over -- under 13% -- 12.7% of net income and 19.2% in diluted EPS.

Consolidated operating revenues increased $13.3 million or 3.5% over the fourth quarter of 2005 to a level of $396.3 million. That number excludes the 2005 lock\line revenue, and does not incorporate revenues for the 2006 ASI revenues. On this basis, Financial Services revenues decreased $1.4 million or 0.6%.

Increases in mutual fund shareowner processing revenues, data processing support revenues that DST charges to our joint venture Argus, and professional services revenues increased, but they were offset by the decline that I mentioned earlier in license fee revenues of $12.9 million, that was primarily a DSTI, DST International Investment Management license fee revenues that fell short.

We do believe that the sales activity around the licenses was somewhat positive in the fourth quarter, and we think that some of the license shortfall really is a timing issue, and anticipate that the revenues may be occurring in the first or second quarter of '07.

Again, license fees represent a relatively small percentage of our Financial Services operating revenues. But because of the nature of license revenue, they can significantly impact earnings when they're recognized or when they're not realized.

Output Solutions operating revenues increased by $17 million or 14.3%. Output had higher processing volumes, they had increased International revenues from some new customer relationships, and increased revenues from the cost of paper stock now billed to clients, where in some cases clients had acquired their stock directly before.

The items mailed increased by 15.5% to 639 million pieces, and images produced increased by just under 30% -- 29.9%, to 4.1 billion. However, lower per unit pricing for certain large daily cycle billing customers, combined with higher volumes from those same customers, negatively impacted the overall revenue growth.

Consolidated income from operations in the fourth quarter of 2006 decreased by $1.6 million, or 1.7%, to a level of $93.8 million. Financial Services income from operations decreased $400,000 or 0.4% over the fourth quarter of 2005, to $92.1 million. That reflects the lower license fees and the absence of a lock\line operating income, which was only partially offset by our other revenue increases.

Output Solutions loss from operations was $1.5 million versus a break-even level for the fourth quarter of 2005. Lower unit pricing for certain clients and the increased cost to support the higher volumes, along with expenditures for the implementation of new printing and inserting technologies continue to impact output income.

Implementation of our new proprietary printing and mailing technology is proceeding as planned, and deployment has begun in some of the additional locations, in addition to Sacramento.

The overall consolidated operating margin was 22.4%. That was unchanged from 2005. Increased operating margin in Financial Services was offset by the operating loss at Output Solutions.

In Financial Services, the operating margin of 32.7% was positively impacted by some professional fee income that was recognized in the fourth quarter that may not necessarily be recurring, and also by some catch-up fees for data processing support charge to some joint venture operations that, once again, can't be extrapolated from the fourth quarter levels.

The equity and earnings of the unconsolidated affiliates increased by $9 million from the 2005 fourth quarter to a level of $17.3 million, and that's principally from the inclusion in the equity and earnings section of the Asurion income and higher earnings at BFDS, IFDS, and Argus.

Higher BFDS earnings were the result of increased accounts serviced and improvements in operations. The earnings increase at IFDS primarily reflected the higher professional fee service revenue in the quarter. Earnings at Argus increased primarily from the impact of processing of Medicare Part D claims for a number of our clients that participate in that market.

Interest costs associated with the debt incurred by Asurion earlier in the year to finance the third quarter cash distribution to its shareowners reduced DST's equity and earnings of Asurion by approximately $4.4 million in the quarter, and the cost of that financing is expected to continue to negatively impact DST's equity in the earnings of Asurion.

We generally report on intangible amortization. The combined amortization of intangibles affecting DST's equity and the earnings of Asurion during the fourth quarter of '06 was $1.7 million.

DST also recorded approximately $1.5 million of intangible amortization during the fourth quarter of '06 as a result of the acquisition of DST Health Solutions, and another $2.8 million of intangible amortization related to the acquisition of ASI. $1 million of in-process R&D costs at ASI are reflected in that $2.8 million and those -- that $1 million of in-process R&D really is pretty much a onetime cost.

The effective income tax rate for the 2006 third quarter was 36.4%. That compared to 37.5% for the 2005 fourth quarter. If we exclude the affects of discreet period items, DST currently expects its recurring effective tax rate for 2007 to be approximately 35.3%.

Turning to some drivers, mutual fund shareowner activity, US mutual fund open shareowner accounts process totaled $105.8 million at December 31st 2006. That's a net increase of $1.1 million or 1.1% since September 30th, 2006, and an increase of $3.6 million or 3.5% since December 31st of '05.

In that increase, tax advantage, retirement, and educational savings accounts serviced totaled $40.5 million at December 31st '06. That's an increase of $200,000 or 0.5% since September 30th of '06, and an increase of $1.5 million or 3.8% since December 31st of '05.

Two new client commitments -- mutual fund client commitments were received at BFDS during the quarter. And that will add approximately 1.1 million accounts to our basis that we're serving. Conversions of those accounts are expected by the end of second quarter of 2007.

As previously announced, the large client assigned earlier participating in a conversion of approximately 7 million accounts based on their current levels scheduled for the third quarter of 2007.

During the quarter, DST repurchased 782,000 shares of its common stock for an aggregate cost of $48.8 million, roughly $62.40 a share. That leaves approximately 4 million shares remaining under the existing share repurchase authorization at the end of 2006.

DST had 65.7 million shares outstanding at December 31st 2006. That includes 2.5 million shares of unvested restricted stock. However, those shares, the restricted stock, 2.5 million, are excluded from the average shares outstanding.

So the combined effect of share repurchase and shares issued from stock option exercises resulted in a net decrease in total shares outstanding of 400,000 or 0.6% for the quarter, and 6 million or 8.4% for the year.

The average diluted shares for the fourth quarter of '06 were 70.1 million. That's a decrease of 1.9 million shares or 2.6% from the third quarter of 2006, and 4.5 million or 6% from the fourth quarter of 2005.

The dilutive effect of the convertible debentures, outstanding stock options, and restricted stock were as follows: Convertible debentures, 3.6 million shares; outstanding stock options, 1.9 million shares; and restricted stock, 1.2 million shares.

The higher average share price for DST during the quarter increased the dilutive impact of the convertible debentures by approximately 1 million shares as compared to the prior-year quarter.

Total stock options and restricted stock -- equity units outstanding at December 31st 2006 were 11.4 million. That's a decrease of 200,000 shares -- or 200,000 equity units, or 1.7% from September 30th 2006. That's about a 1.7% decrease, and it's a decrease of 1.9 million shares or equity units, or 14.3% from December 31st 2005.

That concludes our remarks. Operator, Greg, if you want to open up the call to questions, we'd be glad to accept those.

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Question-and-Answer-Session

Operator

[Operator Instructions].

Your first question comes from the line of Pat Burton from Citigroup. Please go ahead.

Pat Burton - Citigroup

Hi. Good morning and congratulations on both the quarter and the year. My first question is for Tom, and that is, you mentioned a couple of factors that helped the fourth quarter operating margin. Were there any kind of one-off expenses in there related to ramping of some of these new big contracts that might level out as we move into 2007?

Tom McDonnell

Pat, I wouldn't call them one-off in the quarter. The expenses, particularly for large conversions, are incurred well in advance of the actual conversion. There's conversion testing, there's systems modifications and so forth. And we don't anticipate any change in the actual run rate level of those, at least until the conversions occur, which would be the bulk of the -- I mean, the major one would be third quarter of '07.

So I don't think you would see any significant delta between now and then.

Pat Burton - Citigroup

Okay. Thank you. And the follow-up is actually for Ken, and that is, what would you anticipate the average share count to be in '07, Ken -- the fully diluted share count, assuming just where you ended the year on the buyback?

Ken Hager

Pat, I think it'd be difficult to answer that question. I mean I think the -- you know, excluding share repurchase activities, we really don't see much change in the share value -- in the share -- diluted share number right now, because it's right now, principally being impacted by our share price. And so I can't give you a really good answer, because I don't think we predict what our share repurchase activities would be.

Pat Burton - Citigroup

Right. But if you didn't buy back any stock, would it stay at roughly $70.1 million, the fully diluted number?

Ken Hager

Assuming the share price stayed at its current level, yes.

Pat Burton - Citigroup

Okay. And that's a function of accounting for the dilutive equivalent on the converts?

Ken Hager

Converts and stock options.

Tom McDonnell

And restricted stock.

Pat Burton - Citigroup

Restricted stock. Okay. Thank you very much and congratulations on another solid year.

Ken Hager

Thank you.

Operator

Next we'll go to the line of Charlie Murphy from Morgan Stanley. Please go ahead.

Charlie Murphy - Morgan Stanley

Thanks very much. I understand there's some puts and takes in the '07 financial services EBIT margin excluding items outlook, but are you comfortable expressing whether or not you expect it to be up in '07 year-over-year?

Tom McDonnell

I think if you are using the 32.7 as the benchmark and saying with that increase, I think it's unlikely, because that had some tailwind behind it with the two items that I mentioned, which were -- is the disproportionate amount of processing fees in that quarter.

And because of, in effect, some higher volumes that we anticipated from some of our joint ventures where we support them in our data center, some, in effect restructuring, of the support agreements, which in effect had the affect of bringing some income into the fourth quarter that would have inflated that margin a bit. I wouldn't predict a dramatic drop-off, but I certainly don't see any reason to say that it would improve from there.

Charlie Murphy - Morgan Stanley

Okay, great. And I wanted to ask about the US Pension Protection Act of '06. Our equity strategists think that can add an additional 7 million US workers in 401Ks in the '08 enrollment season. How does that compare to DST forecasts and how many accounts do you think this act can add in '08 for DST?

Tom McDonnell

Well, I don't think we've actually predicted that. But if you look underneath the 40 million accounts that we report as sort of retirement or tax deferred accounts, and those are made up of IRAs, HR 10s, 529s, and 401Ks, then the impact will primarily be in the 401K area. I think our 401K account -- Tom McCullough is here, is around 4 million, 4.5 million, something like that?

Tom McCullough

4 million participants.

Tom McDonnell

So I guess there's two questions or two factors. One is how many people will adopt the actual automatic enrollment. And statistics would generally indicate that participation right now stays around 60% of employees. So of existing plans, you might get a pickup of -- if you just say that you picked -- if all of them, which I doubt would happen, would go to automatic enrollment, it would seem like on our current base, you might have, oh say 1.5 million or so accounts that could derive from that.

Whether or not the Pension Act will actually increase the number of 401K plans, and it could. I think if it does, it probably will be in the small employer area where a lot of our client's business comes from. So there could be some positive there. But at least at this point, if -- from the just kind of rough calculation I just ran out for you, we don't currently see it as a bonanza.

But I also think some of the things that are brought up in the Pension Act, if you extrapolate them out over a period of time, like some change in being able to go from certain plans to Roth-type IRAs, and things that will be generally more attractive probably are long-term positive. But I think to put too much stock in the pickup that you'll get, at least in the short-term, is really dependent upon employers making those decisions.

And by the way, to the extent that they make those decisions, they're going to have to deal with an immediate cost increase, because to the extent people are not currently participating, the company then isn't providing the match. So if they go after it aggressively, there's going to be a lot of tradeoffs they're going to have to consider before they adopt that strategy. So I don't think it's going to be automatic.

That's a bit of a long answer. But I think, at least, from our view at the moment, the enthusiasm -- I think the changes are good and constructive long-term. But I think the short-term enthusiasm is maybe a little overdone.

Charlie Murphy - Morgan Stanley

That's very helpful, thanks.

Operator

Your next question comes from the line of Greg Smith from Merrill Lynch. Please go ahead.

Greg Smith - Merrill Lynch

Yeah, hi. Ken, what was the magnitude of the deferred professional fees that were recognized in the financial services segment in the quarter, and were there any costs against that or was that 100% margin?

Ken Hager

There were roughly $3 million, and there really weren't any costs in the quarter against those numbers.

Greg Smith - Merrill Lynch

Okay, okay. And then, the IFDS, there was that real nice uptick there in profits, largely from professional services revenue. But is that something that we can expect to continue or should we expect those profits to kind of fall right back?

Ken Hager

You wouldn't expect theirs to fall right back. In the international segments, the pricing structure and the client arrangements are somewhat different than in the US, where in addition to per account fee income, there are more professional fee services for adding unique aspects to either a clients' portfolio of funds from a software and support side. Or there's -- in the case of the UK, there's a little more dynamics and regulatory changes which usually give rise to additional professional fees.

So that's more of an ongoing component. It probably won't stay at the same level as the fourth quarter, but it certainly won't evaporate. I mean I'd say probably -- there's probably a 15%, 20% bandwidth there.

Greg Smith - Merrill Lynch

Okay. That's very helpful. At Asurion last quarter in 3Q, there was some, I think, integration expenses. Was that all cleaned up? And then is the 4Q number a pretty good run rate?

Tom McDonnell

I think the answer to both of those is yes. Ken, was there an unusual item in the fourth quarter or was all that in Q3?

Ken Hager

Well, they had the litigation expense in the fourth quarter that we took as a non-GAAP adjustment. The third quarter item was the dividend equivalent payments. That was the big item in the third quarter.

Tom McDonnell

Yeah. I don't think -- just recognizing when you get down to the Asurion level, maybe three or four things. One is -- one of the reasons we're reporting the intangible amortization is because of the way the thing was structured as a reverse triangular merger, or whatever. They have amortization on their books, and then we have amortization on ours. So we report that as a combined number, which was, I believe, the 1.7 that I referred to earlier.

In addition to that, because of their decision to incur debt to distribute dividends to the shareowners, as we mentioned, that cost which was $4.4 million in the quarter, will continue forward. And Ken mentioned that they did have some litigation expense that was occurred in the -- incurred in the quarter. But as we discussed upfront, when we were talking, we backed that out for -- it's a GAAP expense, but we back it out because we don't see it as part of the ongoing run rate.

So I think what you've got there pretty much is, you know, the current run rate. And I guess at least for the foreseeable future, I don't see much -- see any reason why it would deviate too much from that.

Greg Smith - Merrill Lynch

Okay. And then just along the equity income line too, you're now breaking out Argus. But that still leaves the other category, which had, you know, a fairly large loss of $1.7 million. What is in there, and what can we expect going forward for that category?

Ken Hager

What's in there primarily are a number of real estate joint ventures. And there was no one particular issue that caused the largest component of that loss. Our joint venture on the -- for the IRS center is just ramping up now, so there are some costs associated with the implement -- putting that into production.

But I don't think we can point to any one thing. I think you would probably see those things operate -- the other category probably continue to operate at a small loss moving forward.

Greg Smith - Merrill Lynch

Okay. And then last question. Just on the international software sales, Tom, you mentioned that you feel like you potentially can pick some of that up next year. Just wanted to make sure there's nothing fundamentally sort of wrong or competitive issues or environment that's significantly changed?

Tom McDonnell

I would say the environment hasn't changed much. And, you know, we did have license revenue in Q4 of 16 and change -- $16 million and change. That just happened to be off from 29 the year before. As we've discussed, you know, the timing of licenses is very difficult.

Generally, we pursue them on a basis that we think is sensible. You know, sometimes companies in order to try to bring revenue in do discounting and whatever. We choose not to do that. So to some extent, we don't, you know, leverage revenues into any particular quarter.

The nature of the kind of sales activities that there's now are with some reasonably significant clients. And, you know, the larger the prospect, it seems -- and particularly when you're dealing with -- in some cases they're multijurisdictional from a geography standpoint. It's just a much more complex and elongated sale.

So we think the prospects are still very solid. We think we do have a good opportunity. But whether they'll -- I mean there's always a risk they won't materialize at all. But even at this point, with a lot of activity and interaction that's gone on whether Q1 or Q2 would be very hard to call at this point.

But we do think there are still legitimate sales prospects. There's nothing really changed in that marketplace. In fact, I would say anything, probably -- if anything, the overall health of the worldwide equity markets is -- because usually when investment managers are seeing increased profits, they tend to enhance some of their investment in our type of system.

So I think that's generally a positive environment. But, you know, as we've said many times, the timing of these things is extremely difficult to predict.

Greg Smith - Merrill Lynch

Great. Thank you very much.

Operator

Your next question comes from the line of Jim Kissane from Bear Stearns. Please go ahead.

Jim Kissane - Bear Stearns

Thanks. Tom, can you update us on your targets for output margins and maybe your thoughts on the timing of achieving those? Sorry.

Tom McDonnell

Yes. Well, right now, Jim, my first target is that they're positive. And, you know, over time -- I mean we still believe that's a business that can get into at least the low double-digits.

Having said that a number of times and having been able over several years to kind of take it from that area to where we are now, I mean that's been a very tough competitive market out there. As we mentioned, you know, we've seen pricing, particularly on the very large agreements, being very aggressive.

However, on the flip side, we do think that the type of technology we're putting in will differentiate us going forward and should put us in a much better position to realize positive, and hopefully -- positive margins and hopefully move them up.

I will say however, though, that you should recognize that while we're still in this implementation phase, that it is still our policy to use accelerated depreciation for books and tax. So you know, that is we're continuing to add machines and equipment to support that. You'll see that phenomenon for a few quarters yet.

Jim Kissane - Bear Stearns

And then the timing of the large output customer going away, is that still on track and maybe the impact on profitability there?

Tom McDonnell

It's still on track. Ken, is it Q2?

Ken Hager

Q2.

Tom McDonnell

Really the impact on profitability depends on -- we do have some other business coming in there. And there is some equipment retirements that will be associated with that. I can't give you an exact impact on profitability at the moment. Right now, we think we can absorb it somewhat gracefully.

Jim Kissane - Bear Stearns

If I can get one last one. Can you give us a little insight into your AWD business, the demand there and maybe size the business for us?

Tom McDonnell

Well, Tom McCullough is here. He might -- we have traditionally sort of referred to it in size by number of seats. That's not the best measure anymore, just because of the different way that the product is integrated to different processing environments. Let me let Tom talk to that.

Tom McCullough

You know, from a seat basis and a customer basis, we have over 400 customers today that use AWD in a variety of the industries besides mutual funds such as insurance, brokerage, healthcare, and mortgage are the primary industries. We have over 140,000 seats worldwide.

You know, the business still has very strong demand. And our business is really more business process management, BPM, with imaging as a piece of it. So work flow is a key part of what we offer in comparison to some of our competitors.

Jim Kissane - Bear Stearns

Tom, can you put a revenue range or revenue per seat?

Tom McCullough

No, we really don't break that out in any kind of information we provide.

Jim Kissane - Bear Stearns

All right. Thank you.

Operator

Your next comes from line of Murali Gopal from KBW. Please go ahead.

Murali Gopal - KBW

Good morning. And thanks for taking my call. A couple of quick questions. When I look at the operating margin for financial services, just all else being equal, just directionally, you know, just having ASI for a full year next year, directionally, you think that's got to be a positive to the margins? Or you think it's probably going to be a little lower than where it was in Q4?

Tom McDonnell

Well, you've got -- as we mentioned, you've got 2.8 -- there was $2.8 million of amortization in the fourth quarter. And $1 million of that was R&D, which we don't consider to be recurring. So you'll have a -- not an insignificant amount of amortization. So I don't think you can necessarily translate it to a significant impact on a positive way.

I mean I don't think it will be a negative. We finalized the purchase accounting on that a little while back. And I just don't have in mind what that amortization level will be going forward, probably not too terribly different than Q4. But you've got to take that into account.

Murali Gopal - KBW

Okay. And then also quickly, when I look at the healthcare claims processing business, just looks like, you know, the market is huge and opportunities are enormous, just given some of the regulatory changes and the move to a more consumer-centric model.

Just could you just quickly, you know, kind of size the market just in terms of where you think your growth opportunities in this business are? And when you talk about that, could you also just talk a little bit on ASI acquisition and what it means to the long-term strategic goal?

Just given that it seems like ASI's claims platform is pretty well recognized. So what does it mean in terms of, you know, competing in this market with much larger players?

Tom McDonnell

Well, maybe to sort of add to that in reverse, I mean we would agree that there's a very significant market in the healthcare and the claims processing side of healthcare. And we think that some of the consumer-based plans will drive demand for software and technology to support those.

Having said that, I think both the ASI platform and some of the health solutions platforms are well-recognized in the industry. And between the two, they're installed in quite a number of clients. But when you look at the overall healthcare industry, virtually all payers are operating on some system today, whether it's an in-house legacy system or whether it's systems that were purchased some time back.

So from a marketing strategy standpoint, you know, you've got several different dimensions. One, as the healthcare providers or the claims providers looks to reduce cost.

There's more opportunity for, in effect, what's referred to in that industry as BPO, or business process outsourcing, you know, where you take over larger functions that are currently in-house or organizations that would choose not to, on a long-term basis, run their own data processing, that gives you some ASP side.

Software licensing in that business is more difficult, because, as I say, there's virtually everybody that is paying claims already has a system. So the conversions are large and complex. We think we're differentiating the systems with the integration of AWD.

And that's part of our sales strategy, is to take a different dimension to the client, which allows them not only to have a quality and functional software that incorporates technology to support some of the contemporary plans, like CDH, as it's generally referred to, consumer-directed healthcare, but also to give them operating efficiencies.

So it's very difficult to size that market. If you threw out total data processing spend in the claims processing industry, it's a very, very significant number. It's very difficult to get underneath that number and say really what's the available market. But you know we have some other competitors out there, and ourselves.

We think we're reasonably well positioned. But it's a business that, again, we think has a very significant potential market. But a lot of it, I think, is going to depend on how quickly some of these organizations adopt more consumer-directed, how quickly they need the technology to support that, and really whether there's a predictable and significant movement to, in effect, outsourcing existing operations.

Murali Gopal - KBW

That's very helpful. And lastly, when I look at Asurion's contribution, it seems like -- just trying to understand if there was any seasonality there, just given that when I look at the second quarter, which was a fairly clean quarter with no adjustments.

And then adjust for the $4 million or so interest expense -- DST share of interest expense, it still seems like a solid quarter for Asurion. Is there any seasonality in the business there?

Tom McDonnell

Not -- well, there is some degree. Really, a lot of it is dependent upon when the Asurion customers are -- when they're hitting their big promotions for the sale of phones. A lot of that occurs around Christmas, a lot of it occurs in the first quarter around -- the ads they run, get the sports scores on your phone and all that.

A lot of it is driven, really, by those customer cycles. Those aren't dramatic in their seasonality. From an overall business standpoint, since it is a claims management business, tend to be more claims in the summer when people are out on boats and stuff, and lose their phones. But there's no -- I wouldn't suggest that there's a huge seasonality one way or another.

So I think we felt the fourth quarter was a solid quarter delivered by them. And I think that's probably reasonably representative going forward.

Murali Gopal - KBW

Okay. Thank you very much.

Tom McDonnell

Yes.

Operator

Your next question comes from the line of Pete Heckmann from A.G. Edwards. Please go ahead.

Pete Heckmann - A.G. Edwards

Good morning, gentlemen. As regards the industry, I know you stopped giving commentary as regards the total backlog in potential RFPs. But could you provide a little bit of color on your thoughts on what the market looks like, in terms of potential new business?

Any trends within the industry, any changes in pricing pressure on large renewals, and then, any changes in maybe the dynamics from some of the large mergers in the mutual fund industry?

Tom McDonnell

Well, again, we're not going to slip inadvertently, Pete, into discussing what's out there. It's really not much different than it has been when we were publishing a year back some overall numbers. And obviously, some of the clients we signed, you take them out there.

The remaining universe is shrinking, obviously, because of the conversions that we picked up. There's still -- excluding what we consider to be sort of the ones that will never change, like a Fidelity and a Vanguard, they're still a significant component of in-house business.

Clearly, with the competitive landscape out there, there's significant pricing pressure. We need to respond to that, both to retain and get clients, but also respond to it in addressing the efficiencies with which we process those. But the pricing pressure is there, has been for quite a while, and I don't see it really going away.

So I think that the outlook probably is not much different than it's been for the last year, year and a half. There's still some activity out there. But the bids on these things are really quite aggressive. And the expectation of mutual fund organizations is that by going out to another provider or switching providers, that they can be impacted favorably on the economic side, as well as getting a better overall service.

So I wouldn't call it disastrous or anything, but it's certainly a difficult pricing environment.

Pete Heckmann - A.G. Edwards

Okay. And can you disclose, or were there any pieces of business that made decisions to convert that you were bidding on that you did not win in the fourth quarter?

Tom McDonnell

I don't think any that we were bidding on we lost.

Tom McCullough

Right.

Pete Heckmann - A.G. Edwards

Okay. Okay. Great. And then my last question. As regards the buyback, is there sensitivity? The stock has had a nice move here. Is there sensitivity to the current price on the stock? Would you anticipate -- or is there a level at which you would materially slow the buyback, given the rise in the stock price?

Tom McDonnell

We don't spend a lot of time adjusting for stock price. Obviously, we're not in the business of predicting where it goes or whatever. Most of our buybacks, with the exception, Pete, of when we've had significant cash inflows, like with the sale of a division or whatever, they're pretty much just methodical, or just kind of constant.

So you wouldn't expect too much deviation quarter-to-quarter. And it's not -- I'm not going to tell you that we are insensitive to price. But we're not adjusting day-to-day based on the pricing of the stock. We tend to set up, sort of, an approach over, not necessarily an extended, but at least a several-month period, and we just kind of buy sort of on a consistent basis.

Pete Heckmann - A.G. Edwards

All right. Thank you.

Operator

Your next question comes from the line of Glenn Greene from ThinkEquity Partners.

Glenn Greene - ThinkEquity Partners

Thank you. Good morning. Just want to go back to the Financial Services operating margins for a second. Clearly, that was kind of the upside surprise in the quarter. And just kind of looking sequentially, the operating profits were up about $25 million. And you didn't get quite the benefit that some of us would have thought from the software license sales.

So I'm just wondering -- and the only thing that systemically looks like it changes, you rolled in ASI this quarter because of the acquisition, but the profitability profile probably there is perhaps not that different from the core business. Did anything systemically change from a cost structure standpoint?

I know you highlighted some of the discreet items. But they didn't look that material, maybe 3 to 5 million or so. But just want to get a better understanding for the strong improvement in the operating margin. And even besides this quarter, or the three prior quarters, the margin improvement was very strong.

So trying to understand, besides the discreet items you highlighted, the extent of the operating margin leverage going forward.

Tom McDonnell

Well, we have over time been trying, as all organizations have been addressing the cost side of the equation. So we think we've made some progress there. And we had anticipated margins improving. I would caution you on the fourth quarter. Because there's -- as you suggest, $3 to $5 million. But fourth quarter, there's probably some other kind of fourth quarter unique items in there that I can't exactly put my finger on at the moment.

So I wouldn't suggest that it's trending up from there or is even exactly sustainable there. As I indicated earlier, I don't think it would drop off precipitously, but I don't think it will sustain right where it is. I think at a minimum, you have to adjust for the couple things that you mentioned.

And like most organizations, I don't know if its most organizations, but just our wage adjustments for employees and everything kick in late in the fourth quarter. So you'll see that impact starting in the first quarter next year. That's an annual sort of phenomena. So I just want to caution you a little bit on where that number might be.

But like I said, I don't want to get too concerned, because like I said, I don't see a precipitous drop-off. But you certainly have to adjust at least, say, for that 5, 6 million range that you were referencing.

Glenn Greene - ThinkEquity Partners

Okay. And then on -- just some clarity. On the $1.1 million accounts you picked up, were those remote or full service? And also just refresh us on the $7 million accounts?

Tom McDonnell

Well, the $7 million will be remote. And the 1.1 come in through BFDS. So they're full service to BFDS, remote to DST. So that it really gets picked up at two levels. The DST part of it gets picked up in the equity and earnings of BFDS, and the other in increased processing fees from the joint venture to DST.

Glenn Greene - ThinkEquity Partners

Okay. And then just finally, I was wondering if you could just give us some color on the real estate joint venture? It's kind of the first time you've highlighted it. I know it's been in your Qs. But what’s sort of going on there and the potential opportunity for you overtime with that venture?

Tom McDonnell

Well, it basically was an opportunity to develop a property for the IRS. It was a significant opportunity. There was a $350 million financing put in place with it. The IRS has now occupied it, at least in part. And will completely occupy it in the first quarter. We think as an investment and as a sort of long-term, it has the type of properties -- type of characteristics you would expect in a real estate property.

But quite frankly, if you want to color it, it will be red because the GAAP accounting for a real estate operation with the depreciation and other expenses tends to be different than what we would consider to be the economic accounting of the value of the property from a cash flow and an appreciation standpoint.

Glenn Greene - ThinkEquity Partners

Got it. Okay. Thank you very much.

Operator

Your next question comes from the line of Bryan Keane from Prudential. Please go ahead.

Bryan Keane - Prudential

Yeah. Hi, good morning. I just wanted to clarify, Ken, you noted a couple or two items that boosted Financial Services margins, the professional fee income and then there were some other catch-up fees. Did those total the $3 million, or were they more like $6 million?

Ken Hager

The $3 million was the professional services fees alone. The total number would be more in the $6 million range.

Bryan Keane - Prudential

Okay. That's helpful. And then when I look at the license sales, was 2005 an abnormally strong year for license sales, and '06 was weak. So we should expect somewhere in between? Or how do we think about that, the license sales, going forward?

Tom McDonnell

I think '05 was a solid year. I wouldn't call it abnormally high. But if you went back and looked at '05, probably the fourth quarter was abnormally high, because we -- it had less software sales in the early quarters. So I don't think you can say that the year in the aggregate was abnormally high.

But just knowing the nature of software sales, I think for our thinking and your thinking, you would be to the conservative side. But we will have software license revenues and we feel reasonably good about it. But, like I say, if you take the year in the aggregate, it was not abnormal.

Maybe if anything, this year was a little light. But you can't -- the quarter-to-quarter is part of the problem, because fourth quarter '05 was very strong.

Bryan Keane - Prudential

Okay.

Tom McDonnell

Am I answering your question at all?

Bryan Keane - Prudential

No. That helps, that helps. Because I was just trying to figure out how to model those license sales, or at least get a sense of it. And then when we look to -- the other thing I'm trying to figure out is the seasonality between the fourth quarter to the first quarter.

What are the -- when we look at the revenues for financial services, for example, what are some of the one-time things that boost revenues in the fourth quarter that might not reoccur in the first quarter?

Tom McDonnell

Well, as far as normal revenues, there's not too much, other than the kind of unusual things we just mentioned, which we don't think are direct outgrowths of the financial services. And when we talk Financial Services, we talk of course, heavily driven by the mutual fund side of the business.

The seasonality in the first quarter would tend to be -- in the fourth quarter and in the first quarter, some of the fee arrangements with clients have transaction costs or transaction charges, say, associated with dividends or proxies or something like that. So it tends to be a little bit of a pickup in the fourth quarter.

First quarter, you may still have some of that revenue as you put out 1099s and so forth. The biggest impact seasonality-wise from the mutual fund business really is in output -- in DST output because of the volumes driven by yearend statements, 1099 production, and then late in the quarter, to the extent mutual funds have requirements to put out proxies or other materials, you sometimes see some seasonality there. So from output, the strongest quarter is the first quarter.

Also on the mutual fund side, because of 401Ks, generally, the enrollees are January 1 and July 1, so you tend to have some pickup from that side. And then for lack of a better term, what I would just call the New Year's resolution impact, where people say, I'm really going to start saving, I'm going to open an IRA, I'm going to open an account, do some of that stuff, usually have a little bit more activity in the first quarter. But that's the nature of the seasonality.

Third quarter, collectively, is usually the lowest. But the factors I mentioned, both in Q4 and Q1, are the ones that drive most of what you would refer to as seasonality. Second quarter is a bit of a mix, because with April 15th being kind of halfway into the quarter, or a third of the way into the quarter, you have IRA activity that slips over into that month.

Bryan Keane - Prudential

Okay. And so if I look at my model historically, there was a drop-off in revenues between the fourth quarter and first quarter, but that might just be through divestitures and other. So there doesn't sound like there's as big of a drop-off or a step down, besides some of the small items you mentioned in the fourth quarter to the first quarter?

Tom McDonnell

Well, other than the license revenue, which we talked about, the underlying recurring financial services revenue, should not predictably have a decline Q4 to Q1.

Bryan Keane - Prudential

Okay. And then just moving that same chain of thought to the operating margin, it sounds like the big difference in the financial services operating margin from the fourth to the first is some of the salary buildup. Is there anything else in that number that brings out -- because historically that's dropped to pretty significantly from the fourth quarter?

Tom McDonnell

I don't think there's anything that's sort of organic that's different. But again, you've got to figure out what you're backing out of the fourth quarter for some of the items that we -- Ken quantified for you earlier.

Bryan Keane - Prudential

Yeah, right. Okay. Great. Thanks.

Tom McDonnell

Yeah.

Operator

Your next question comes from the line of Dave Koning from Robert W. Baird. Please go ahead.

Dave Koning - Robert W. Baird

Yeah. Thanks. Just one more clarification on the $6 million of catch-up/professional fees. Is that all -- that full $6 million is all no costs, I guess, associated with that?

Ken Hager

Pretty much, that's the case.

Dave Koning - Robert W. Baird

Okay. And then secondly, the other income line, I think it was about $10 million this quarter. I know that includes dividends from Computershare and State Street. What else is in that line? And is this something that we should look at as kind of $8 million to $10 million a quarter going forward?

Ken Hager

This is Ken. I mean, it's mostly dividends from, as you pointed out, plus dividends on any other marketable equity securities that we hold. And we have some level of interest income when we have investable balances. I don't believe right now, that there's anything -- the one thing that impacts it, Computershare only pays dividends twice a year. And so they had a dividend the second and the fourth quarter. But that would be the main thing that I would think of that would have an impact on it.

Dave Koning - Robert W. Baird

Great. And then just one final question. CapEx, I think, was somewhere around 10% of rev this year. Is that a fair way to look at the future?

Ken Hager

I think that would be reasonable, yes.

Dave Koning - Robert W. Baird

Great. Thank you.

Operator

Your next question comes from the line of Paul [Goldschmid] from King Street Capital. Please go ahead.

Paul Goldschmid - King Street Capital

Hi, guys. I actually wanted to follow-up on that last CapEx question. Going forward, it just seems like every year your CapEx has been coming down. I wanted to know how much going forward -- there was about $50 million in output solutions this year. How much going forward will there be in output solutions?

Ken Hager

This is Ken. I would say that output would probably be for '07 would be reasonably consistent with '06, as we continue the deployment of the new technology into other locations.

Paul Goldschmid - King Street Capital

And the building investments would be about the same, about $12 million?

Ken Hager

We don't see anything significant in the area of building in '07. We did do some facility expansions in '06, and I believe those would be substantially done.

Paul Goldschmid - King Street Capital

Okay. Thank you very much.

Operator

Your next question comes from the line of Phil Mickelson from JP Morgan. Please go ahead.

Phil Mickelson - JP Morgan

Good morning, gentlemen. Just a quick question or just a refresh. I think you had announced in the summer Delaware was converting from a remote processing to a full service. Just kind of getting a sense is -- was that -- has that business been converted?

And also want to kind of get a little bit of color on the pipeline for clients that could possibly follow Delaware's lead in becoming full service clients from remote processing?

Tom McCullough

This is Tom McCullough. Yes, Delaware has converted. And we continue to see interest in exploring those opportunities, but nothing specific.

Phil Mickelson - JP Morgan

And just kind of wanted to get a sense, too, I mean, I know you don't do pipeline analysis. But is there anything in terms of -- I know in last first quarter you announced your big Putnam win. Is there anything from a seasonality perspective of when fund families could make a decision to kind of outsource their record keeping? You know, is that a decision that would be made early in the year?

Tom McCullough

No, there's really no seasonality to it. It all depends when they start the process, and how long they want to spend on the process.

Tom McDonnell

There's no seasonality that we've ever experienced in the decision. Really, you just generally don't see -- we've got a couple of conversions that will end up in the second quarter. But we usually don't see any conversions, like from say, December 1st to March 1st or so, just because of yearend activity and all that. So there's no seasonality to the decision. But there is the seasonality to actually being able to convert business.

Phil Mickelson - JP Morgan

Just kind of thinking about organic growth within your account base. I know it's difficult to predict markets and equity markets performance. But I think you had somewhere 3%, 4% organic growth in your accounts this year. And would you expect that kind of same rate again in 2007?

Tom McDonnell

We'd certainly like to see at least that. But I think 2006 was kind of a pretty good year for markets in general, and I think the general sense we hear is that there is some reasonable optimism about '07. So I think that 3% to 4% may well materialize.

Phil Mickelson - JP Morgan

Got you. Just kind of switching gears to the healthcare processing business. Can you give us a little more color strategically? I know the initiatives there were ramping up the sales force, you know it seemed to be building that business. Could you give us a little more color on what the focus is for 2007?

Do we have that sales force ramped up? Is that where we can see kind of a revenue, you know hopefully some sort of inflection point as far as revenue growth in that business?

Tom McDonnell

I think the sales force is now where we want it to be, because we've combined the sales forces of Health Solutions and what was ASI. So I think we've got the right size sales organization. A lot of the focus will be -- we think the true outsourcing side, the BPO is probably the greatest opportunity, so there'll be a lot of focus there.

There'll be focus, of course, on new clients. But also because of products like AWD and being able to move people, say, from an ASP to a BPO, or from a licensed in-house operation to an either ASP or BPO, a lot of focus will be on existing clients. So it will be a mix. So I think with the ASI acquisition, a lot of that sales force consolidation has just really now come together solidly.

So I think at the end of this quarter and going into next, we can give you a much better sense of how we see that progress going forward. But I think the steps we've talked about, we have taken. And so I think we should be in a position to start to see some impact of that sales force, the combined operation, and a strategy that I indicated is probably heavily oriented towards outsourcing business from in-house or remote clients.

Phil Mickelson - JP Morgan

And that was my next question. Is really the opportunity here is replacing in-house processing systems? Or is it possibly taking market share from other competitors in the space?

Tom McDonnell

Well, in some case, when you take an in-house system, a very high percentage of in-house systems are somebody else's software that's been bought and installed. So it really, in that sense, it takes a share from a competitor. But the key issue is, with everybody's -- focus in all businesses is heavily on, how do they reduce costs.

In many cases, we can provide a far more economical operation because of our scale, because of the geographies we operate in, and because of some of the technology that we employ, like AWD. So we can create cost differentials. The key thing is, demonstrating to the client that there is a significant enough cost differential to undertake the conversion effort upfront, because it's not inconsequential. But I think it's really -- the driver is here is a better solution.

Where that business comes from? In fact, in some cases, it could come from a client who owns our existing technology and software, but we convert them to a BPO. Or it could be from a competitor's software. Or in some cases, you know older legacy in-house systems. On the healthcare claims side, there's probably not that many pure in-house systems. A lot of them go back to systems that haven't been actively sold for years

But that had been acquired and highly customized by the customer. So that's kind of the nature. But like I said, once we get this sales team out in the field, it's put together -- they're out in the field now, but I would like to be able to -- I'd like to think we would see some results. We'd probably be more articulate on this in future quarters.

Phil Mickelson - JP Morgan

That's helpful. And finally, with the healthcare business, is the focus on -- you know is it investing in that business and revenue growth opportunities, could we also see maybe that the function of growing revenue, but margin expansion in that business? Or is that not really a focus at this point for the healthcare business?

Tom McDonnell

I think we would hope to see margin expansion. Again, that when you break -- you have to kind of look at it in a couple pieces, because we think if, particularly from the BPO and ASP, there is operating leverage and we can add volume there. So that would enhance the margins.

You will still have in the healthcare side some component of license sales. So I think you almost kind of have to separate those, and not think of them as a blended margin, because when the software sales occur, they will obviously positively impact the margin in the period they're reported.

But longer-term, we should be able to see margins improve just because of the scale that we can accomplish on the BPO side.

Phil Mickelson - JP Morgan

All right. Thank you very much.

Operator

Peggy [Corsillo] from Meridian. Please go ahead.

Peggy Corsillo - Meridian

Hi, a couple questions. Let me start with the Financial Services business. On the $1.1 million accounts, they seem to be coming on much faster than some of your other conversions. Is that because there are smaller customers coming through BFDS? Or what's the reason you can get them on pretty quickly?

Tom McDonnell

Well, it's not so much that they're coming from -- coming through BFDS. It's that they, just as you suggested, they're smaller-sized customers and far easier to convert.

Peggy Corsillo - Meridian

Okay. And then a question for you on Output. Can you kind of review for us the strategic reason, do you need to own Output? Do you need to use it to sell printing services with either the more of the Financial Services side of the business, or the healthcare side of the business?

Tom McDonnell

The answer to do we -- absolutely need it to sell business in those areas, the answer is no. Historically in the mutual funds side of the business, there's been a very high correlation, however, that if we get the mutual fund business, we can easily get the print business.

So if you put it in the context that this was at once a more attractively profitable business, getting that kind of revenue is still a good idea. In the health side, we have very little print penetration. In fact, that's an area that we do think we can grow our print services, because we think that that's a client base and we can serve more effectively by integrating some of the output with the underlying technology that we provide them.

And but if you add up the mutual fund and what health business we actually do, it's probably about 25-30% of the overall. So 70% of it is really being in the print mail business with very large clients, either in the telecom industry, cable, satellite and other billers.

We think that historically we've differentiated all of our businesses with investments in technology. We're making a significant investment in this business with the technology we're bringing on, very high-speed four-color presses that allow individualization down to each individual customers, as far as sales messages, targeting subsets that more and more of these organizations.

Because customer acquisition costs are very high, and once you acquire them, you certainly like to expand the revenue per customer. We think we're putting in the type of technology that will allow us to, on a run rate basis going forward, have a much more cost-effective operation, but with a substantially improved range of product to offer to the clients.

So viewed that way, we look at it as a business that we should be able to materially improve where it is from here. And I guess, you know, I would admit it should have more upside at this point because we're starting pretty much from ground zero. But you know, we think it is a legitimate business to apply this type of technology to.

It certainly can be enhanced by our other relationships, where we do think we have a better entree to pick up the print mail, either in healthcare or mutual funds. But to answer your question directly, it is not an essential element to selling into those industries.

Operator

And your final question today, comes from the line of Steve Balog from Cedar Creek Management. Please go ahead.

Steve Balog - Cedar Creek Management

In the context of the healthcare business, could you explain what you meant by consumer-directed plans, and why that is important to DST's growth in that area?

Tom McDonnell

Well, for instance, an example of a consumer-directed plan might be a health savings account. The whole push -- or not the whole, but a significant push in management of healthcare costs, you know, from insured and provider plans, is to engage the insured participant more actively in a decision-making process that reduces the overall cost.

It means more and more complex -- more and more complexity to the structure of these plans. So one, you try to structure a plan, for instance, through either deductibles or co-pays to disincent the use of emergency rooms for anything other than real emergencies. You know a lot of emergency rooms are used, you know for say, by working parents who take a child, for an instance, to an emergency room because it's more convenient than taking them to a doctor.

More plans that incent the use of generics. More plans that incent the use of mail-order drugs to reduce overall cost. Health savings accounts, which you know, go suggest that higher deductibles, but that the use of a health savings account that lets the covered individual put money away, either for the current expenses or tax defer them for longer-term needs.

All of that stuff adds complexity to sort of the underlying processing and the technology and the software that is required to keep track of these more complex plans. So the movement to consumer-directed tends to take significant additions and modifications to basic claims paying systems, to facilitate all of those types of strategies that payers are trying to employ in order to get more buy-in from the consumer in helping to reduce the overall healthcare cost bill.

So that's -- I may have wandered around a bit over there. But that's really what we see as the dimension of moving towards CDH that should lend itself to, a positive outcome for well, not only ourselves, but our competitors, because, I think we're in a better position to make and accommodate some of those changes than in-house operations, because we accommodate a health savings account.

We do it for a broader base than an individual organization that might be doing it just, for a more limited number. So I think overtime, that whole consumer-directed approach is positive for us.

Steve Balog - Cedar Creek Management

So is that if some of this complexity is the straw that breaks the camel's back, and the organization will look to scrap its in-house system?

Tom McDonnell

It could in some cases. I wouldn't say that would be universal, because a lot of these systems and some of the technologies we've developed are actually modular, so they can be added to existing systems.

But I'm sure there are instances out there where sort of the cumulative affect of older systems that really haven't been cap up, when you have to make significant additions, that there will be people who say, well, this is finally the time just to change the whole thing.

So you could have that, but I wouldn't suggest that it will be -- while, I just can't tell you how significant it would be across a broad customer base. But it certainly could well be a factor.

Steve Balog - Cedar Creek Management

That's great. Thank you.

Operator

And there are no further questions.

Tom McDonnell

Well, we want to thank everybody for participating in our call today. And we look forward to talking to you at the end of the first quarter. And Greg, with that, I think you can make the announcement on the recorded call.

Operator

Thank you. Ladies and gentlemen, this conference will be available for replay after 3:15 Central Time today, through January 31st. You may access the AT&T Teleconference Replay System at any time by dialing 1-800-475-6701 and entering the access code 858022. International participants dial 320-365-3844. Those numbers once again are 1-800-475-6701 or 320-365-3844 with the access code 858022.

That does conclude your conference for today. Thank you for your participation, and for using AT&T Executive Teleconference. You may now disconnect.

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