Executives
Thomas A. McDonnell - President and CEO
Kenneth V. Hager - VP and CFO
Citigroup
James Kissane - Banc of America Securities
Charles Murphy
Merrill Lynch
Murali Gopal
Analysts
Patrick Burton
Morgan Stanley
Gregory Smith
Keefe, Bruyette & Woods
David Koning - Robert W. Baird
DST Systems, Inc. (DST) Q2 FY08 Earnings Call July 23, 2008 11:00 AM ET
Operator
Ladies and gentlemen, thank you for standing by and welcome to the DST Systems Second Quarter Earnings Release Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer period. Instructions will be given at that time. [Operator Instructions]. As a reminder, today's conference call is being recorded.
I would now like to turn the conference over to your host, President and CEO, Tom McDonnell. Please go ahead.
Thomas A. McDonnell - President and Chief Executive Officer
Good morning. I am joined this morning at DST here by Tom McCullough and Ken Hager. Before we start, I will make the following statement. 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 filed with the SEC.
All such factors should be considered in evaluating any forward-looking statements, which we may make today. Our comments today on financial results are based on the results taking into account the items set forth in the press release under the section, Description of Non-GAAP Adjustments. A reconciliation of reported GAAP results income adjusted for certain non-GAAP items accompanies the earnings release.
For the quarter, on a non-GAAP basis, net income totaled $53.7 million and that was $0.93 per diluted share versus $58.7 million last year or $0.81 per diluted share. It’s a decrease of 8.5% in net income but an increase of 14.8% in diluted EPS.
Consolidated operating revenues increased $9.4 million or 2.3% over second quarter 2007 to $426.6 million. Consolidated income from operations in the second quarter increased by $4 million or 5.1% to $83 million. Consolidated operating margin increased from 18.9% in the second quarter of 2007 to 19.5% in the second quarter of 2008.
The equity and earnings of unconsolidated affiliates declined by $10.9 million. There were no... there was no equity and earnings of Asurion recorded in 2008 and that compared to $10.5 million of income that was recorded in the second quarter of 2007. We also experienced lower equity and earnings at BFDS and at Argus.
Financial Services revenues increased by $14.3 or 5.1% to a level of $294.5 million, reflecting higher mutual fund shareowner processing services, AWD software license fees, and AWD and DST Health Solutions professional services.
Software license fee revenues increased by $2.9 million or 22.8% to $15.6 million and that was from higher AWD license fees and partly offset by international license fees decline.
Financial Services income from operations increased $4.1 million or 5.8% from the second quarter of 2007 to $74.5 million. Increased contributions from mutual fund shareowner processing and AWD were partially offset by lower contributions from international operations. Lower international contributions are attributable to decreased demand for AWD and investment management software and services and higher personnel cost.
The operating margin for the second quarter of 2008 was 25.3% as compared to 25.1% in the second quarter of 2007. As discussed in our first quarter 2008, the company changed the measurement for occupancy cost at Output Solutions segment beginning January 1st, 2008 and all periods prior to 2008 have been restated to reflect that change.
Turning to Output Solutions operating revenues, they decreased by $4.7 million or 3.5% to a $131.1 million and that was principally from lower U.S. images produced. Items mailed increased 3.8% to $575.2 million and images produced decreased by 20.9% to $3.4 billion. The decrease in images is due to certain telecommunications clients reducing the amount of transaction information included on invoices that resulted in the lower total images produced. Increase in items mailed is primarily due to the conversion of a new telecommunications client during the fourth quarter of 2007 and higher volumes rather existing clients. On a per image basis, operating revenue increased by approximately 23.9% compared to the second quarter of 2007.
Output Solutions operating income for the quarter totaled $7.4 million as compared to $7.5 million in the second quarter of 2007. Decreases in operating revenues during the second quarter of 2008 were substantially offset by lower material costs, lower leased equipment costs which resulted from implementation of owned digital print and insertion technologies but also in the quarter we had to a degree higher compensation and benefit related costs.
Depreciation and amortization decreased by $1.2 million as compared to the second quarter of 2007. The operating margin for the second quarter of 2008 increased to 5.6% as compared to 5.5% in the second quarter of 2007.
Our equity and earnings of unconsolidated affiliates was $11.6 million in the second quarter of 2008. That was a decrease of $10.9 million from the second quarter of 2007 and there were several items that made up that change.
DST had recorded $10.5 million of equity and earnings in Asurion in the second quarter of 2007. We now account for our ownership... reduced ownership in Asurion on a cost basis.
BFDS has recorded approximately $3.4 million of lower earnings that resulted from investment earnings reflecting lower interest rates on cash balances maintained by BFDS on behalf of customers, a one-time costs associated with the reduction in staffing levels during the second quarter.
The $800,000 earnings increase at IFDS, International Financial Data Services, reflects higher revenues from increased shareowner accounts serviced and some partial offset by costs associated with new customer conversions, higher compensation costs and higher income taxes.
Earnings at Argus decreased by $600,000 primarily from a reduction in investment earnings resulting from lower interest rates on cash balances maintained by Argus on behalf of its customers. The $2.8 million increase in equity and earnings of other unconsolidated affiliates is primarily the result of a gain from the early extinguishment of debt at a real estate joint venture and higher rental revenues and cost efficiencies on various other real estate operations.
Other income was $3.5 million in the second quarter of 2008. That was a decrease of $4.2 million as compared to the second quarter of 2007. That decrease is primarily due to unrealized losses on marketable securities designated as trading and higher accounts receivable securitization program fees.
Interest expense was $13.8 million for the second quarter of 2008. And that's a decrease of $5.6 million from the second quarter of 2007. The decrease in interest expense was a result of lower average interest rates and lower average debt balances. Cost associated with accounts receivable securitization program are included in other income as opposed to interest expense.
The income tax rate for the quarter was 36.3% compared to 34.6% for the second quarter of 2007. The increase in the tax rate is primarily due to changes in the relative proportions of domestic, international and corporate joint venture income. Currently, we expect the tax rate for the remainder of 2008 to be approximately 35.5%.
Turning to mutual fund shareowner accounts, total accounts serviced were 119.8 million at June 30th, 2008. That’s a decrease of 100,000 from March 31st, 2008 and an increase of 700,000 or six-tenth of a percent from December 31st, 20007 and that’s an increase of 9.6 million or 8.7% compared to June 30th of last year.
Total registered shareowner accounts serviced totaled 114.4 million at June 30th, 2008 and that's a net decrease of 600,000 or 0.5% since March 31st, 2008 and that's comprised... the decrease is comprised of conversions to non-DST subaccounting platforms of 1.6 million and conversions to DST subaccounting platforms of 200,000. And that was partially offset by net account growth of the existing clients of 1.1 million accounts and new client conversions of 100,000 accounts.
Tax-advantaged accounts serviced totaled 47.4 million at June 30th, 2008, a net decrease of 500,000 accounts or 1.1% since March 31st, primarily attributable to changes in accounts from existing clients.
Subaccounts serviced totaled 5.4 million at June 30th, 2008, an increase of 500,000 or 10.2% since March 31st, 2008. That results from the conversion of 200,000 new subaccounts from non-DST platforms, 200,000 registered accounts from TA2000, and net account growth from existing subaccounting clients of 100,000.
During the quarter, DST received two new client commitments totaling approximately 200,000 registered accounts and 300,000 subaccounts based on current client levels.
The company anticipates that 1.9 million new registered accounts will convert to TA2000 in the third quarter of 2008 and 200,000 new registered accounts will convert in the first quarter of 2009. We also anticipate that 1.3 million registered accounts will convert to subaccounting platforms during the remainder of 2008, of which 800,000 will convert to our subaccounting and 500,000 will convert to non-DST subaccounting platforms. The company also expects that 3.7 million new subaccounts will convert to TA2000 subaccounting from non-DST platforms in 2008 and 300,000 new accounts will convert during 2009 and 2010.
In summary, based on the accounts serviced at June 30th, 2008 and the conversion activity described above, this doesn't take into account any other changes in the accounts serviced during the remainder of the year, we anticipate that at December 31st, 2008 that there will be 124.9 million accounts serviced comprised of a 115 million registered accounts and 9.9 million subaccounts.
The actual number of accounts estimated to convert to and from various DST systems as well as the timing of those events is dependent upon a number of factors and the actual results could defer from our current estimates.
Defined contribution participants were 4.5 million at June 30th, 2008 and that was a decrease of 400,000 or 8.2% since March 31st, 2008, and an increase of 300,000 as compared to June 30th, 2007.
The decline in participants during the second quarter represents a seasonal movement of terminated participants and new participant enrollments. The company has also received notice that an existing track client currently serviced by BFDS will internalize its participant accounting which will result in a loss of approximately 1 million participants in the third quarter of 2008.
Also, during the quarter, the company repurchased 2 million shares of its common stock at an aggregate cost of $121.7 million or approximately $60.90 a share. At June 30th, 2008 the company had approximately 4.2 million shares remaining under its existing share repurchase plan.
The company had 53.3 million shares outstanding at June 30th, 2008. The net effect of share repurchases and shares issued from stock option exercises resulted in a decrease in shares outstanding of 1.9 million shares since the end of the first quarter.
Average diluted shares outstanding for the second quarter of 2008 were 58 million shares, a decrease of 13.8 million or 19.2% from the second quarter of 2007 and a decrease of 6.3 million shares or 9.8% from the first quarter of 2008.
At June 30th, 2008, the dilutive effect of the convertible debentures was 3.5 million shares, outstanding stock options was 1.2 million shares, and restricted stock, 1.7 million shares for an aggregate dilution of 6.4 million shares, which is 3.8 million shares less than the prior-year quarter as a result of decreases in the company's average stock price and a lower number of stock options outstanding.
Total stock options and restricted stock equity units outstanding at June 30th, 2008, were 8.6 million. That is a decrease of a 100,000 equity units or 1.1% from March 31st, 2008, and a decrease of 1.2 million equity units or 12.2% from June 30th, 2007.
With that, we’d now like to open the call to questions.
Question and Answer
Operator
[Operator Instructions]. Our first question comes from Pat Burton from Citi. Please go ahead.
Patrick Burton - Citigroup
Hi. Congratulations on the quarter. A two-part question, in terms of the shareholder services business, Tom, could you maybe talk a little bit about just the tone of business given the stock market through the first seven months of the year and then second, any additional information on that one account that's going to be internalized in the third quarter of '08? Thanks.
Thomas A. McDonnell - President and Chief Executive Officer
I'm not sure when you say the tone, I mean, I think that given the volatility of the market we certainly have seen kind of slower internal account growth, the rest of the business is, I mean, the other activity in the business, the number of RFPs and so forth out there has definitely slowed down. There is not a lot of them going on at the moment. We have had a couple of positives and some wins, and some smaller decisions and also some reasonable size subaccounting, and subaccounting as we discussed, has movement going both directions.
The client that's internalizing on track, which is why I believe you're referencing, there has been a client through BFDS for some greater time and because of the nature of that client, as an insurance organization they have developed some internal software that it's our understanding that is more integrated with the rest of their operation. So, we see that not as anything that's indicative of other movement in the kind of 401-K track subaccounting area, but pretty much unique to that one client. And we didn't try to point out, maybe we haven't focused as much on the past is in the first and second quarter there is an unusual... well, not unusual, there is a seasonal movement of accounts because participants are on the books and records often times through year-end and until terminated employees are paid out, then they come off and then in the first quarter there is the two major open enrolment periods for employee benefit participants in the early January and early July. So, the indication of accounts reduced and accounts added really reflects that and that is a seasonal activity. We will try and break it out more definitively going forward but as to the one client decision we think that's sort of unique and certainly not indicative of any change that we would see in the marketplace. It’s more mutual fund related. This was very much an insurance company client.
Patrick Burton - Citigroup
Thanks. One follow-up and then I will drop. In terms of the... Altura is another very significant buyback in May. Could you just update us on your thinking there in terms of the allocation of capital? Thanks.
Thomas A. McDonnell - President and Chief Executive Officer
Well, I think as a background we... we've always completed every repurchase that we've announced and at this point we still are generating free cash and also are comfortable with certain levels of debt on the balance sheet. So, we are pursuing stock repurchases kind of consistent with that overall view. So, I think, I can't give you exact timing but you can easily... you should anticipate that the currently authorized repurchase will be accomplished.
Patrick Burton - Citigroup
Thank you. Glad to see it.
Operator
Our next question comes from James Kissane from Banc of America Securities. Please go ahead.
James Kissane - Banc of America Securities
Great. Thanks. Tom, can you size the revenue impact from the TRAC client loss or maybe give the total size of the TRAC business?
Thomas A. McDonnell - President and Chief Executive Officer
Not in revenue terms because we don’t break that out, but it is sort of twofold. There is a revenue impact at BFDS and then there would be the processing fees, Jim, that fell through the DST. I think you can assume that it’s ballpark, if you look at it in terms of overall… those accounts, there is mutual fund accounts underlying those, it's relatively modest, because it's… like less than 1% of overall mutual fund accounts.
James Kissane - Banc of America Securities
Okay. So, they will pull with them the mutual fund account, in fact [ph] those would be registered accounts?
Thomas A. McDonnell - President and Chief Executive Officer
No, this is just a participant side.
James Kissane - Banc of America Securities
That's right.
Thomas A. McDonnell - President and Chief Executive Officer
To the extent they have non-proprietary funds in there that they may be servicing in some other way, the account still stay around.
James Kissane - Banc of America Securities
That's what I thought. And for a simple equity guy, can you explain what was the dynamics of the convert, assuming that $300 million of the converts are not quoted [ph], which I wouldn't think that they will be? Will you be calling those at some point, maybe just in simple terms, what are the dynamics?
Thomas A. McDonnell - President and Chief Executive Officer
The provisions of the convert allow people to put them in a 20-day period prior to I believe it’s August 14 and they are putable at par, since stock is above par we think it’s unlikely that… I guess, Jim, you might think an equity guy might put them, but we are assuming sophisticated bond people or not. We think that the put is unlikely. At this point we haven't made any decisions rather call them or not, there has been some changes in accounting as to how you handle some of those stuff on a net converted to whatever basis. But at this point, we anticipate that there is some positive characteristics just to leave the issue outstanding because if people are looking at the debenture, I mean, as of August 14, they still carry a coupon, but it is no longer payable in cash. In the aggregate, there is a modest delta to the underlying coupon based on the... an interest rate applied to the accretive value of the bond. So, right now, it would appear to us that just leaving the issue outstanding and now that could result in some people deciding from time to time to convert, but it would appear in the economic interest of the company right now, just to leave it out there.
James Kissane - Banc of America Securities
Okay. So, you will... it is unlikely you will call them for cash?
Thomas A. McDonnell - President and Chief Executive Officer
If you are asking me today, I'd say it's unlikely, but given the volatility of these markets, if you ask us two weeks ago, we might have had a different answer. We continue to review it on an ongoing basis, but I think you should assume for the moment that in calculating where you think that will be over time, that it can be an equity component although we may change the decision to do that at any time. But right now, it's unlikely that we would take any action.
James Kissane - Banc of America Securities
Okay. Great. Are you aware of any negotiations or RFPs outstanding today that could cause like your 150 million register account target at year-end to be off by a fair amount?
Thomas A. McDonnell - President and Chief Executive Officer
No.
James Kissane - Banc of America Securities
Okay. Great. And are you familiar with the Merrill Lynch business that's being sold for eight times revenue?
Thomas A. McDonnell - President and Chief Executive Officer
Yes. We are.
James Kissane - Banc of America Securities
Is it comparable to DST which trades at six times EBITDA?
Thomas A. McDonnell - President and Chief Executive Officer
That is... I'm really not confident to make a judgment on that. But yes, we have seen that node.
James Kissane - Banc of America Securities
Is it a competitor on the subaccount side or is it mostly internal business?
Thomas A. McDonnell - President and Chief Executive Officer
Mostly internal business. I mean, it has subaccounting aspects to it obviously with accounts that Merrill controls, but that's been a phenomena that has been present in Merrill for years.
James Kissane - Banc of America Securities
Yes. Okay. Thanks, Tom.
Operator
Our next question comes from Charlie Murphy from Morgan Stanley. Please go ahead.
Charles Murphy - Morgan Stanley
Thanks very much. Tom and Ken, you raised your forecast for total U.S. accounts at December 31st, 2008 from what was in the Q which was encouraging. How do you evaluate the probability of additional material conversions from your registered account base to sub-accounting from here?
Thomas A. McDonnell - President and Chief Executive Officer
Well the way we derive those is general input from sort of known situations. We are not using any algorithm or speculation on it. So, right now that's our best take. And at this point, given the length of time it usually takes to have those changes occur, we… at this point we do not see anything that would materially impact that forecast other than what could be extreme market movements, which wouldn't necessarily change the opinion as to what will be registered and what will be subaccounts. But if people lose a lot of confidence in the market, you can net decreases in mutual fund accounts. So, we certainly have seen less growth because of these markets, but ex market conditions, we see no reason that that number wouldn't be what we would believe to be the case today.
Charles Murphy - Morgan Stanley
Okay. Great. And as a quick follow-up, I am curious about the outlook for Financial Services segment EBIT margins for the back half of this year. Would you say that the 6% EBIT growth posted this quarter is a reasonable type of growth rate to expect for the back half of this year?
Thomas A. McDonnell - President and Chief Executive Officer
Well, I can't answer that.
Kenneth V. Hager - Vice President and Chief Financial Officer
Charlie, we don't predict margins. I think one thing you have to look into account is, what would be the... the factors would be, what would be license sales from the last half of the year. That's going to have an impact, and then as you get to the third quarter, we would have anniversaried the conversion of Putnam [ph] accounts. And so, those accounts, which weren't in the book in the first half are now in the book in the last half… for the last of the year. So you'll have a more comparable... more comparability in terms of the first half and last half numbers in terms of number of accounts.
Charles Murphy - Morgan Stanley
Okay. Is it possible to get any sense for the license sale pipeline for the back half of this year?
Thomas A. McDonnell - President and Chief Executive Officer
Well, we had a little bit of positive experience in the second quarter with some licenses that had been in the works for quite sometime in Health Solutions and at AWD. Right now, I would say, I wouldn't really describe licenses as having a pipeline quite frankly. I mean, there are some activity in AWD and a little bit in Health Solutions. Investment management software still pretty sparse, and I think as we've discussed before the buyers of that software are some of the large multinational organizations that are pretty stressed with their own balance sheets and financials right now. So, I'm anticipating not very much positives in the way of license sales, particularly from international investment management software in the second half. And again, with a lot of the users of, like AWD software in particular, large financial institutions and there is just a lot of budget constraints in those organizations right now. So, I don't think we could give you any optimism on the next couple of quarters, doesn't mean that we are not... that we don't see some licenses, but to say we have a robust pipeline would really be a stretch.
Charles Murphy - Morgan Stanley
Okay. Thanks very much.
Operator
And the next question we have is from Greg Smith of Merrill Lynch. Please go ahead.
Gregory Smith - Merrill Lynch
Yes. Hi, good going [ph]. In the Health Solutions business, can you just give us an update on the kind of underlying transition you've been trying to make from a software license to an outsource model?
Thomas A. McDonnell - President and Chief Executive Officer
Well, I think the strategy there is twofold, one, to face off against the market with new modules and components that couldn't be vended to clients on a processing basis, but also to go back to the existing client base of licenses and provide alternative processing arrangements either in the ASP or full service processing, and we've had a couple of commitments there. So, I think the strategy is in place. The corporate decision to move that direction is in place. But it's one that will play out over time and I think we are seeing... I think we believe that it's a strategy that can't be executed and that will play out well over the next 18, 24, 36 months, but I can't size it for you that there is n amount of revenue moving in the next several months, but that is the position we've adopted that we're going to move that direction. So, you should see particularly in the Health Solutions side much more emphasis going forward on the recurring process and full service revenues.
Gregory Smith - Merrill Lynch
Okay. And then in Output Solutions, just how are you feeling about the progress to get the double-digit margins and anything changing your view as to whether or not this business belongs as part of the DST family?
Thomas A. McDonnell - President and Chief Executive Officer
Well, we are still progressing there, I think that we've indicated that it will take a couple of years to get there although I fully accept that somebody might jump in and say you told us that before. We have now got pretty much a full complement of the new high-speed four-color printing technology in three locations or three plants. So, heavy emphasis on Sacramento. That's a highly efficient operation. We did pick up a telecom customer fourth quarter last year. We haven't talked about the number of images being reduced because of the way telecom billers are changing the context of their bills but even with that reduction there is still some increase in margins on what has effected somewhat lower revenue base.
In addition to the printing technology, we are enhancing sort of our end-to-end technology. We have invested quite of bit in and I think some pretty good engineering that's proprietary to us to integrate inserting operations with the printing. So, with the class movements we have in place and with hopefully some improved revenue outlook in the fourth quarter this year, first quarter next that you'll start to see some of that materialize. And just to reiterate again, with the equipment we brought in and so forth we use accelerated depreciation for books as well as tax on the big pieces of technology. So, everything else being equal, with the passage of a couple of more quarters you should see some predictable margin improvement from reduced depreciation charges.
Gregory Smith - Merrill Lynch
Yes. And then just considering the current market environment in your transfer agency business, there is a lot of chatter about some banks potentially selling their fund company business and then I'm just sort of curious what you think on that front and any potential impact. But then on the flip side with the tough market conditions is it possible we may be see some big fund families that have been resistant to outsource may be considering outsourcing because of the pressures? How do you think about those two dynamics, please?
Thomas A. McDonnell - President and Chief Executive Officer
Well I guess the first, if bank sell their business it's not usually an issue to us if somebody is a seller. It's a question of who is the buyer, and if the buyer is somebody who either has a long-term relationship with another supplier and/or the buyer has a large in-house operation that can always be a risk for us.
Historically, a lot of these transactions have taken place with the new entrants which hasn't changed the relationships or in someplace non-U.S. players that have come in. So, I am not sure we would see any particular risk or issues there. I think as to large in-house operations, there is fewer of those around today but, I think at least a couple of them are looking at it. It's not the huge players. It is unlikely that Fidelity or Vanguard would look there but maybe what you might refer to as second-tier might be lucky in that. And we continue to see valuations from our remote clients wanting to subdivide their book of business and in effect take stuff that they were doing and engage either Boston Financial or DST to do it. So, we continue to see that sort of evaluation of their remote operations as to what businesses they should really be engaged in as opposed to using a BFDS or DST to support. But, I don't think there is going to be any huge shift from either source at this point and… so that could change but I think the continual cost pressures that have come up over the past several years put more and more constraints on in-house operations and I think that has benefited us with the patent conversion last year and so forth. So, you never know when you want come out of the woodwork but there is nothing that's specifically visible. There right now.
Gregory Smith - Merrill Lynch
Okay, that's helpful. Thank you.
Operator
And the next question we have is from Murali Gopal. Please go ahead.
Murali Gopal - Keefe, Bruyette & Woods
Good morning. On the subaccounting front, the last quarter, I guess the concern was you had 3.4 million accounts moving to subaccounting and clearly that's moderated and you had about 1.6 million this quarter. Is this... if we go back and look prior to the first quarter, is the 1.6 million kind of the level that you would... was you experienced historically or you still think the 1.6 million would go down more as moderate more to get back to more normalized expectations?
Thomas A. McDonnell - President and Chief Executive Officer
Well, neither the first quarter or the 3.4 million of the last quarter would be normal on any three to four look back. There were a couple of decisions taken in those quarters that altered the landscape a little bit. I think we pretty well laid out what we see for the rest of the year and we don't have good visibility beyond that, but it's not clear that there has been a trend... the huge shifts, this has affected a couple of institutions making decisions. I'm sure there will be others, but I guess our sense would be that certainly the last quarter is closer to what longer would be in probably less than that over time.
Murali Gopal - Keefe, Bruyette & Woods
Right.
Thomas A. McDonnell - President and Chief Executive Officer
I don't know that you can go back and say it'll repeat the history of three years ago where there was almost no activity.
Murali Gopal - Keefe, Bruyette & Woods
Right.
Thomas A. McDonnell - President and Chief Executive Officer
But I do think both quarters were somewhat exaggerated and the first quarter particularly so.
Murali Gopal - Keefe, Bruyette & Woods
And could you give us some color in terms of what's causing this kind of exaggerated activity and how many institutions comprise the 1.6 million? Is it a pricing related issue? Why is this an issue, the last two quarters that we haven't seen in the last few years?
Thomas A. McDonnell - President and Chief Executive Officer
Well, it's particular broker-dealers deciding that they want to undertake a subaccounting strategy in connection with their overall customer relationships and in some cases, new arrangements with some fund groups to allow that. It is an economic positive to the broker-dealer. So, to the extent that they embrace it and they see that. Now, on the other hand, we've expanded our presence in subaccounting and while the revenue characteristics are different, it's still better for us to have that product integrated than not to have it, and then we also have, in effect, what we call a full service subaccounting through a subsidiary called [inaudible] that will assist some smaller broker-dealers in the subaccounting activity and that has a more favorable revenue characteristics. But it's really a direct function of the view that broker-dealers have as to how they want to interface with their clients and to what extent they can make arrangements with fund groups who let them do so, and there is just a bit of a flurry of activity in the first couple of quarters, I would say it's hard to predict. I would say we would think it would be diminished, but that's, as we said earlier, our view as of today.
Murali Gopal - Keefe, Bruyette & Woods
Okay. And just very quickly on the health line solutions processing business, I know you talked a little bit on the strategy, but just in terms of your experience since the acquisitions that you have done in the business, is it trending in terms of revenue expectations what you had and what you are experiencing today and the margins? I know I have asked this question before. I mean when you look at what spend you see unfolding, is it kind of... how does it relate to your expectations and if it's better than expectations then are you thinking in terms of investing more on growing this business, how should we think about this business longer term?
Thomas A. McDonnell - President and Chief Executive Officer
Well, I think the way to look at the business over the last four years the sort of majority of independent claims processing providers consolidated the company that was public called TriZetto, acquired a competitor called QCSI and that organization is subsequently by our higher understanding either had a process or has gone private. We acquired part of the business from Computer Sciences, then we acquired another company to build what is today DST Health Solutions. So, those are the two primary providers of this type of technology.
Now having said that, the demand for claims processing is oftentimes driven by new product introductions by the providers where their existing systems may not handle features that they now want to offer and decisions of course are made based on trying to contain their cost also. So, I think we see the direction as, us being able, DST Health Solutions being able to deliver more efficient process in either in ASP or full service, which is where we are concentrating, with a real low emphasis on the software technology but I think the business certainly... and there is no shortage of money being spent in the whole health arena, including the fictional cost of processing claims and so forth. So, our approach is, as I said, to go to the remote and full service and then integrate more closely with our prescription claims add. So, I think that at this point we would say, we do think there is opportunities for legitimate growth and that legitimate growth, given the structure business should produce, improve margins over a period of time but again you are dealing in rather... in most of our businesses where we're delivering very sophisticated large systems are generally dealing with clients who are larger and then in some cases complicated and extended decision processes. So, I'm not sure we're totally comfortable that we can predict timing of decisions but we still think it is a business that has a legitimate opportunity to grow double digits in profitability and double-digit margins.
Murali Gopal - Keefe, Bruyette & Woods
Okay, thank you.
Operator
The next question we have is from Dave Koning of Robert W. Baird. Please go ahead.
David Koning - Robert W. Baird
Yes, thanks and I just had two questions. I guess, first of all, given kind of your commentary on the subaccounting shift, if we would just assume a pretty stable market condition over the next year or so and the subaccounting shift that you are kind of seeing, would you be surprised if registered accounts were up in '09?
Thomas A. McDonnell - President and Chief Executive Officer
I wouldn't be surprised necessary if they are up, but I would expect a more modest increase in registered than in what we believe to be some movement that we can probably achieve in the subaccounting side. So, I think over time relative to DST's book of business, you will see subaccountings creep up as a percentage. I wouldn't say dramatic increase overnight, but I would personally think that the decline in registered accounts by the end of '09 in the aggregate is unlikely.
David Koning - Robert W. Baird
Okay. That's great and then secondly just in terms of the interest expense and other income, I guess it’s a little muddy now, the distinction between the two since the AR securitization sort of interest expense falls in other income but if we just combine the two and certainly there is dividend income and some other things on there, if we combine the to it is about $10 million of net expense in Q2. Is that about, how we should think of it over the next couple of quarters assuming limited debt paydowns and just using it to buyback stock instead, I mean, $10 million, is that ballpark next couple of quarters?
Thomas A. McDonnell - President and Chief Executive Officer
Well, I think, one, I would not anticipate much paydown, in fact I'd probably anticipate some increment in the amount of debt as we continue repurchases and we are moving back to what we think is a legitimate balance sheet ratio and then whatever, your guess is as good as ours obviously on the interest rate. So, I would guess it would move up modestly from there. I'll let Ken, is there some structural stuff in that we should be aware of?
Kenneth V. Hager - Vice President and Chief Financial Officer
Well, the other thing that impact the second quarter and the other income was the process on the securities [inaudible], which was close to $4 million and that's a function of what the market is.
David Koning - Robert W. Baird
Okay. Great, thank you.
Thomas A. McDonnell - President and Chief Executive Officer
Just to make that clear, what we... the company has certain deferred plans that have allowed individuals to select primarily collective investment products to fund those. So, we reflect either gains or losses as obligations to the employee but then we reflect the flip side of that in another portion of the income statement, which is the offsetting gain or loss since the underlying portfolio actually offsets those obligations.
David Koning - Robert W. Baird
All right. Great, thank you.
Operator
And our last question comes from Fred Brian [ph] from Admiral Capital. Please go ahead.
Unidentified Analyst
How are you doing this morning? Appreciate the call. You mentioned it earlier on the call and given the financial headlines backing up lower spending across the board, notably in softwares and in your case software license fees. Can you please account for the strength in the financial software licensing segment at DST, specifically discussing the timing of revenue recognition as related to the increase in the segment in Q2?
Thomas A. McDonnell - President and Chief Executive Officer
Well, there was... it was around AWD license of some significance that had been in the process for, I think, literally four or five quarters and it just happened to mature in the quarter and then there was a similar longer term license that had been signed sometime back in Health Solutions but was we being held on balance sheet waiting completion of a couple of remaining deliverables. So, Ken is shaking his head and says that's not the case.
Kenneth V. Hager - Vice President and Chief Financial Officer
It wasn't right.
Thomas A. McDonnell - President and Chief Executive Officer
It wasn't right. That is okay, so that was really the AWD that have been around for a while.
Unidentified Analyst
So, what percentage of your revenues and income from that segment is based on this significant contract that was in [inaudible] four or five quarters ago?
Thomas A. McDonnell - President and Chief Executive Officer
Yes, it was less than 3 million but the licenses, it was about 20%.
Kenneth V. Hager - Vice President and Chief Financial Officer
Right.
Thomas A. McDonnell - President and Chief Executive Officer
Over the quarter licenses, it would been about 20%.
Unidentified Analyst
So, you could probably and you say [inaudible] definitely gross in this segment is not expected going forward?
Thomas A. McDonnell - President and Chief Executive Officer
No, I think given the sort of the financial circumstances of the customer base at both AWD and investment management software, the primarily users there are heavily oriented to the financial services industry and I don't see any budget elasticity there. I wouldn’t think at least through the end of this year, because everybody has really tightened that down given the losses that they have reported. So, I wouldn't see much optimism there.
Unidentified Analyst
Okay. Great. And a follow-up, if you could, given your 2008 change in operating lease accounting to capital lease accounting for your facilities in Connecticut, Missouri and California, which DST does not earn, can you... can you better detail why you are doing that and detail the depreciation method and the life… the life of the assets you are discounting and the... as well the discount rate used in obtaining the net present value of the lease commitments going forward?
Kenneth V. Hager - Vice President and Chief Financial Officer
This is Ken Hager. We actually do own those facilities and the change we made… we own those facilities and we own them in our investments in other segments. We've always leased those facilities to the operating segment. And so, what Output Solutions had in its numbers previously was a lease cost from the investments and other segments. What this change does is that is in effect treat those as if they are owned by the Output Solutions segment. So what you are seeing is the actual depreciation on the building now reflected in the Output Solutions segment as opposed to a lease cost to another segment.
Unidentified Analyst
I guess there is really just a... all it was just a transfer from one segment to other because the facilities are primarily used in the Output Solutions segment rather than the previous segment where it was stated?
Thomas A. McDonnell - President and Chief Executive Officer
It's less, it's more than just primary use. An office building, we would not look at the same way. These factories are, for all practical purposes, single-purpose factories, specifically designed, footprint, engineering systems or whatever to support the output operations. And to the extent that are comparable companies out there like what used to be more now part of our Donnelly [ph] and so forth, their facilities are generally owned and the ownership cost is reflected in their financials relative to the, what we used to reflect as lease cost. So, there are two reasons, one, because these facilities were unique to the particular operation, not just because there was a primary user. It is that unlike office space, you could not necessarily find a legitimate alternative user and also to try and make the comparisons of what we believe to be our margins compared to others are more comparable is the reason that we did that. So, on the one hand, you are correct, there was a transfer from one entity to the other, but it goes... it wasn't just a function of their primary users, it recognizes the sort of unique character of these particular facilities for all practical purpose, or what... they are custom built and unlikely that you have readily available alternative users for anyone else.
Unidentified Analyst
Right. And it would be harder for you to divest those assets because of the specific usage?
Thomas A. McDonnell - President and Chief Executive Officer
Correct.
Unidentified Analyst
Right. So… Okay, that's... I understand that now is a little vague in the last Q and in the statement. Can you discuss... you mentioned a little earlier in the call, you are… going forward that you are probably going to see an incremental increase in subaccounts relative to registered accounts and that would probably be the trend going forward, although you may have an increase in overall accounts you are probably going to see a increase in the percentage of subaccounts relative to the total. Can you discuss how that would impact your operating income and margins because your... because subaccounting effectively is a lower margin business?
Thomas A. McDonnell - President and Chief Executive Officer
That’s certainly a lower revenue business... and I guess what we would see is that we have positioned ourselves we believe to compete the sub accounting business and move it from other platforms. So, I guess, when we look out and say as we are facing off against the market for the foreseeable future there may be increased opportunities to move sub accounting business relative to the overall book of business. So, that will be the primary reason I think that you would see a shift and an increase in the percentage of subaccounts. So, it really as a function... it gets to be quite a complex equation, it depends if the subaccounts solely come from another subaccount provider that's positive. If they come partially from there and partially off our registered book, it has a different characteristic, but we think our ability to effectively compete in the subaccounting market and move subaccounting relationships from other providers is a net positive. Certainly an absolute earnings might have some modest over time pressure on margins but I'm not sure actually that is actually clear today.
Unidentified Analyst
All right. Thank you very much, Tom.
Thomas A. McDonnell - President and Chief Executive Officer
Okay.
Operator
There are no further questions in queue
Thomas A. McDonnell - President and Chief Executive Officer
Okay. Well, thanks everyone for joining us today and we look forward to our next quarterly call.
Operator
Ladies and gentlemen, this conference will be at 4 PM Central Time and will remain available through July 30th. The dial-in number for the replay is 1-800-475-6701, access code 929466. Again that number is 1-800-475-6701, access code 929466. For international participants, the dial-in number is 320-365-3844, again access code 929466. That does conclude our conference for today. Thank you for your participation and you may now disconnect.
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