UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

ý  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005

or

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                          to                         

Commission File Number 1-14036

DST SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

(816) 435-1000

(Registrant’s telephone number, including area code)

No Changes

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý     No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ý     No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o     No ý

Number of shares outstanding of the Company’s common stock as of October 31, 2005:

Common Stock $0.01 par value – 71,618,500

DST Systems, Inc.

Form 10-Q

September 30, 2005

Table of Contents

The brand, service or product names or marks referred to in this Report are trademarks or services marks, registered or otherwise, of DST Systems, Inc. or its subsidiaries or affiliates or of vendors to the Company.

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DST Systems, Inc.

Form 10-Q

September 30, 2005

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Introductory Comments

The Condensed Consolidated Financial Statements of DST Systems, Inc. (“DST” or the “Company”) included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission.  Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to enable a reasonable understanding of the information presented.  These Condensed Consolidated Financial Statements should be read in conjunction with the Company’s audited financial statements and the notes thereto for the year ended December 31, 2004.

The results of operations for the three and nine months ended September 30, 2005, are not necessarily indicative of the results to be expected for the full year 2005.

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DST Systems, Inc.

Condensed Consolidated Balance Sheet

(dollars in millions, except per share amounts)

(unaudited)

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

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DST Systems, Inc.

Condensed Consolidated Statement of Income

(in millions, except per share amounts)

(unaudited)

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

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DST Systems, Inc.

Condensed Consolidated Statement of Cash Flows

(in millions)

(unaudited)

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

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DST Systems, Inc.

Notes to Condensed Consolidated Financial Statements

(unaudited)

1.  Summary of Accounting Policies

The Condensed Consolidated Financial Statements of DST Systems, Inc. (“DST” or the “Company”) included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission.  Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to enable a reasonable understanding of the information presented.  These Condensed Consolidated Financial Statements should be read in conjunction with the Company’s audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal interim closing procedures) necessary to state fairly the financial position of the Company and its subsidiaries at September 30, 2005, and the results of operations for the three and nine months ended September 30, 2005 and 2004, and cash flows for the nine months ended September 30, 2005 and 2004.

Certain amounts in the prior year’s consolidated financial statements have been reclassified to conform to the current year presentation.

The results of operations for the three and nine months ended September 30, 2005, are not necessarily indicative of the results to be expected for the full year 2005.

2.  Sale of EquiServe

On June 17, 2005, the Company completed the sale of its wholly-owned subsidiary, EquiServe, Inc. (“EquiServe”) to Computershare Ltd. (“CPU”) in accordance with the terms of an agreement dated October 20, 2004.  Under the terms of the agreement, DST sold all of the shares of EquiServe for $237.1 million in cash and 29.6 million shares of CPU common stock which shares had a value, based on the closing price of CPU stock on the closing date of the transaction, of approximately $145.8 million.  Included in the total cash proceeds of $237.1 million is $21.1 million of cash received during the three months ended September 30, 2005 related to finalizing the closing balance sheet working capital adjustment with CPU.  Under the terms of the October 20, 2004 agreement, the Company will continue to provide EquiServe various services including transition data processing support, AWD products and services, Output Solutions services, E-Proxy services, and lost instrument surety bond coverage, for which elements a portion of the purchase price has been deferred.  In addition, the Company provided a perpetual sourcecode license for Fairway to CPU and agreed to restrict its use of the software.  Upon the closing of this transaction, Fairway software was redesignated from software that was developed for internal use in the Company’s stock transfer business to software that will be for external use, in accordance with SOP 98-1, “Accounting for Costs of Software Obtained or Developed for Internal Use”.  As a result, $34 million of Fairway capitalized software costs were removed from the consolidated balance sheet and taken into account in the determination of the $120.4 million pretax gain (the net gain was approximately $70 million after taxes, deferrals and other expenses) from the sale of the EquiServe business.  The Company recorded operating revenues related to EquiServe of $99.9 million from January 1, 2005 through the date of sale.  EquiServe recorded operating revenues of $234 million for the year ended December 31, 2004.  At December 31, 2004, assets and liabilities of EquiServe were categorized as assets and liabilities held for sale in the consolidated balance sheet.  The disposition does not qualify to be reported as a discontinued operation due to ongoing cash flows from the aforementioned agreements.  The $145.8 million of CPU common stock received by the Company in connection with this acquisition has been treated as non-cash consideration for the sale of the EquiServe business.

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3.  Health Solutions, Inc. Exchange

On April 29, 2005, the Company completed the exchange of its investment of 7.1 million shares of Computer Sciences Corporation (“CSC”) common stock for CSC’s Health Plan Solutions business (now known as DST Health Solutions, Inc. or “HSI”).  HSI is an enterprise software developer, software application services provider and business process outsourcer for the U.S. commercial healthcare industry.  The exchange value of the CSC shares at closing was $45.53 per share and HSI held $224.6 million of cash at the time of the exchange.  Under the terms of the exchange agreement, the HSI operating business had a negotiated value of $100.0 million and its assets at closing included additional cash of $224.6 million.  For financial reporting purposes, 4.9 million CSC shares were valued at $45.53 (representing the cash element of the HSI exchange) while the remaining 2.2 million shares were valued at $43.06 (representing the exchange value of the HSI operating business based on the closing price of the CSC common stock on April 29, 2005). Accordingly, for financial reporting purposes, the Company recorded a pretax gain of approximately $76.3 million from the exchange of the CSC shares in the second quarter of 2005, which is included in Other Income on the consolidated statement of income.  The $224.6 million of cash included in the exchange which equates to the 4.9 million shares of CSC common stock has been classified as cash flow from an investing activity on the consolidated statement of cash flows.  The HSI business received in exchange for 2.2 million shares has been treated as non-cash consideration.  The Company has determined that the HSI financial results should be presented in the Financial Services business segment.  The Company has performed an allocation of purchase price value in excess of the net assets of the HSI business received which resulted in $20 million of proprietary software, $20.6 million of identifiable intangible assets, and $52.6 million of goodwill.  The Company has not yet finalized its accounting for deferred taxes related to the acquired assets; when finalized, it is possible that goodwill will be adjusted.  From April 29, 2005 through September 30, 2005, amortization of identifiable intangible assets (customer relationships, order backlog, etc.) resulted in $3.3 million of amortization expense.  Amortization expense related to these intangible assets and proprietary software is estimated to be $1.5 million for the remainder of 2005 and is estimated to be $5.9 million for each of the years ending December 31, 2006, 2007, 2008 and 2009.

4.  Sale of the Innovis Entities

On July 1, 2005, the Company completed the sale of the capital stock of its wholly-owned subsidiaries DST Interactive, Inc. and DST Innovis, Inc. (collectively “Innovis Entities”) to Amdocs Ltd. (“Amdocs”).  The Company received $234.3 million of net cash proceeds from Amdocs (including a $3.5 million payment to Amdocs related to finalizing the closing balance sheet working capital adjustment) and recognized a pretax gain of $153.8 million which is included in Gains on Sale of Businesses in the consolidated statement of income.  The Innovis Entities comprised the Company’s Video Broadband/Cable/Satellite TV Customer Care and Billing business.  The business, which essentially represents the Company’s Customer Management Segment, had approximately 700 employees and recorded operating revenues of $93.9 million from January 1, 2005 through the date of sale and $183.0 million for the year ended December 31, 2004.  In conjunction with the closing of this transaction, the Company incurred $6.9 million of compensation related costs associated with the vesting of restricted stock previously granted to employees of the Innovis entities.

As part of the transaction, DST through its subsidiary, DST Output, will continue to provide electronic and print/mail services to customers of the Innovis Entities under a long term contract with Amdocs.  DST Output will be a preferred vendor of such services for customers of Amdocs in the United States.  Included in the Output Solutions Segment are operating revenues (exclusive of out-of-pocket reimbursements) of approximately $24.6 million and $50.6 million for the period January 1, 2005 through the date of sale and for the year ended December 31, 2004, respectively, representing intersegment revenue for output services to the Innovis Entities.   Under a separate agreement with Amdocs, DST will also continue to provide support of its AWD software for customers of the Innovis Entities who currently utilize AWD.  Elements of the purchase price were deferred related to transitional services that will be provided to Amdocs.  Due to the ongoing cash flows that will be recorded by the Company from the Innovis Entities subsequent to the sale, the Company has determined that the Innovis Entities transaction should not be accounted for as a discontinued operation.

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5.  Agreement to Merge lock\line

On October 27, 2005, the Company entered into a definitive agreement to merge its lock\line subsidiary into Asurion Corporation, a privately held company with principal operations in Nashville, Tennessee, in a tax free merger.  lock\line provides administrative services for the extended warranty programs of telecommunications carriers, handset replacement programs for wireless carriers and consumer debt protection programs.  lock\line has approximately 1,500 employees and recorded operating revenues of $93.0 million and $97.3 million for the nine months ended September 30, 2005 and for the year ended December 31, 2004, respectively.  Asurion provides services related to warranty management, device protection, roadside assistance and enterprise managed mobility solutions for technology firms in the U.S., Canada and Asia.  Asurion has approximately 2,500 employees and recorded revenues of $517.3 million and $417.8 million for the nine months ended September 30, 2005 and for the year ended December 31, 2004, respectively.  Upon the closing of this transaction, the Company’s captive insurance subsidiary, Vermont Western Assurance (“VWA”), who reinsures certain underwriting risk related to lock\line’s wireless handset replacement program, will enter into a retrocession agreement to cede certain premium revenues to Asurion.  For the nine months ended September 30, 2005, VWA’s premium revenue related to this program was approximately $29 million.

As a result of the merger, the Company will own approximately 35% of the combined Asurion / lock\line organization and expects to account for the investment using the equity method.  The Company will receive no cash proceeds in connection with the agreement.  For accounting purposes, the Company will be required to treat the transaction as both a sale of lock\line and a corresponding purchase of interests in Asurion.  Because of the significant continuing involvement as an equity method investment of the Company, the merger of lock\line will not qualify to be reported as a discontinued operation.  The Company expects to recognize for book purposes a pretax gain on the merger that will range from approximately $60 million to $85 million, such amounts are dependent upon the finalization of a valuation of the assets being exchanged.  Certain of the Company’s equity and incentive compensation plans contain change of control features.  In conjunction with the closing of this transaction, the Company estimates recording compensation related charges ranging from $6 million to $10 million due to the acceleration of vesting and incentive compensation accruals associated with these change of control features.  The Company estimates that this merger transaction may be slightly dilutive to earnings per share, on a prospective basis, principally as a result of the amortization of identified intangibles associated with purchase accounting for its interests in Asurion.

The agreement is subject to regulatory approval under the Hart-Scott-Rodino Act, certain state regulatory agencies, in addition to receipt of final opinions from the Company’s tax advisors as to the tax free status of the reorganization.

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6.  Investments

Investments are as follows (in millions):

The table above includes $0.9 million of investments classified as Assets of businesses held for sale in the consolidated balance sheet as of December 31, 2004.

CPU is a global provider of share registry management/transfer agency services and technology to the global securities industry.  CPU’s common stock is listed on the Australian Stock Exchange under ASX:  CPU.  The aggregate market value of the Company’s investment in CPU’s common stock presented above was based on the closing price on the Australian exchange at September 30, 2005.  As discussed in Note 2, the Company obtained 29.6 million shares of CPU, which represents slightly less than 5% of CPU’s total issued capital, in connection with the sale of the EquiServe business on June 17, 2005.

As discussed in Note 3, the Company exchanged its investment in CSC shares on April 29, 2005 in connection with the HSI Exchange transaction.

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

The Company has a cash management service for full service mutual fund transfer agency clients, whereby end of day available client bank balances are invested overnight by and in the name of the Company into credit-quality money market funds.  All invested balances are returned to the full service mutual fund transfer agency client accounts the following business day.  The Company had $86.0 million and $75.2 million of transfer agency investments and deposits at September 30, 2005 and December 31, 2004, respectively.

The following table summarizes the fair value and gross unrealized losses of the Company’s investments by the length of time that the securities have been in a continuous loss position, at September 30, 2005 (in millions):

Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s current carrying value, thereby possibly requiring an impairment charge in the future.  Such a charge could have a material effect on the Company’s financial position.

The market value of the Company’s investment in CPU has fluctuated during the period that the Company has held this investment.  The value of the Company’s investment in CPU on June 17, 2005, the date of acquisition, was $145.8 million.  An unrealized loss of $13.5 million on this investment had occurred by June 30, 2005.  However, an unrealized gain of $3.1 million had occurred as of September 30, 2005. At October 31, 2005, the unrealized loss on this investment was $0.7 million. The Company will continue to monitor the performance of this investment.  An other than temporary decline in value may result in an impairment charge.

The Company recognized $3.1 million of investment impairments for the nine months ended September 30, 2005, and $0.3 million and $1.6 million for the three and nine months ended September 30, 2004, respectively, which the Company believed were other than temporary.  No such impairments were recorded during the three months ended September 30, 2005.  The impairments related to available for sale investments in the Investments and Other Segment and other investments held by the Financial Services Segment.  A decline in a security’s net realizable value that is other than temporary is treated as a loss based on quoted or derived market value and is reflected in the Other Income, net line in the statement of income.

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

Included in earnings for Boston Financial Data Services, Inc. (“BFDS”) for the nine months ended September 30, 2005 is the recognition of a $11.2 million deferred gain resulting from the sale of EquiServe.  BFDS is a corporate joint venture of DST and State Street Corporation (“State Street”).  In 2002, BFDS sold its partial interest in EquiServe to DST and recorded a gain in its stand-alone financial statements.  DST deferred its share of the 2002 equity in earnings of BFDS that related to this related party gain transaction.  The previously deferred gain was recognized on June 17, 2005 when DST sold EquiServe to CPU, an unrelated third party.

7.  Goodwill, Intangibles and Other Assets

The following table summarizes intangible assets (in millions):

The table above includes $14.0 million of intangible assets classified as Assets of business held for sale in the consolidated balance sheet as of December 31, 2004. As discussed in Note 5, the Company entered into a definitive agreement to merge its lock\line subsidiary into Asurion Corporation.  Included in the table above at September 30, 2005 are net intangible assets of $87.1 million related to lock\line.

Amortization of intangible assets for the three and nine months ended September 30, 2005 was $2.2 million and $7.0 million, respectively.  Amortization of intangible assets for the three and nine months ended September 30, 2004 was $2.1 million and $6.3 million, respectively.  Annual amortization amounts for intangible assets recorded as of September 30, 2005 are estimated at $9.0 million for 2005, $8.2 million for 2006 and 2007, $7.6 million for 2008 and $7.4 million for 2009.  Except for approximately $20.6 million of intangibles acquired in the HSI transaction, substantially all of the remaining intangibles in the above table are tax-deductible.

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The following table summarizes the changes in the carrying amount of goodwill for the nine months ended September 30, 2005, by segment (in millions):

The table above includes $179.9 million of goodwill classified as Assets of business held for sale in the consolidated balance sheet as of December 31, 2004.  Concurrent with the sale of EquiServe during the second quarter of 2005, goodwill was decreased by this amount.  As discussed in Note 5, the Company entered into a definitive agreement to merge its lock\line subsidiary into Asurion Corporation.  Included in the table above at September 30, 2005 is goodwill of $83.6 million related to lock\line.  Except for approximately $52.6 million of goodwill acquired in the HSI transaction, substantially all of the remaining goodwill is tax-deductible.

The August 2, 2002 acquisition of lock\line was accounted for as a purchase.  The minimum purchase price of $190 million was paid in cash at closing and was financed by debt.  There are provisions in the acquisition agreement that allow for additional consideration to be paid in cash if lock\line’s revenues, as defined in the acquisition agreement, exceed certain targeted levels for 2004.  Goodwill was increased by the amount of additional consideration paid during the second quarter of 2005 and is reflected in the column labeled as Acquisitions in the table above.  The Company has been asked to make an additional contingent payment of approximately $4 million.  The parties to the lock\line transaction continue to discuss the amount of the final payment related to the acquisition agreement.

8.  Debt

Line of credit facility

On June 28, 2005, the Company entered into a new syndicated line of credit facility to replace its existing line of credit facility.  The credit agreement provides for a five-year revolving unsecured credit facility in an aggregate principal amount of up to $600 million. The interest rates applicable to loans under the credit agreement are generally based on the offshore (LIBOR), Federal Funds, or prime rates, plus applicable margins. The revolving credit facility has a grid that adjusts borrowing costs up or down based upon the Company’s consolidated leverage ratio. The grid may result in fluctuations in borrowing costs.  The credit agreement contains customary restrictive covenants, as well as certain customary events of default.  The covenant limiting restricted payments, in addition to certain other exceptions, contains exceptions permitting the Company for a specified period to repurchase or redeem a specified amount of its capital stock.  Among other provisions, the credit agreement limits consolidated indebtedness, liens, investments, subsidiary indebtedness, and asset dispositions, and requires minimum consolidated net worth and certain leverage and interest coverage ratios to be maintained.  If any event of default occurs and is continuing, all amounts payable under the credit agreement may be declared immediately due and payable.  The maturity date for the credit facility is July 1, 2010.  On June 28, 2005, the date of the refinancing transaction, the administrative agent transferred $300 million of the outstanding balance under the old credit facility to the new credit facility.  This transfer has been treated as a non-cash transaction.  The Company used a portion of the cash proceeds from the EquiServe sale on June 17, 2005 to repay the remaining amount outstanding under the old line of credit facility.

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Repayment of promissory note related to common stock

On June 8, 2005, the Company entered into a promissory note with a bank in the principal amount of $107.4 million.  The Company agreed to pay the principal amount plus interest (at an annual rate equal to 1% over LIBOR) on or before the maturity date of June 30, 2005.  The Company had the right to prepay the promissory note in whole or in part, without premium or penalty, subject to the requirements of the loan agreement.  This promissory note settled the forward stock purchase agreement previously entered into by the Company in January 2005.  The Company used a portion of the proceeds from the EquiServe sale to repay the promissory note before June 30, 2005.

Subsidiary line of credit

On September 30, 2005, one of the Company’s subsidiaries entered into a new line of credit agreement to replace an existing line of credit facility that is used for working capital requirements and general corporate purposes.  The agreement provides for unsecured revolving borrowings up to $50 million and matures on September 30, 2007. Borrowings under the facility are available at rates based on the Federal Funds or LIBOR rates.  Commitment fees of 0.15% per annum on the unused portions are payable quarterly.  Among other provisions, the agreement requires the subsidiary to maintain certain interest coverage ratios and tangible net worth levels.  In the event of non-compliance, an event of default may occur, which could result in the loan becoming immediately due and payable.

9.  Income Taxes

In general, the Company provides income taxes during interim periods based on its best estimate of the full year’s effective tax rate.  Certain items, however, are given discrete period treatment and, as a result, the tax effects of such items are reported in full in the relevant interim period.  The Company’s effective tax rate was 39.5% and 39.4% for the three and nine months ended September 30, 2005, respectively, compared to 31.8% and 34.3% for the three and nine months ended September 30, 2004, respectively.   The Company estimates its effective tax rate will be 34.9% for the remainder of 2005.  However, if the lock\line transaction (see Note 5) closes in the fourth quarter, this rate could change.  The effective tax rates for 2005 are higher principally due to higher effective tax rates relating to the HSI exchange (see Note 3), the EquiServe sale (see Note 2), the Innovis Entities sale (see Note 4) and the sale of an office building.  The full year 2005 effective tax rate can be affected as a result of variances among the estimates and amounts of full year sources of taxable income (e.g. domestic consolidated, joint venture and/or international), the realization of tax credits (e.g. historic rehabilitation, research and experimental and state incentive) and adjustments which may arise from the resolution of tax matters under review.

The HSI exchange transaction (see Note 3) has been structured to meet the requirements for treatment as a tax-free reorganization in accordance with Section 355 of the Internal Revenue Code.  The Company received two separate tax opinions at the “more likely than not” level of assurance that the transaction will comply with the provisions of Section 355.  The tax opinions are not binding on the IRS.  It is possible that the IRS could take a position contrary to the Company’s.  If the IRS were to take such a contrary position and ultimately prevail, then the Company could be required to recognize a gain on the exchange as if the Company sold the CSC shares at fair market value.  The Company estimates, that under those circumstances, it would recognize a tax gain of approximately $283 million and would incur federal and state tax liabilities of approximately $111 million.  Given the size and unique nature of the transaction, and the fact that the tax opinions of the Company’s tax advisors have not reached the “should” level of assurance, the Company, for financial accounting purposes, has provided a tax reserve for the potential tax.  The Company provided an additional $32 million of tax provision at the time of the exchange transaction, which, when added to previously recorded amounts results in a $111 million accrual for the full amount of the potential tax.  The Company will accrue interest, through the Company’s tax provision, related to the potential tax.  As promulgated by Generally Accepted Accounting Principles, the Company has presented this $111 million accrual as a current liability in Income Taxes Payable, however, management estimates the resolution of this uncertainty could take more than one year.

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10.  Stockholders’ Equity

Earnings per share.  The computation of basic and diluted earnings per share is as follows (in millions, except per share amounts):

The Company had approximately 72.2 million and 83.0 million shares outstanding at September 30, 2005 and December 31, 2004, respectively.  For financial reporting purposes, however, restricted shares in the amount of 2.7 million and 2.8 million at September 30, 2005 and December 31, 2004, respectively, are excluded from the determination of average common shares outstanding used in the calculation of basic earnings per share in the above table.  Shares from options to purchase shares of common stock that were excluded from the diluted earnings per share calculation because they were anti-dilutive totaled 2.0 million and 4.2 million for the three months ended September 30, 2005 and 2004, respectively and 2.1 million and 4.2 million for the nine months ended September 30, 2005 and 2004, respectively.  The Company issued convertible senior debentures that if converted in the future would have a potentially dilutive effect on the Company’s stock.  The Series A debentures are convertible into 11.0 million shares of common stock and the Series B debentures are convertible into 6.1 million shares of common stock, subject to adjustment.  The Company intends to settle any conversions with cash for the principal and accrued and unpaid interest and issue common stock for any conversion value amount over the principal and accrued and unpaid interest amounts.  Related to the debentures, the calculation of diluted earnings per share would begin to include an incremental amount of shares assumed to be issued for the conversion spread if the Company’s stock price exceeds $49.08 per share.  For the three months ended September 30, 2005, there was additional dilution of approximately 1.0 million shares related the Company’s average daily share price exceeding $49.08 during the quarter.  There was no impact during the nine months ended September 30, 2005 because the Company’s average daily stock price for the nine months did not exceed $49.08.

The Company settled purchases of 742,954 shares at an approximate cost of $54.22 per share from October 1, 2005 through October 7, 2005.  These share repurchases completed the outstanding share repurchase authorization (discussed below in this Note under the heading “stock repurchases”), however, these shares were not included in the determination of the number of common shares outstanding at September 30, 2005 and were not considered treasury shares in the calculation of basic and diluted average shares outstanding at September 30, 2005.

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Comprehensive income (loss).  Components of comprehensive income (loss) consist of the following (in millions):

Stock repurchases.  Prior to December 31, 2004, DST’s Board of Directors had authorized an 11.5 million share repurchase plan.  On August 2, 2005, DST’s Board of Directors authorized an additional 8.0 million share repurchase to its existing 11.5 million share repurchase plan and extended the repurchase period to July 31, 2008.  Through September 30, 2005, the Company had repurchased 18.8 million shares at an average cost of $50.96 per share under this repurchase plan, including 11.0 million at an average cost of $52.29 during the three months ended September 30, 2005.  For the nine months ended September 30, 2005, the Company had repurchased 13.1 million shares at an average cost of $52.04 per share.  Included in these repurchased shares were 2.1 million shares at a total cost of $107.6 million, including interest, acquired under the Company’s forward stock purchase agreement that was settled in June 2005.  As mentioned above, the Company settled purchases of 742,954 shares at an approximate cost of $54.22 per share from October 1, 2005 through October 7, 2005.  These October 2005 share repurchases completed the outstanding share repurchase authorization dated August 2, 2005.  Effective October 25, 2005, DST’s Board of Directors authorized a new 6.0 million share repurchase plan through July 31, 2008.  The new plan allows, but does not require, the repurchase of common stock in open market and private transactions through July 31, 2008.

Restricted Stock Grant.  Prior to December 31, 2004, the Compensation Committee of the Board of Directors of the Company voted to grant approximately 2.8 million shares of restricted common stock of the Company to officers and certain other participants in the DST Systems, Inc. 1995 Stock Option and Performance Award Plan.  For nine senior executive officers, the restricted shares are subject to the earnings per share goal that must be met as an additional condition to the lapse of restrictions on January 31, 2010.  Subject to early lapsing and forfeiture provisions, the restrictions on the shares granted to all other officers and participants lapse on November 10, 2009.  The restricted stock grants cover the five-year period of 2005 through 2009 and are intended to be the only restricted stock grants for such periods other than for new hires or promotions, for special employee recognition purposes, and, in accordance with past practice, for the portion of each annual incentive bonus the executive officers and certain other participants are required to take in the form of equity compensation.  During 2005, additional restricted stock awards have been granted, including an award of 0.2 million shares to certain HSI employees in June 2005.  The restrictions lapse on November 10, 2009.

At September 30, 2005 and December 31, 2004, the Company had unearned compensation of $111.0 million and $132.6 million, respectively.  The impact of amortized compensation expense for the three and nine months ended

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September 30, 2005 was $14.1 million and $27.2 million, respectively, including approximately $6.9 million in the three months ended September 30, 2005 associated with accelerated vesting in connection with the sale of the Innovis Entities. The Company estimates that the impact of amortized compensation expense attributable to the grants for each subsequent year covered by the grant, based upon the average of the high and low trading prices for the Company’s shares will be approximately $34 million for 2005, $27 million each for the years 2006 through 2008 and $24 million in 2009.  These estimates assume that all shares will be vested and all performance criteria will be met.

Stock-based compensation.  The Company accounts for stock-based compensation in accordance with Accounting Principles Board Opinion (“APBO”) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations and has presented the required Statement of Financial Accounting Standards (“SFAS”) No. 123 “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” pro forma disclosure in the table below.

On May 10, 2005, stockholders of DST approved the DST Systems,  Inc. 2005  Equity Incentive Plan (the “Employee Plan”) and the DST Systems, Inc. 2005 Non-Employee Directors’  Award Plan (the “Directors’  Plan”).  These plans became effective as of May 10, 2005.  The term of both the Employee Plan and the Directors’ Plan is from May 10, 2005 through May 9, 2015.

The Employee Plan amends, restates and renames the DST Systems, Inc. 1995 Stock Option and Performance Award Plan (“1995 Plan”).  The number of shares of common stock reserved for delivery under the Employee Plan is the sum of (a) 4.0 million shares, plus (b) the number of shares remaining under the 1995 Plan (originally 30 million shares available) as of May 10, 2005 (not subject to outstanding Awards under the 1995 Plan and not delivered out of the Shares reserved thereunder), plus (c) shares that become available under the 1995 Plan after May 10, 2005 pursuant to forfeiture, termination, lapse or satisfaction of an award in cash or property other than shares of common stock,  application as payment for an award, or, except with respect to restricted stock, to satisfy tax withholding, plus (d) any shares of common stock required to satisfy substitute awards.

The Directors’ Plan will replace the component of the 1995 Plan that provided for equity awards to directors who are not employees of DST or any affiliate (“Non-Employee Directors”).  Subject to adjustment,  as provided in the Directors’  Plan, the number of shares of common stock reserved for delivery under this plan is the sum of (a) 0.3 million shares plus (b) any shares of common stock required to satisfy “substitute awards”, as defined in the Directors’ Plan.

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The Employee Plan provides for the availability of shares of the Company’s common stock for the grant of awards to employees, prospective employees and consultants to the Company or an affiliate.  Awards under the Employee Plan may take the form of shares, dividend equivalents, options, stock appreciation rights, limited stock appreciation rights, performance units, restricted stock, restricted stock units, deferred stock, annual incentive awards, service awards and substitute awards (each as defined in the plan).  The Directors’ Plan provides for the availability of shares of the Company’s common stock for awards to non-employee members of the Company’s board of directors.  Awards under the Directors’ Plan may take the form of shares, dividend equivalents, options, restricted stock, restricted stock units, deferred stock and substitute awards (each as defined in the plan).  The option prices must be at least equal to the fair market value of the underlying shares on the date of grant.  Options become exercisable and expire as determined by the Compensation Committee of the Board of Directors at the date of grant.  The Company applies APBO No. 25 and related interpretations in accounting for its stock based compensation, and accordingly, no compensation cost has been recognized for the Company’s stock option awards under the plans.  Had compensation cost been determined consistent with SFAS No. 123, as amended by SFAS No. 148, the Company’s net income would have been reduced to the following pro forma amounts:

The Company uses the Black-Scholes option pricing model which requires the Company to make certain assumptions in order to estimate fair value.

Rights plan.  The Company is party to a Stockholders’ Rights Agreement (the “Rights Plan”) dated as of October 10, 2005.  Pursuant to the terms of the Rights Plan, each share of the Company’s common stock held of record on October 18, 2005 has received one Right.  Each Right entitles the registered holder to purchase from the Company 1/1000ths of a share of Series A Preferred Stock,  or in some circumstances,  shares of the Company’s Common Stock,  other securities,  cash or other assets,  at a purchase price of $225 per share, subject to certain adjustments.  Under certain circumstances, the Company may redeem the rights in whole, but not in part, at a redemption price of $0.0025 per Right.

The Rights, which are automatically attached to common stock, are not exercisable or transferable separately from shares of common stock until upon the earlier of (i) ten (10)  business days following a public announcement that a person or group of affiliated or associated persons has acquired beneficial ownership of fifteen percent (15%) or more of the then outstanding shares of Common Stock (each such person or group of affiliated or associated persons referred to herein and in the Rights Agreement as an “Acquiring Person”),  or (ii) ten (10) business days following the commencement of a tender offer or exchange offer that would result in a person or group becoming

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an Acquiring Person, unless the Board of Directors sets a later date in either event. The Rights attached to the stock of an Acquiring Person become void.

The Rights Plan is intended to encourage a potential acquiring person to negotiate directly with the Board of Directors, but may have certain anti-takeover effects. The Rights Plan could significantly dilute the interests in the Company of an Acquiring Person. The Rights Plan may therefore have the effect of delaying, deterring or preventing a change in control of the Company.

11.  Commitments and Contingencies

The Company has entered into an agreement to guarantee 50% of a construction loan of a 50% owned joint venture.  The construction loan becomes due and the Company's guarantee thereof expires in June 2008 and allows for borrowings up to $2.6 million.  At September 30, 2005, there were no outstanding borrowings against the loan.

The Company and DST Realty, Inc. have entered into an agreement to guarantee 50% of a $10.0 million line of credit loan for a 50% owned real estate joint venture.  The loan becomes due and the Company's guarantee thereof expires on June 17, 2006.  At September 30, 2005, total borrowings against the line of credit were $5.6 million.

The Company has entered into an agreement to guarantee, jointly and severally, and limited to $10.0 million related to a $60.0 million construction loan for a 50% owned real estate joint venture.  The $60.0 million loan becomes due and the Company's guarantee thereof expires on December 31, 2005.  At September 30, 2005, total borrowings on the loan were $24.4 million.

The Company and a wholly owned subsidiary of the Company have entered into an agreement to guarantee $1.0 million (which, in the event a certain debt service coverage ratio requirement is not met, will increase to $2.0 million) plus any enforcement costs related to a $32.0 million mortgage loan to a 33% owned real estate joint venture.  The $32.0 million loan matures on July 1, 2010.  At September 30, 2005, total borrowings on the loan were $28.4 million.

The Company is a 50% partner in a limited purpose real estate joint venture.  The real estate joint venture is developing approximately 1.1 million square feet of office space to be leased to the U.S. government.  The project is estimated to cost approximately $362 million and has been financed with $315.4 million of non-recourse insured bonds (issued June 2004) with the remainder in the form of equal equity contributions from the real estate joint venture partners.  At September 30, 2005, each partner had contributed half of the aggregate equity of $34.5 million.  The real estate joint venture partners have committed aggregate additional equity investments of approximately $12.1 million to complete the financing and up to $33.3 million of equity investments in the aggregate in the event of delays in construction or lease commencement.  The remaining equity contributions of $12.1 million to $45.4 million have been secured through $45.4 million of letters of credit that will expire beginning in 2007 through 2008.  The Company is responsible for $22.7 million of the letters of credit.  At September 30, 2005, there were no outstanding borrowings against the letters of credit.

The Company and State Street Corporation (“State Street”) have each guaranteed 50% of a lease obligation of International Financial Data Services, U.K. Limited (“IFDS U.K.”), which requires IFDS U.K. to make annual rent payments of approximately $3.6 million through 2017, for its use of a commercial office building.  The commercial office building is owned by a wholly owned affiliate of International Financial Data Services, (Canada) Limited (“IFDS Canada”) and was financed with a $19.5 million mortgage loan from a bank.  The loan has a floating interest rate based upon LIBOR and fully amortizes over the 15 year term.  To fix the rate of borrowing costs, the IFDS Canada affiliate entered into a 15 year interest rate hedge agreement with the same bank. The interest rate hedge, which has an initial notional amount value of approximately $19.5 million and scheduled reductions that coincide with the scheduled principal payments for the mortgage loan, was entered into for the purpose of fixing the borrowing costs of the mortgage at approximately 6.3%.  The Company and State Street have each guaranteed 50% of the amounts of the interest rate hedge obligations.  Upon default, the Company would be required to pay 50% of the total amount to close out of the hedge.

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The Company’s 50% owned joint ventures are generally governed by shareholder or partnership agreements.  The agreements generally entitle the Company to elect one-half of the directors to the board in the case of corporations and to have 50% voting/managing interest in the case of partnerships.

The agreements generally provide that the Company or the other party has the option to establish a price payable in cash, or a promise to pay cash, for all of the other’s ownership in the joint venture and to submit an offer, in writing, to the other party to sell to the other party all of its ownership interests in the joint venture or to purchase all ownership interests owned by the other party at such offering price.  The party receiving the offer generally has a specified period of time to either accept the offer to purchase, or to elect to purchase the offering party’s stock at the offering price.  The Company cannot estimate the potential aggregate offering price that it could be required to receive or elect to pay in the event this option becomes operable, however the amount could be material.

FIN 45 Disclosures

In addition to the guarantees entered into discussed in Commitments and Contingencies above, the Company has also guaranteed certain obligations of certain joint ventures under service agreements entered into by the joint ventures and their customers.  The amount of such obligations is not stated in the agreements.  Depending on the negotiated terms of the guaranty and/or on the underlying service agreement, the Company’s liability under the guaranty may be subject to time and materiality limitations, monetary caps and other conditions and defenses.

In certain instances in which the Company licenses proprietary systems to customers, the Company gives certain indemnities (including infringement indemnities) and warranties to the licensee, the terms of which vary depending on the negotiated terms of each respective license agreement.  Such warranties generally warrant that such systems will perform in accordance with their specifications.  The amount of such obligations is not stated in the license agreements.  The Company’s liability for breach of such obligations may be subject to time and materiality limitations, monetary caps and other conditions and defenses.

From time to time, the Company enters into service agreements and other agreements with unaffiliated parties containing indemnification provisions, the terms of which vary depending on the negotiated terms of each respective agreement.  The amount of such obligations is not stated in the agreements.  The Company’s liability under such indemnification provisions may be subject to time and materiality limitations, monetary caps and other conditions and defenses.  Such indemnity obligations include those described herein.

The Company has entered into purchase and service agreements with its vendors, and consulting agreements with providers of consulting services to the Company, pursuant to which the Company has agreed to indemnify certain of such vendors and consultants, respectively, against third party claims arising from the Company’s use of the vendor’s product or the services of the vendor or consultant.

In connection with the acquisition or disposition of subsidiaries, operating units and business assets by the Company, the Company has entered into agreements containing indemnification provisions, the terms of which vary depending on the negotiated terms of each respective agreement, but which are generally described as follows:  (i) in connection with acquisitions made by the Company, the Company has agreed to indemnify the seller against third party claims made against the seller relating to the subject subsidiary, operating unit or asset and arising after the closing of the transaction, and (ii) in connection with dispositions made by the Company, the Company has agreed to indemnify the buyer against damages incurred by the buyer due to the buyer’s reliance on representations and warranties relating to the subject subsidiary, operating unit or business assets in the disposition agreement if such representations or warranties were untrue when made, or due to any breach of the representations, warranties, agreements or covenants contained in the agreement.

The Company has entered into agreements with certain third parties, including banks and escrow agents, that provide software, escrow, fiduciary and other services to the Company or to its benefit plans or customers.  Under such agreements, the Company has agreed to indemnify such service providers for third party claims relating to the carrying out of their respective duties under such agreements.

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The Company has entered into agreements with lenders providing financing to the Company pursuant to which the Company agrees to indemnify such lenders for third party claims arising from or relating to such financings.  In connection with real estate mortgage financing, the Company has entered into environmental indemnity agreements in which the Company has agreed to indemnify the lenders for any damage sustained by the lenders relating to any environmental contamination on the subject properties.

In connection with the acquisition or disposition of real estate by the Company, the Company has entered into real estate contracts containing indemnification provisions, the terms of which vary depending on the negotiated terms of each respective contract, but which are generally described as follows:  (i) in connection with acquisitions by the Company, the Company has agreed to indemnify the seller against third party claims made against the seller arising from the Company’s on-site inspections, tests and investigations of the subject property made by the Company as part of its due diligence and against third party claims relating to the operations on the subject property after the closing of the transaction, and (ii) in connection with dispositions by the Company, the Company has agreed to indemnify the buyer for damages incurred by the buyer due to the buyer’s reliance on representations and warranties relating to the subject property made by the Company in the real estate contract if such representations or warranties were untrue when made and against third party claims relating to operations on the subject property prior to the closing of the transaction.

In connection with the leasing of real estate by the Company, as landlord and as tenant, the Company has entered into occupancy leases containing indemnification provisions, the terms of which vary depending on the negotiated terms of each respective lease, but which are generally described as follows: (i) in connection with leases in which the Company is the tenant, the Company has agreed to indemnify the landlord against third party claims relating to the Company’s occupancy of the subject property, including claims arising from loss of life, bodily injury and/or damage to property thereon, and (ii) in connection with leases in which the Company is the landlord, the Company has agreed to indemnify the tenant against third party claims to the extent occasioned wholly or in part by any negligent act or omission of the Company or arising from loss of life, bodily injury and/or damage to property in or upon any of the common areas or other areas under the Company’s control.

At September 30, 2005, the Company had not accrued any liability on the aforementioned guarantees or indemnifications as they relate to future performance criteria or indirect indebtedness of others in accordance with FIN 45.

FIN 46 Disclosures

In December 2003, the revised FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51” was issued, which requires the consolidation of certain types of entities in which the Company absorbs a majority of another entity’s expected losses, receives a majority of the other entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the other entity.  These entities are called “variable interest entities.”  The principal characteristics of variable interest entities are (1) an insufficient amount of equity to absorb the entity’s expected losses, (2) equity owners as a group are not able to make decisions about the entity’s activities, or (3) equity that does not absorb the entity’s losses or receive the entity’s residual returns.  “Variable interests” are contractual, ownership or other monetary interests in an entity that change with fluctuations in the entity’s net asset value.  As a result, variable interest entities can arise from items such as joint ventures, lease agreements, loan arrangements, guarantees or service contracts.

If an entity is determined to be a “variable interest entity,” the “primary beneficiary” must consolidate the entity.  The primary beneficiary is the holder of the variable interests that absorb a majority of the variable interest entity’s expected losses or receive a majority of the entity’s residual returns in the event no holder has a majority of the expected losses.  There is no primary beneficiary in cases where no single holder absorbs the majority of the expected losses or receives a majority of the residual returns.  The determination of the primary beneficiary is based on projected cash flows at the inception of the variable interests.

With regard to real estate, the Company is the lessee in a series of operating leases covering a large portion of its Kansas City based leased office facilities.  The lessors are generally joint ventures (in which the Company has a 50% ownership)

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that have been established specifically to purchase, finance and engage in leasing activities with the joint venture partners and unrelated third parties.  Two of the real estate joint ventures, which the Company entered into during 2001 and 2003, have entered into financing arrangements with the Company’s wholly owned captive insurance company.  In each case, the other joint venture partner has guaranteed at least 50% of the joint venture’s borrowings ($37.5 million at September 30, 2005) from the Company’s captive insurance company.  The Company is generally not the primary beneficiary of the joint ventures if the lease terms are consistent with market terms at the inception of the lease and do not include a residual value guarantee, fixed-price purchase options or similar features that disproportionately obligate it to absorb decreases in value or entitle it to participate in increases in the value of the real estate.  The Company’s analyses of its real estate joint ventures indicate that a large portion of the real estate joint ventures are variable interest entities, however the real estate joint ventures do not need to be consolidated because the Company is not the primary beneficiary.

With regard to operating joint ventures, the Company has formed or entered into operating joint ventures to enter into or expand its presence in target markets.  The Company has three significant operating joint ventures; BFDS; IFDS (includes IFDS U.K., IFDS Canada and International Financial Data Services, Luxembourg); and Argus.  Each of these operating joint ventures was formed prior to February 1, 2003.  The Company’s FIN 46 analyses of these operating joint ventures indicate that none qualifies as variable interest entities due to meeting the criteria for the operating joint venture exception in FIN 46.  Accordingly, the Company does not consolidate the operating results of these operating joint ventures.

12.  Recently Issued Accounting Standards

In December 2004, the FASB issued its final standard on accounting for share-based payments, Statement of Financial Accounting Standards No. 123R (“SFAS No. 123R”) (revised 2004).  SFAS No. 123R requires that the compensation cost relating to share-based payment transactions be recognized in financial statements.  The cost will be measured based on the fair value of the instruments issued.  SFAS No. 123R covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans.  SFAS No. 123R replaces SFAS No. 123 and supersedes APB Opinion No. 25.  As originally issued in 1995, SFAS No. 123 established as preferable the fair value based method of accounting for share-based payment transactions with employees.  However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the notes to the financial statements disclosed what net income would have been had the fair value method been applied.  The Company will apply SFAS No. 123R effective January 1, 2006 and expects to use the modified prospective method to adopt the standard.  The Company is currently evaluating the impact of this new accounting standard.

On September 30, 2005, the FASB issued an exposure draft on a proposed accounting standard that would amend SFAS 128, Earnings per Share, to clarify guidance for mandatorily convertible instruments, the treasury stock method, contingently issuable shares, and contracts that may be settled in cash or shares.  DST is currently evaluating the impact of this proposed accounting standard.  DST currently believes that this proposed amendment would impact the way the Company treats the incremental shares to be issued from the assumed conversion of the $840 million of convertible debentures issued in August 2003 in calculating diluted earnings per share.  The proposed amendment, which is designed for convergence with international accounting standards, would require the use of the “if-converted” method from the date of issuance of the convertible debentures.  The proposed amendment would remove the ability of a company to support the presumption that the convertible securities will be satisfied in cash and not converted into shares of common stock.  Accordingly, the Company’s stated intention to settle the conversions with cash for the principal and accrued and unpaid interest and issue common stock for any conversion value amount over the principal and accrued and unpaid interest amounts would no longer be accepted under SFAS 128.  Comments to the FASB on this exposure draft are due by November 30, 2005, and the final statement is expected to be issued in the first quarter of 2006.  The statement would be effective for interim and annual periods ending after June 15, 2006.  Retrospective application would be required for all changes to SFAS 128, except that retrospective application would be prohibited for contracts that were either settled in cash prior to adoption or modified prior to adoption to require cash settlement.  For DST, this would require retroactive restatement of the Company’s diluted earnings per share calculations subsequent to the issuance of the convertible debentures.  Under the revised SFAS 128 “if converted” method included in the exposure draft, in calculating diluted earnings per share the Company would need to increase

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net income for the interest expense associated with the convertible debentures, net of tax, and increase the incremental shares assumed to be issued upon conversion by 17.1 million shares, the amount of shares that would be issued if all $840 million of convertible debentures would be converted to equity.  Under this method, diluted earnings per share would have been $1.67 and $0.57 for the three months ended September 30, 2005 and 2004, respectively, and $4.02 and $1.68 for the nine months ended September 30, 2005 and 2004, respectively.  The above pro-forma information presents only the effect on diluted earnings per share of the “if converted” method included in the exposure draft, but does not include any other computational changes (i.e. treasury stock method considerations) discussed in the exposure draft.  DST is still evaluating the remaining aspects of this proposed accounting standard.

The proposed change in accounting principles would affect the calculation of diluted earnings per share during the period the debentures are outstanding, but does not affect DST’s ability to ultimately settle the convertible debentures in cash, shares or any combination thereof.

The estimated impact of this new accounting standard reflects the Company’s current views.  There may be material differences between these estimates and the actual impact of the standard.

13.  Segment Information

The Company has several operating business units that offer sophisticated information processing and software services and products.  The Company has elected to organize and report on these business units as three operating Segments (Financial Services, Output Solutions and Customer Management).  In addition, investments in equity securities and certain financial interests and the Company’s real estate subsidiaries and affiliates have been aggregated into an Investments and Other Segment.  As discussed in Note 4, the Innovis Entities, which essentially comprised the Customer Management Segment, were sold on July 1, 2005.

Included in costs and expenses in the Investments and Other Segment for three and nine months ended September 30, 2005, are gains of $22.9 million and $26.3 million, respectively, related to the sale of certain fixed assets.  Included in depreciation and amortization in the Investments and Other Segment for the three and nine months ended September 30, 2005, are $2.4 million of impairment charges, related to certain real-estate properties.

Information concerning total assets by reporting segment is as follows (in millions):

The Company evaluates the performance of its segments based on income before income taxes, non-recurring items and interest expense.  Non-recurring items may include net gains and losses on dispositions of business units, net gains and losses associated with securities, restructuring costs and other similar items.  Intersegment revenues are reflected at rates prescribed by the Company and may not be reflective of market rates.

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Summarized financial information concerning the segments is shown in the following tables (in millions):