DST Systems' (NYSE:DST)
Q1 2016 Earnings Conference Call
April 21, 2016, 08:30 ET
Steve Hooley - Chairman, President & CEO
Gregg Givens - CFO
Peter Heckmann - Avondale
David Ridley-Lane - Bank of America Merrill Lynch
Dave Koning - Baird
Welcome to the DST Systems' First Quarter 2016 Earnings Conference Call. [Operator Instructions]. In the course of this conference call today forward-looking statements may be made regarding DST and it's businesses. Such statements are based on the company's views as of today and actual results could differ materially from the forward-looking statements. There are a number of factors that could affect the company's future results including those risk factors set forth in DST's latest annual and quarterly reports filed with the SEC. All such factors should be considered in evaluating any forward looking statements that may be made.
Now, I would like to turn the conference over to our host Mr. Steve Hooley, Chairman. President and Chief Executive Officer of DST. Please go head.
Great, thank you very much. Good morning and thank you for joining DST Systems first quarter 2016 earnings call. With me today is our Chief Financial Officer, Gregg Givens . I'm going to start by going through some of the highlights for the quarter and then will turn the call over to Gregg for additional detail on our financial results.
Overall, we are pleased with the first quarter with positive operating results in all three business segments. Our healthcare business delivered double-digit revenue growth and expanded margins over prior year. We’ve also achieved revenue growth in our financial services segment as the benefits of our recent acquisitions are coming through this quarter's results. Additionally we have generated margin expansion in our customer communications business.
We continue to deliver in line with our strategic plan which includes a focus on growing revenue through organic opportunities, new client wins and targeted acquisitions. While continuing to make investments in our business to prepare and position DST for the future. We remain focused on the operating margins of each of our businesses and our portfolio and expect that over time we will improve our overall operating margin for combination of revenue growth and the realization of operating efficiencies.
However, we expect there will continue to be pressure on our margins in the near-term as we continue to invest in our businesses to assure we are responsive to the ever-changing regulatory environment and challenging market conditions in which we and our clients operate. Additionally, as we have previously discussed we are in the process of converting a significant new customer onto both our mutual fund and sub-accounting platforms and continue to work with our UK joint venture to migrate two customers onto our new wealth management platform.
While we believe these conversions will drive long-term value there is a cost associated with the that we will continue to incur for period of time. We believe our first-quarter results demonstrate quality of our client base coupled with our team's ability to execute in the face of challenging market conditions.
Moving to our results, in the first quarter of 2016, consolidated net income attributable to DST was $58.1 million or $1.70 per diluted share. On a non-GAAP basis consolidated net income attributable to DST was $55.1 million or $1.61 per diluted share compared to $56.2 million or $1.49 per diluted share in the first quarter of 2015. As outlined in our press release today beginning this quarter intangible amortization expense has been excluded from diluted earnings per share after non-GAAP adjustments. We believe this adjustment provides for more meaningful comparison of our results. Prior periods referenced in our results have been adjusted to be consistent with the current year presentation.
Consolidated operating revenues increased to $25.4 million or 5.1% to $521.1 million as compared to the first quarter of 2015. Our improved results are due to the business acquired during 2015 and 2016 as well as year-over-year new and existing client growth across a number of our service offerings. We benefited from one month of revenue from our recent acquisition of Kaufman Rossin Fund Services which was completed on February 24. Kaufman Rossin combined with our Alps operation places us in the Top 20 providers of hedge fund administration services.
We believe this acquisition highlights our vision to opportunistically add complimentary businesses, products and service offerings to our existing portfolio and will continue to contribute to our financial results for the remainder of 2016 and beyond.
Turning to our segment results for the quarter, financial services segment operating revenues for the first quarter of 2016 increased $7.4 million or 2.8% to $274 million compared to the first quarter of 2015. As I mentioned, this increase is primarily due to the business acquired during 2015 and 2016, which contributed 7.1 million of incremental operating revenues in the segment during the first quarter. We also saw an increased professional services revenues associated with our wealth management platform and organic and new client growth within our brokerage solutions and applied analytics business. Our financial services segment margin had been impacted by a number of factors namely cost incurred to convert new clients, continued headwind and continuing investment and depreciation in the areas of risk compliance and security.
Moving to our Healthcare Services segment, operating revenues for the first quarter of 2016 increased $12.3 million or 13.4% to $104.2 million. These results were primarily driven from the successful implementation of new BPO customers and the expansion of services we are offering to our current customers. Additionally, we continue to benefit from organic growth at our existing customers. We also experienced higher margins for the quarter as we benefited from previous investments and leverage due to our scale.
We are encouraged by the positive momentum experienced during the first quarter and potential broader growth opportunities within the healthcare industry. We are confident that our ongoing strategy and investments will continue to expand the value we provide to the marketplace and our clients -- to the market place in our clients and has us well positioned for the future.
Moving to customer communications, we achieved strong operating results within customer communications and are pleased with the margin expansion during the quarter. Operating revenues for the first quarter of 2016 increased $4.2 million to a $164.3 million compared to the first quarter of 2015. During the quarter higher operating revenues from newly converted clients were partially offset by organic declines from certain existing customers and unfavorable foreign currency exchange movements.
In April 2016 we also completed the sale and lease back of our UK customer communications Bristol production facilities for pretax proceeds totaling $16 million. Our equity and unconsolidated affiliates decreased primarily from lower IFDS earnings. The decrease in IFDS earnings is predominantly from lower revenues recognized related to the ongoing client conversion activities. Higher operating costs at IFDS as IFDS expands its infrastructure continued investment in our wealth solution platform and negative foreign currency impacts in both the UK and Canada.
As discussed earlier, IFDS UK began processing on our wealth management system during the fourth quarter of 2015. As other ongoing conversion projects continue to be completed, we expect that IFDS' earnings will be lower than 2015 due to the amortization of the capitalized software costs coupled with decline in implementation revenues. IFDS continues to work closely with both wealth clients to further define the additional enhancements and functionality to wealth management platform.
As these specifications are defined, the scope of effort and timeline for completion of the various requirements will continue to evolve. During the quarter we repurchased proximally 700,000 shares of DST common stock for approximately $75 million. This leaves us with $75 million remaining under our existing share repurchase plan. Looking further into the year there are number of efforts underway which we will continue building DST for the future.
We have a strong team executing on our objectives in an addition to our organic and inquisitive growth opportunities our balance sheet provides additional flexibility to create value and help sustain our results as we achieve our goals.
With that, I would like to turn the call over to Gregg for detailed discussion of 2016 first quarter results.
Well thanks Steve. On a GAAP basis this quarter we reported consolidated net income of $58.1 million or $1.70 per diluted share compared to $107.8 million or $2.87 per diluted share for the first quarter of 2015. The year-over-year decline is primarily due to lower realized gains on the sale of securities in 2016. On an adjusted basis our non-GAAP earnings per share were a $1.61, an increase of $0.12 or a 8.1% over first quarter 2015. Beginning this quarter, our non-GAAP results for both the current and prior year quarters now exclude intangible amortization expense.
We made this change to better align ourselves with our peers and to provide a more meaningful comparison of our results as we've acquired businesses. The remainder of my comments will focus on our adjusted non-GAAP results. Consolidated operating revenues for the quarter were $521.1 million, an increase of $25.4 million when compared to first quarter 2015. The increase is primarily due to the businesses we acquired during both 2015 and 2016 as well as year-over-year new and existing client growth across a number of our service offerings.
This was partially offset by $6 million of negative foreign currency movements. Consolidated operating income increased 3% or $2.4 million to $83.7 million. The increase in operating income is principally from increases within our healthcare services and customer communication which were partially offset by increasing cost within our financial services segment. Consolidated operating margins were 16.1% in the quarter as compared to 16.4% in the first quarter of 2015.
Within the financial services segment operating revenues increased $7.4 million or 2.8% to $274 million. This increase resulted primarily from the businesses acquired during 2015 and 2016, which contributed approximately $7.1 million of incremental operating revenues during the first quarter. We also saw increased professional services revenue associated with our wealth management platform business and organic and new client growth within our brokerage solutions and applied analytics business units.
The operating revenue increases were partially offset by declines in a mutual fund registered shareholder [ph] account processing due to lower registered accounts, a decline in Alps asset management revenues due to volatility in the financial markets, lower software license revenues of $700,000 and negative foreign currency movements of $2.2 million.
Financial services income from operations decreased $6 million or 12% to $43.8 million during the first quarter of 2016 as compared to first quarter of 2015. The primary drivers causing the decrease in operating income are a decrease in higher margin revenue, increase cost to convert new clients, depreciation of the new generator project which was put into production in the fourth quarter of 2015 and depreciation of previously acquired compliance and security software.
Financial services operating margin was 16% which is a decrease from the 18.7% operating margin in the first quarter of 2015. Our Healthcare Services segment operating revenues were $104.2 million an increase of $12.3 million or 13.4% from first quarter 2015. The increase is primarily attributable to new clients implemented in January 2016. Organic growth and expansion of services with existing clients from both the medical and pharmacy businesses.
During the first quarter Healthcare Services income from operations increased by $7.1 million or 67.6% to $17.6 million primarily due to the higher revenues. Costs and expenses increased from increased staffing costs associated with supporting the revenue growth.
Additionally, the operating margin for our medical claims BPO business was lower in 2015 due to implementation costs associated with new clients which are now being processed on our platform in 2016. The combination of these factors increased the operating margin for the quarter to 16.9% as compared to 11.4% in the first quarter 2015. In our customer communication segment, operating revenues increased year-over-year by $4.2 million to $164.3 million.
North America operating revenues increased $2 million or 1.7% to $120.9 million in first quarter 2016. The increase in North America operating revenues is primarily from incremental volumes due to the continued conversion of new clients throughout 2015. The increase was partially offset by a decline in volumes from certain existing customers and unfavorable foreign currency exchange rate movements of $1.1 million related to our Canadian operations.
Our UK operating revenues increased $2.2 million or 5.3% to $43.4 million in first quarter primarily from revenue growth associated with new and existing clients. This was partially offset by $2.7 million of unfavorable foreign currency exchange rate movement as well.
Overall, customer communications operating income was $22.8 million during the first quarter of 2016, an increase of $1.5 million from the same quarter in 2015. Higher operating revenues in North America were offset a higher variable costs for the increased revenues and increase rent expense as a result of the sale lease backed transaction completed in late 2015. The increase in UK operating income was a result of higher operating revenues associated with both new and existing clients.
Customer communication segment operating margin in first quarter 2016 was 13.9% as compared to 13.3% in 2015. DST's equity earnings of unconsolidated affiliates decreased by $4.6 million to $6.7 million in first quarter driven primarily from lower IFDS earnings.
IFDS earnings decreased by $5.8 million to $1.5 million in the first quarter primarily from lower revenues recognized related to the ongoing conversion activities, higher operating costs as IFDS expands its infrastructure to prepare for the addition of new clients and negative foreign currency impacts in both the UK and Canada.
The multiyear implementation efforts for the two wealth management clients continues to progress and are expected to complete in phases basis over the next two years. We continue to expect earnings volatility throughout the implementation and conversion process as these multiyear projects continue to evolve. Our income tax rate for the first quarter was 35.4% compared to 36.1% for the same quarter last year. We expect our income tax rate for 2016 to be approximately 36%.
During the quarter, we received $70.5 million of pretax cash proceeds from the monetization of investment assets $59.8 million came from the sale of marketable securities while the remaining $10.7 million came from private equity investment distributions. We continue to see decline in our dividend income as a result of our past monetization activities.
Turning to our share count, during the quarter the company spent $75 million to repurchase approximately 700,000 shares of DST common stock. Average diluted shares outstanding for the quarter were 34 million shares, a decrease of 8.8% from the first quarter of 2015. As of March 31, DST had $75 million remaining under our share repurchase plan.
We closed the first quarter with $73.4 million in cash and $721.5 million of debt. We continue to maintain a strong balance sheet and believe that our ongoing liquidity gives flexibility to be opportunistic in the marketplace.
I will now turn the call back to Steve for concluding remarks.
Great, thanks, Gregg. DST is continuing to take steps to perform and create value over the long term and we are pleased with our performance to-date. We're confident that we have the right strategy in place and the right team executing in order to deliver on our objectives.
With that I would now like to go ahead and open the call for questions. Operator?
[Operator Instructions]. Your first question comes from the line of Peter Heckmann of Avondale.
One broad question and then a couple specific follow-ups, but are you starting to see -- it seems that we are starting to see across the sector some relatively larger decisions being made including some decisions to increase the level of outsourcing towards more of a BPO format with the wins last quarter that you announced with some of the wins in healthcare to feel that there has been some change in the velocity of decision-making among some of your big target clients?
Yes, it's a great observation, Pete, and I would say we are seeing some change and let me break it out a little bit by segments, right. If you look at the financial services segment, we have such high market penetration. You know, we don't have a significant block of clients to go after. That said, the customers that we have are looking to outsource more to us, right?
So as everybody particularly in that sector is challenged with you know, headwinds and really a tough environment, everybody is looking at ways to increase their own internal efficiency and one of the waste that they are doing that despite outsourcing more and so we are absolutely a beneficiary of that. So we had the big win which was terrific and we've got teams working on that and we are on track to deliver part of that relative to seeing revenue late this year and the other piece late next year, but some of the things you're probably not seeing is that our customers are moving more work to us, right? So that’s helping with organic revenue growth.
In the healthcare sector, there are a lot of big decisions being made and partly because you know, customers are looking at their model and partly because of the transition that's happening you know, between the big providers in the U.S. and you know, there's obviously been a couple high-profile acquisitions that it -- or that are in process, right?
And that will drive some decision and for us, there's obviously some risk of their but we also tend to think there's a significant amount of opportunity. So there is better velocity and momentum I would say around decisions that would favor the top line.?
And Gregg maybe more detailed question. On the sequential growth within Alps of assets under administration, was Kaufman Rossin included in that AUA figure and if so, about how much did it add?
It is included in that figure and I think it was directionally 20 billion.
20 billion, right and then of the AUA number, 163 billion I think it was? Can you give us some rough approximation of what percent of that now might be hedge funds or other alternative investment, do you have that at your fingertips?
I do not have that one at my fingertips. We can get back to on that one.
Your next question comes from the line of David Ridley-Lane of Bank of America.
Sure, Gregg just a level set for investors, do you have the adjusted EPS under the new definition for 2014 and 2015?
I have it for 2015 and it would be -- so it was $5.94 on a non-GAAP basis in 2014 and it would increase to $6.34 when you take out the intangible amortization and so that's directionally $0.40 difference. And I will just embellish upon that a little bit, taking the acquisitions that we have in place, we know what they are right now, all right? We would indicate that the amortization which was of intangible amortization that came from business combinations in 2014 was directionally $20 million of expense. We think that same expense will be $25 million in 2016.
And then was there anything one time in healthcare revenue during the first quarter? I guess I'm just trying to square the reported 13% revenue growth through the 6% growth you’ve seen in claims. Maybe some of your existing clients are taking additional services to sort of try to understand that?
So you are spot on. There was no one-time event that took place in the first quarter in our healthcare business. We have seen both in the claims side and on the medical life side more revenue per claim and per life and so it's simply an expansion of the business both through new revenues and expanded organic growth, so we are really pleased with the first quarter that that team put together and I think again, it illustrates the strength of the client base that we have there and that our clients continue to win significantly in the marketplace.
And then, you know, next quarter the company will anniversary part of step of investments in security compliance and regulatory that hit the financial services segment pretty hard. Based on the progress you are making, will you expect financial services segment margin to be closer to flat once you anniversary those costs? Are some of the ongoing investments you're making there going to continue to drag on the segments margins? Thanks.
So, the investments that we've made and we talked about it, we talked about it last quarter, have kind of plateaued but they plateaued at a relatively high level and they are going to stay there and so you are right, we will anniversary some of the significant investments spend that we started you know, a year or so ago, but we do expect that expense to remain at a relatively high level. As it relates to impact on the margins, the financial services margins have been under pressure, you know, I would like to think that we've you know, we are close to the bottom here and expect we should be able to maintain where we were at for the rest of the year.
Your next question comes from the line of Dave Koning of Baird.
And I guess following up on that last question, you know the GAAP like you said in healthcare you grew 13% revs but lives were flat year-over-year and claims were only up 6%. Is that yields? I mean the yield growth was tremendous. Is the yield sustainable going forward? Or do you think that revenue in the teens is more a function of claims and lives starting to accelerate and yield flattening out?
You know, in the healthcare business, what we talked about and we mentioned this last quarter is you know, we would hope that during 2016, we should be able to see double-digit topline growth, right? And we've consistently talked about trying to get this business into kind of mid- teen operating margins which again, the team was able to do in the first quarter and so, those two goals really haven't changed and again I think we've got -- Jonathan Boehm [ph] and his management team are doing a terrific job and I think it speaks to the quality of the customers that we service and their ability to win in the marketplace.
Okay. And the healthcare margin was also up a ton sequentially, and I think historically Q1 is not always been such a good quarter for margins. Is the current level sustainable through the year? I mean, do you expect kind of a sequential ramp or is this kind of a good level just to assume it stays around you for the rest of the year?
I think it will be a little bit lumpy, but we do expect you know, we will finish out the year kind of in those mid-teen margins that we've talked about as a goal.
And then one other thing, subaccounts were down a 1 million sequentially. I know you've had a really good growth profile for longtime and that could move around quarter to quarter but was there anything to that?
Yes it's actually that the vast majority of that is due to a rebalance that took place at one of our large customers, so you know occasionally our customers will go off and they will rebalance their portfolio. We can see an uptick in accounts when that happens or if they decide to reduce the number of investments in an investment pool, we can see a reduction and again the majority of that million -- it was a little bit of organic decline but the vast majority of it was one rebalance that took place from one of our very large customers.
Those things in my mind kind of net out sometimes you're in the positive side, sometimes you’re on the negative side this quarter in particular, you know, the number was on the negative side but we’re still very bullish about that business. We have a big conversion that we've talked about which will add directionally 10 million subaccounts still on schedule to complete that conversion towards the back end of this year. And again, I think we will see continue to see nice organic growth there. So we are excited about that business and again, I think the team is doing a nice job there.
And if I can just make sneak one quick one in, buybacks have been aggressive and you still have plenty of assets to sell, great cash flow, are we ever going to get to a point where the share count is so low that it gets hard to just go out and buy or you maybe just don’t have a willingness to buy as much stock back just simply because there is not that much float out there or should we just near-term and intermediate-term just expect ongoing buyback?
Listen, I think Gregg has talked a lot about us being consistent and I think our Board has shown a real willingness to be creative in returning capital to shareholders, the institution of the dividend, you know, a couple of years ago the Board has elected to raise that three times since we instituted. We think share buyback is a good tool to have and I would say in the short-term, I think again, we're trying to be consistent as we think that's in the best interest of the shareholders.
At this time there are no further question. I will now turn the call to Steve Hooley for any additional or closing remarks.
Great. Well thank you all for joining us today. We look forward to speaking with you next quarter.
Thank you for participating in the DST Systems first quarter 2016 earnings conference call. You may now disconnect.
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