UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

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

For the quarterly period ended June 30, 2007

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 x     No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

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

Yes o  No x

Number of shares outstanding of the Company’s common stock as of June 30, 2007:

Common Stock $0.01 par value — 63,448,649

DST Systems, Inc.

Form 10-Q

June 30, 2007

Table of Contents

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

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DST Systems, Inc.

Form 10-Q

June 30, 2007

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 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

The results of operations for the three and six months ended June 30, 2007, are not necessarily indicative of the results to be expected for the full year 2007.

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DST Systems, Inc.

Condensed Consolidated Balance Sheet

(unaudited and dollars in millions, except per share amounts)

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.

5

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 (“GAAP”) 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.  The Condensed Consolidated Balance Sheet as of December 31, 2006 has been derived from the audited Consolidated Balance Sheet at that date, but does not include all of the information and notes required by GAAP for complete financial statements.  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, 2006.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal interim closing procedures) necessary to present fairly the financial position of the Company and its subsidiaries at June 30, 2007, and the results of operations for the three and six months ended June 30, 2007 and 2006, and cash flows for the six months ended June 30, 2007 and 2006.

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 six months ended June 30, 2007, are not necessarily indicative of the results to be expected for the full year 2007.

2.              Asurion Corporation Transaction

DST acquired an approximate 37.4% ownership interest in Asurion Corporation (“Asurion”) on January 1, 2006 when it merged its DST lock\line, Inc. subsidiary into a wholly-owned subsidiary of Asurion.  Beginning January 1, 2006, DST accounted for its interest in Asurion under the equity method.  On July 3, 2007, the Board of Directors of Asurion consummated a transaction whereby certain private equity firms acquired a significant stake in Asurion.  As a result of the transaction, in July 2007 DST has received cash proceeds of $980 million and receivables of approximately $45.8 million that are expected to be collected within one year from the closing of the transaction, and DST’s equity interest in Asurion has been reduced to approximately 6%.  Effective with the closing of the transaction on July 3, 2007, DST will account for its investment in Asurion under the cost basis of accounting and will no longer record equity in earnings of Asurion.  Approximately $575 million of the cash proceeds have been used to pay down debt and related facilities, while the remainder, most of which will be used to fund the Company’s estimated tax obligations resulting from the transaction, has been temporarily invested in high grade short term investments.

.

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3.  Investments

Investments are as follows (in millions):

State Street Corporation issued approximately 61.0 million shares in connection with its July 2, 2007 acquisition of Investors Financial Services Corporation.  As a result of this share issuance, DST’s approximate ownership percentage in State Street Corporation will be diluted from approximately 3.4% to approximately 2.8%.

The following table summarizes certain information related to the Company’s available-for-sale securities (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.  Invested balances are returned to the full service mutual fund transfer agency client accounts

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the following business day.  The Company had $103.2 million and $125.6 million of transfer agency investments and deposits at June 30, 2007 and December 31, 2006, 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, as of June 30, 2007 (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.  These 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 and results of operations.

The Company recognized $1.5 million and $2.0 million of investment impairments for the three and six months ended June 30, 2007 and $0.9 million for the three and six months ended June 30, 2006, which the Company believed were other than temporary.  The impairments recorded during the three and six months ended June 30, 2007 and 2006, 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.

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

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4.  Goodwill and Intangible Assets

Goodwill

The following table summarizes the changes in the carrying amount of goodwill for the six months ended June 30, 2007, by segment (in millions):

As further described in Note 7, DST adopted a new income tax accounting standard on January 1, 2007.  The adoption of this accounting standard resulted in a reduction in goodwill of approximately $52.6 million and intangible assets of approximately $16.5 million that were acquired during the April 2005 acquisition of DST Health Solutions, Inc.

Intangible Assets

The following table summarizes intangible assets (in millions):

Amortization of intangible assets for the three and six months ended June 30, 2007 was approximately $0.5 million and $1.1 million, respectively.  Amortization of intangible assets for the three and six months ended June 30, 2006 was approximately $0.7 million and $1.3 million, respectively.  The Company estimates that amortization expense attributable to intangible assets recorded as of June 30, 2007 will be approximately $1.0 million for the remainder of 2007, $2.1 million for 2008, $2.0 million for each of 2009 and 2010 and $1.9 million for each of 2011 and 2012.

5.  Debt

Senior Convertible Debentures

Holders of the Company’s $840 million senior convertible debentures were eligible to convert these bonds during the three months ended March 31, 2007 and the three months ended June 30, 2007 as a result of DST’s common stock trading above 120% of the applicable conversion price ($49.08) for at least 20 trading days during the period of 30 consecutive trading days ended December 31, 2006 and March 31, 2007.  Actual conversions during the six months ended June 30, 2007 have been less than $0.1 million and cash was used to settle the principal portion of these conversions.  The senior debentures continue to be convertible through September 30, 2007 as the stock price conversion feature was still in effect at June 30, 2007.  Conversion rights, and ultimate classification as a current or non-current liability, for subsequent quarters will be a function of future DST stock prices.

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Equipment Promissory Note

During the six months ended June 30, 2007, DST purchased $11.3 million of computer equipment with a promissory note.  The note matures on April 1, 2010 and is secured by the equipment.  Interest accrues at a fixed rate of approximately 4.9% per year.

BFDS Promissory Note

Since March 2006, the Company has maintained a promissory note with Boston Financial Data Services, Inc. (“BFDS”).  The agreement provides for unsecured revolving borrowings by the Company of up to $50 million and matures on July 1, 2010.  In March 2007, an amendment to the existing promissory note between the Company and BFDS was executed.  The amendment increased the unsecured revolving borrowings limit from $50 million to $100 million.  The amount outstanding under this loan agreement was $70.0 million at June 30, 2007.  For the three and six months ended June 30, 2007, the Company recorded interest expense related to this loan of $1.0 million and $1.7 million, respectively.

Syndicated Line of Credit

The Company amended its revolving $600 million syndicated line of credit facility as of July 19, 2007 to, among other things, (i) allow DST to repurchase or redeem its capital stock in an amount not to exceed $600 million with proceeds received from the Asurion transaction described in Note 2, (ii) increase the amount of permitted restricted payments for the last half of 2007, and (iii) allow a one time addition of $150 million to the $50 million exclusion on real property liens if incurred prior to June 30, 2008.

6.  Accounts Receivable Securitization Program

On May 24, 2007, DST entered into a $200 million accounts receivable securitization program with a third party multi-seller asset-backed commercial paper conduit. Under the terms of the securitization program, (a) DST periodically acquires accounts receivable originated by certain of its domestic subsidiaries, including DST Output, DST Health Solutions and DST Technologies (the “Subsidiary Originators”), (b) DST transfers receivables originated by DST and receivables acquired from the Subsidiary Originators, on a periodic basis, to a wholly-owned bankruptcy remote special purpose subsidiary of DST (the “SPE”), and (c) the SPE then sells undivided interests in the receivables to the commercial paper conduit.  DST retains servicing responsibility over the receivables.

The assets of the SPE are not available to satisfy the creditors of any other person, including DST or any of its subsidiaries or affiliates.  Further, neither DST nor the SPE guarantees collectability of the receivables or the creditworthiness of obligors.  The conduit’s purchase commitment will expire on May 22, 2008 unless otherwise extended in accordance with the program agreements.

The periodic transfers of undivided interests in the receivables by the SPE to the conduit meet the requirements for sale accounting treatment in accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.”  Accordingly, the portion of the receivables transferred to the conduit, up to an advance amount which cannot exceed $200 million, have been removed from the balance sheet.  The SPE retains an interest in the receivables in excess of the amount transferred to the conduit, and such receivables will continue to be recognized on the balance sheet.  The carrying value of the retained interest approximates its estimated fair value at the balance sheet date.  Increases in the level of assumed interest rates and/or credit losses compared to assumptions in effect at the balance sheet date by 10% or 20% would not materially affect the fair value of the retained interest at the reporting date.

At June 30, 2007, the total outstanding undivided interest in the receivables held by the conduit was $200.0 million.  Cash collections relating to the transferred receivable interests serviced by DST that had yet to be remitted to the conduit or used to purchase an interest in newly originated receivables at June 30, 2007 were $200.0 million, and this amount has been included in amounts due under accounts receivable securitization program in the consolidated balance sheet.  In July 2007, this entire amount was remitted to the conduit.  Aggregate transfers of undivided interests in the receivables from the SPE to the conduit totaled $203.0 million from May 24, 2007 (inception date) through June 30, 2007.  A $65.2 million retained interest in the receivables partially sold is included in

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accounts receivable on the consolidated balance sheet at June 30, 2007.  The impact on net income stemming from these transfers was not material.

Delinquencies and credit losses related to the accounts receivable sold were not significant from the inception date of the securitization program through June 30, 2007.

7.  Income Taxes

Effective January 1, 2007, DST adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB No. 109” (“FIN 48”).  This interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements.  FIN 48 indicates that the impact from adoption should be reflected as a cumulative effect adjustment from a change in accounting principle to the beginning retained earnings amount reported for that fiscal year, unless the amount relates to a previous business combination, in which case the impact would be recorded as an adjustment to the purchase price allocation for the previous business combination.  The adjustment to the purchase price allocation would first reduce remaining goodwill and identified intangibles related to the business combination and the residual would be reflected as a cumulative effect adjustment to beginning retained earnings.

DST’s adoption resulted in approximately $87.5 million of previously recorded liabilities for uncertain tax positions being released, of which $68.2 million (net of related deferred income taxes) resulted in a reduction in previously recorded identified intangibles (including capitalized software) relating to the Company’s April 2005 acquisition of DST Health Solutions, and the remainder of $19.3 million was recorded as an increase in stockholders’ equity as a cumulative effect adjustment.  The reduction in the identified intangibles resulted in a reduction in amortization expense of approximately $1.5 million and $3.0 million during the three and six months ended June 30, 2007, respectively, as compared to the same periods in 2006.  The reduced amortization will continue in the future, as no identified intangibles remain from the DST Health Solutions acquisition.

Prior to the adoption of FIN 48, the Company classified all income tax uncertainties as current liabilities.  Upon adoption of FIN 48, the Company reclassified approximately $64.0 million of income tax uncertainties that are estimated to take more than 12 months to resolve to non-current liabilities.

The amount of gross unrecognized tax benefits as of January 1, 2007 is $53.8 million.  Included in the Company’s net unrecognized tax benefit at January 1, 2007 are $47.3 million of tax positions which, if recognized, would affect the effective tax rate.  Also included in the net unrecognized tax benefit at January 1, 2007 are $3.7 million of tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility.  Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.  The gross amount of unrecognized tax benefits did not materially change during the three and six months ended June 30, 2007.  A favorable resolution of an international income tax issue resulted in a $3.8 million reduction in income tax expense during the three and six months ended June 30, 2007.

The Company recognizes interest and penalties accrued related to unrecognized tax benefits in income taxes, which is consistent with the recognition of these items in prior reporting periods.  As of January 1, 2007, the Company had $13.1 million of interest and penalties accrued associated with unrecognized tax benefits.  The liability for interest and penalties increased $1.9 million through June 30, 2007.

It is expected that the amount of unrecognized tax benefits will change during the next year; however, the Company does not expect the change to have a significant impact on its results of operations or financial position.

The Company files income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions.  The IRS examination of the tax years ended December 31, 1999 through 2001 concluded during 2006.  In connection with the examination of the Company’s 2000 tax return, the IRS is continuing to examine a transaction the Company consummated in that year.  An IRS examination for the tax years ended December 31, 2002 through 2005 began during 2006.  As of June 30, 2007, the IRS has not proposed any significant adjustments which would be material to the Company’s financial statements.  Various state, local, and foreign income tax returns are also under examination

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by taxing authorities.  The Company does not believe that the outcome of any examination will have a material impact on our financial statements.

In general, the Company records income tax expense 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 31.9% and 32.9% for the three and six months ended June 30, 2007, respectively, compared to 27.7% and 34.7% for the three and six months ended June 30, 2006, respectively.  The higher effective tax rate for the three months ended June 30, 2007, compared to the same period in the prior year, is primarily due to the absence of a benefit from a settlement and refund with the IRS related to research and experimentation credits resulting in a lower effective tax rate during 2006, which is partially offset by a favorable resolution of an international income tax issue during the three months ended June 30, 2007.  The lower effective tax rate for the six months ended June 30, 2007, compared to the same period in the prior year, is primarily due to the absence of the gain relating to the lock\line merger with Asurion which attracted a higher effective tax rate during 2006 and due to a reduction in the interest accruals relating to unrecognized tax benefits resulting from the adoption of FIN 48.  The full year 2007 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 experimentation and state incentive), adjustments which may arise from the resolution of tax matters under review and the Company’s assessment of its liability for unrecognized tax benefits.

8.  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 63.4 million and 69.5 million shares outstanding at June 30, 2007 and 2006, respectively.  For financial reporting purposes, however, unvested restricted shares in the amount of 2.5 million at  June 30, 2007 and 2006, 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 common stock that were excluded from the diluted earnings per share calculation because they were anti-dilutive were 0.8 million for the three and six months ended June 30, 2006.  There were no anti-dilutive shares from options to purchase common stock during the three and six months ended June 30, 2007.  The Company has 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

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includes an incremental amount of shares assumed to be issued for the conversion spread when the Company’s average daily stock price exceeds $49.08 per share.  There was additional dilution of approximately 6.5 million shares and 5.9 million shares for the three and six months ended June 30, 2007 and 2.9 million shares and 2.8 million shares for the three and six months ended June 30, 2006, related to the Company’s average daily share price exceeding $49.08 per share.

Stock repurchases

The Company repurchased 2,250,000 shares of DST common stock for $177.5 million or approximately $78.90 per share during the three months ended June 30, 2007.  For the six months ended June 30, 2007, the Company had repurchased 3,386,900 shares of DST common stock at an average cost of $76.50 per share.  Cash proceeds from operations and borrowings on debt facilities were used to repurchase these shares.  At June 30, 2007, approximately 5.6 million shares remained under the existing share repurchase authorization plan.

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

9.  Commitments and Contingencies

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

The Company has letters of credit of $18.4 million and $21.0 million outstanding at June 30, 2007 and December 31, 2006, respectively.  Letters of credit are secured by the Company’s debt facility.  Letters of credit at June 30, 2007 include $14.1 million related to real estate joint ventures discussed below.

The Company has entered into agreements with certain officers whereby upon defined circumstances constituting a change in control of the Company, certain benefit entitlements are automatically funded and such officers are entitled to specific cash payments upon termination of employment.

The Company has established trusts to provide for the funding of corporate commitments and entitlements of Company officers, directors, employees and others in the event of a change in control of the Company. Assets held in such trusts at June 30, 2007 were not significant.

The Company has entered into an agreement to guarantee 50% of the obligations of a 50% owned joint venture as a tenant under a real estate lease for an office building.  The initial term of the lease is 10 years and 7 months,

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commencing March 1, 2007 and expiring September 30, 2017, with two five-year options to extend.  The base rent for the initial term is $4.8 million per year, plus all operating expenses for the building.

The Company had entered into an agreement to guarantee 50% of a construction loan made to a 50% owned joint venture.  The construction loan becomes due and the Company’s guarantee thereof was to expire in June 2008 and allowed for borrowings up to $2.6 million.  On June 28, 2007, the loan and guarantee were terminated.

The Company has entered into an agreement to guarantee 50% of a $10.0 million line of credit provided to a 50% owned real estate joint venture.  The line of credit becomes due and the Company’s guarantee thereof expires on December 16, 2007.  At June 30, 2007, total borrowings against the line of credit were $10.0 million.

The Company entered into an agreement to guarantee 10% of any amounts between $10.0 million and $20.0 million, and 20% of any amounts thereafter, related to a $48.2 million construction loan to a 50% owned real estate joint venture.  The $48.2 million loan matures on the earlier of the completion of the project or December 31, 2007.  At June 30, 2007, total borrowings on the loan were $31.0 million, resulting in a guarantee of $3.2 million by the Company.

The Company 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 June 30, 2007, total borrowings on the loan were $28.4 million and the Company’s guarantee totaled $1.0 million.

The Company is a 50% partner in a limited purpose real estate joint venture.  The real estate joint venture was formed to develop and lease approximately 1.1 million square feet of office space to the U.S. government.  The project was substantially completed in fourth quarter 2006 and became fully leased in 2007.  The project was financed with $315.4 million of non-recourse insured bonds (issued June 2004) with the remaining funding from equal equity contributions from the Company and its real estate joint venture partner.  At June 30, 2007, the Company and its joint venture partner had each contributed $28.5 million of equity for the project.  The Company and its joint venture partner continue to provide $14.1 million each of an additional equity investment commitment associated with the project.  The Company is responsible for $14.1 million of the letters of credit at June 30, 2007 associated with the equity commitment, which are scheduled to expire through 2008.  At June 30, 2007, there were no outstanding borrowings against the letters of credit.

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 interest 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.

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Guarantees

In addition to the guarantees entered into as mentioned 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 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 warranties and infringement indemnities to the licensee, the terms of which vary depending on the negotiated terms of each respective license agreement, but which generally warrant that such systems will perform in accordance with their specifications. The amount of such obligations is not stated in the lease agreements. The Company’s liability for breach of such warranties may be subject to time and materiality limitations, monetary caps and other conditions and defenses.

From time to time, the Company enters into 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 the following:

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.

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.

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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 June 30, 2007 and December 31, 2006, 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, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.”

10.  New Accounting Standards

Fair Value Measurements

In September 2006, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements” (SFAS 157), which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements.  SFAS 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information.  The Company will be required to adopt this standard in the first quarter of 2008.  Management is currently evaluating the requirements of SFAS 157 and has not yet determined the impact on the consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” (SFAS 159).    SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings.  SFAS 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value.  The Company will be required to adopt this standard in the first quarter of 2008.  Management is currently evaluating the requirements of SFAS 159 and has not yet determined the impact on the consolidated financial statements.

Earnings Per Share

The FASB previously issued an exposure draft on a proposed accounting standard that would amend SFAS No. 128, “Earnings per Share” (“SFAS 128”), to clarify guidance for mandatorily convertible instruments, the treasury stock method, contingently issuable shares, and contracts that may be settled in cash or shares.

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 conversions of its convertible debentures 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, if amended as proposed.  The final statement has yet to be issued.  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, adoption of this statement, as proposed, will require retroactive restatement of the Company’s diluted earnings per share

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calculations subsequent to the issuance of the convertible debentures.  In calculating diluted earnings per share under the revised SFAS 128 “if converted” method included in the exposure draft, the Company would need to increase 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 (less shares already included in diluted earnings per share), the amount of shares that would be issued if all $840 million of convertible debentures would be converted to equity.  Under this “if converted” method, diluted earnings per share would have been $0.94 and $0.70 (versus reported diluted earnings per share of $1.01 and $0.76) for the three months ended June 30, 2007 and 2006, respectively, and $1.77 and $1.78 (versus reported diluted earnings per share of $1.91 and $1.87) for the six months ended June 30, 2007 and 2006, 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 continuing to monitor the FASB’s progress towards finalizing this proposed accounting standard.

The proposed change in accounting principle would affect the calculation of diluted earnings per share during the period the debentures are outstanding, but would 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 estimates based upon the exposure draft in its current form. There may be material differences between these estimates and the actual impact of the standard when issued as final.

11.  Segment Information

The Company’s operating business units offer sophisticated information processing and software services and products. The Company has elected to organize and report on these business units as two operating Segments (Financial Services and Output Solutions). 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.

Included in costs and expenses in the Investments and Other Segment for the three and six months ended June 30, 2007 is a gain of $12.4 million related to the sale of certain real property.

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.  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):