Unisys Corporation
Q4 2007 Earnings Call Transcript

Published: 29 Jan 2008

[Operator:]

Welcome to the Unisys fourth quarter and full year 2007 results conference call. At this time, I would like to turn the conference over to Mr. Jack McHale, Vice President of Investors Relations at Unisys Corporation. Please go ahead, sir.

[Jack McHale:]

Thank you, operator. Hello, everyone, and thank you for joining us this morning. A little while ago, Unisys released its fourth quarter, and full year 2007 financial results. And with us this morning to discuss those results and our repositioning program is our CEO, Joe McGrath; and our CFO, Janet Haugen. Before we begin, I want to cover just a few housekeeping details. First, today's conference call is being webcast by the Unisys Investor website. This webcast is being recorded, and will be available as a replay on our website shortly after the conclusion of the live event. Second, on our Investor website, you can find the earnings release, as well as the presentation slides that we'll be using this morning to guide the discussion. These materials are available for viewing as well as downloading and printing. Third, today's presentation, which is complimentary to the earnings press release, includes some non-GAAP financial measures. Certain financial comparisons made in this call will be without the impact of retirement expense and cost reduction charges. In the presentation, we have provided a reconciliation of our reported results on a US GAAP basis compared with our results, excluding the impact of cost reduction charges and retirement expense. Finally, I'd like to remind you that all forward-looking statements made in this conference call are subject to various risks and uncertainties that could cause actual results to differ materially from expectations. These factors are discussed more fully in the earnings release, and in the company's periodic reports as filed with the SEC. Copies of these SEC reports are available from the SEC and also from the Unisys Investor website. Let me now turn the call over to Joe.

[Joe McGrath:]

Thanks, Jack. Hello, everyone, and welcome to today's call. Over the past two years, Unisys has been implementing an aggressive multiyear program to rebuild our profitability and our competitive position in the IT market. This effort paid off in 2007 with significant growth in our profitability and cash flow. You can see highlights of the quarter for the year on slide 1. We reported fourth quarter operating profit of $136 million, excluding cost reduction charges and retirement expense. That was up 29% from a year ago level, and represents an 8.9% operating profit margin, which is our highest quarterly operating margin in four years. We also generated $247 million in operating cash flow in the quarter, up 48% from the year ago quarter. For the full year of 2008, we reported operating profits of $273 million, excluding cost reduction charges and retirement expense. That's a 91% increase over 2006. Our operating margins for the full year of 2007 came in at 4.8%, excluding cost reduction charges and retirement expense. Janet Haugen will provide details of our financial results. What I'd like to do now is share with you some graphs that highlight just how far we've come financially in the past few years. I will show you graphs from both a GAAP basis and non-GAAP basis, excluding cost reduction charges and retirement-related expenses. Note that we have included reconciliation as backup sides for your review. First, costs. As you know, we have been undergoing a painstaking and ongoing effort to benchmark our operations, reengineer and streamline processes, and reduce our global headcount. Slide 2 shows the progress we made in operating expenses over the 2005 to 2007 time period. This is on a GAAP basis, including cost reduction charges and retirement expenses. Slide 3 shows operating expenses on a non-GAAP basis, excluding these items. As you can see, our SG&A expenses are down $82 million since 2005. As a percentage of revenue, SG&A expenses have declined from 17.7% of revenue in 2005 to 16.6% in 2007. We've also streamlined our R&D expenditures by refocusing our investments. In our technology business, we've shifted our R&D investments toward software and services-based offering, while leveraging the R&D investments of our partner NEC for hardware design and development. As we move from custom CMOS chips to standard Intel chips, this has also reduced our need for R&D investments for chip design. This has enabled us to reduce our overall R&D expenditures, while effectively allowing us to get the value of a much larger R&D investment pool through our partners. Overall, we've reduced R&D expenses by $86 million or about 36% since 2005. As a percentage of revenue, R&D is now 2.7% of revenue compared to 4.2% of revenue in 2005. Moving to slide 4, we've also significantly reduced our retirement-related cost. Coming into 2005, the company had highly volatile and unpredictable expense levels for our US Defined Benefit Pension Plan. We made the tough decision to end future accruals into this plan and increase contributions to our US 401(k) plan. Retirement-related expenses hit a peak of $200 million in 2005. And through the actions we've taken, this expense declined to $82 million in 2007. We anticipate total retirement related expense to go to a net zero in 2008 as our US 401(k) retirement expense is offset by incomes from our pension plans. We've also transformed our workforce and labor costs through this repositioning effort. In our services business, which is now 86% of our overall revenue, labor costs are the largest cost category. Coming into the repositioning, our labor costs were too high. We've had too many people in high-cost countries, and we were behind our competitors in terms of shifting delivery resources to lower cost locations, and taking advantage of strong technical resources available in such locations as India. This was making us uncompetitive in the market. We have to bring down our workforce levels, while also changing the mix of our delivery resources. We have to make this transition with minimal impact on our revenue and our client service delivery levels. Since this has been the biggest single change we've implemented in the company over the past two years, it has been a massive effort, implemented quickly and aggressively, and it hasn't gone perfectly, but we've made tremendous progress. Slide 5 shows where we've come in this program. Since the beginning of 2006, we've announced approximately 7,400 headcount reductions as part of the repositioning effort. As of the end of 2007, we have completed 6,700 of those reductions and reduced our workforce about 70% over 2005 level. The bulk of the restructuring is now behind us and we go forward today with about 29,900 employees. At the same time that we've reduced our headcount in high-cost regions, we have moved aggressively to build out our offshore delivery resources. We set a goal of having about 6,000 resources based primarily in India, China and Eastern Europe by the end of 2008. We created new global sourcing centers in these countries and have rapidly build out our resources there. In 2005, we had about 1,500 offshore workers, including partner resources in these countries. From that base, we have build out our offshore works to about 4,200 Unisys and partner resources as of the end of 2007. We expect to add about 1,800 resources in offshore regions in 2008. That would put us above our target of 6,000 total resources in low-cost countries by the end of this year. To maintain client service delivery levels, some of our countries in practices have had to use temporary contract labor as they transition work from restructured employee. We are still working through that process, but we are making progress in completing the reengineering of processes, and eliminating the added cost of these contractor resources. We took out about half of the added contractor cost in the fourth quarter, and expect to eliminate the rest by the end of the first quarter. As a result of all these work, our operating profit margins have improved dramatically over the past two years. Slide 6 shows our profit progress on a GAAP basis since 2005. On slide 7, on a non-GAAP basis, excluding cost reduction charges and retirement expense, our operating income grew from $38 million in 2005, to $273 million in 2007, a $235 million improvement. As a percentage of revenue, we moved from 0.7% operating margin in 2005 to 4.8% operating margin in 2007. That's an improvement of 410 basis points. This profit improvement has been driven by progress in our services business, which represents today about 86% of our revenue. Entering the repositioning program, our services business was losing money. We essentially had to rebuild this business from the ground up, refocusing our strategy, our portfolio and our delivery structure, and enhancing the profitability of our business process outsourcing operation. While we still have much work to do, the progress we've made in just two years has been remarkable. Slide 8 shows operating profit in our services business on a GAAP basis since 2005. Turn to slide 9 for a view of services operating profit, excluding cost reduction charges and retirement expense. As you can see, we've moved from a $41 million operating loss in 2005 to $195 million operating profit in 2007, a $236 million improvement. Over the same period, services operating margins have increased 490 basis points from a negative 0.9 margin in 2005 to 4% for the full year of 2007. Another gauge of our profit progress is EBITDA. Slide 10 shows EBITDA over the 2005 to 2007 timeframe. This excludes cost reduction charges. As you can see, our EBITDA has grown from $212 million or 3.7% of revenue in 2005 to $571 million or 10.1% of revenue in 2007. That's a $359 million improvement over a three-year period. This is significant progress. We are doing what we set out to do with this turnaround; to transform the profitability of this company, and create a foundation for growth. The progress is real, it's tangible, and it's substantial. I am proud of the tremendous effort and hard work shown by the employees of this company. Our biggest disappointment is that our progress is not reflected in our stock price. I would just like to state clearly to all of you that the number one priority of our Board of Directors and management team is to enhance shareholder value. And we believe the stock is substantially undervalued. It is quite frustrating to us and to all Unisys employees who have worked so hard on this transformation effort, to see our progress not be rewarded in the stock price. Janet and I have had conversation with many of you in recent months about the decline of the stock. In addition, as I am sure you know, one of our investors, MMI Investments, has requested that the Unisys Board of Directors consider strategic alternative to enhance shareholder value. As we announced last week, we have postponed the deadline for Director Nominations and shareholder proposal in connection with the Annual Meeting. The Unisys Board believes this will facilitate discussions with MMI. We are not in position this morning, to comment on discussions with MMI, and we will not comment further on this topic on this morning's call. I would like to reiterate, however, that the Board and management team have considered and will continue to consider alternative for enhancing shareholder value and improving the company's performance. We are listening, we hear your concerns, and we are taking them into consideration. Particularly, given the volatility of the financial market, our focus right now is on driving the business, completing the third-year of our repositioning and building on the great financial improvement we have made over the past two years. Our primary objective during this turnaround has been to create a profitable foundation on which to grow this company going forward. Now that we've made significant progress on building this foundation, we are accelerating our focus on growth as we continue to drive for higher profit margins. Over the past two years we would be doing a great deal of work to establish our strategic growth program and rebuild our growth engine. While our total revenue has been down modestly over the past couple of years, there is an important mix change occurring within our revenue base. Slide 11 shows our strategic program. Our growth businesses as you know, our enterprise security, outsourcing open source solutions, Microsoft solutions and real time infrastructure solutions. Outsourcing is our biggest strategic program. In 2007, our outsourcing business grew 6% and is now more than $2 billion. Our other strategic programs, in particularly our enterprise security practice, grew even more in 2007. Collectively, the strategic growth businesses grew about 10% in 2007. At the same time, other areas of our portfolio are becoming smaller pieces of the total, either because of secular industry trend or because we are deliberately stepping away from business that is not attracted to us. ClearPath, and the associated core maintenance revenue, continue to be critical areas of our portfolio, but they are declining securely. We've had a solid year in 2007 in our ClearPath program and we are doing a good job of slowing declines in ClearPath and core maintenance. But these proprietary businesses will continue to decline for us and for the industry as a whole as a percentage of the total. We’re also deliberately stepping away from certain businesses that don’t meet our growth and margin profile. These businesses, including deemphasized solutions, and programs in our systems integration business, low margin project work in infrastructure services and non-strategic specialized technology revenue in our technology business. Currently, the declining areas of the business are keeping our overall revenue line from growing, but as our strategic programs continue to grow we expect that trend to reverse itself. More importantly, as this begins to happen, we believe there is great operating leverage in our margins as we begin to grow our revenue base on a more efficient stream lined cost structure. As we move into 2008 we believe there are a number of key drivers that will enable us to accelerate the success and growth of these strategic programs. You can see these four drivers summarized in slide 12. The first driver is the refreshed portfolio. Over the past two years we've refocused and enhanced our portfolio offerings in every one of our businesses in outsourcing, in systems integration and consulting, in our industry specific programs, and in our technology business. We've developed new more relevant solutions based on our strategic programs. I discussed some of these new solutions on recent earnings calls. Our next generation offerings for airline passenger reservations, for electronic payments, for Medicaid claims processing, for communication messaging and others. These solutions are based on leading edge software development environments such as J2EE, .Net and Open Source software and they deliver breakthrough price performance in their market segments. As we continue to gain traction selling these solutions we expect to build on that momentum in the year ahead. The second key driver in the changes we've made is in our sales and go-to-market approach. To increase the effectiveness of our sales team we focused their efforts on growing our business with our top 500 accounts around the world. We're seeing good results in this effort as well, in fact our top 50 targeted accounts will replace a great deal of focus, our revenue was up high single digits in 2007. The third key driver is related to our focus on large accounts. We are rolling out a major initiative to drive success in winning large mega deals with our targeted top 500 accounts. It takes nearly as much sales effort to win us $3 million deal as it takes to win a $30 million or $50 million and the $30 million deal will do more to move the needle for our revenue and margin. In 2007, we recruited and put in place a highly experienced team of sales leaders to pursue large outsourcing mega deals in the UK and continental Europe. They are individuals with an average of more than 15 years experience who came from the likes of Accenture, IBM, EDS and Hewlett-Packard. The mega deal team is responsible for identifying opportunities early in the life cycle, communicating with the client, building a win strategy, and putting together the right team to win and deliver on the deal. Before we submit a bid, we do an exhaustive process of challenging ourselves in our proposals from our competitors' eyes and making changes to sharpen our competitive edge. Well, we've already seen some of the success in UK and Europe with this mega deal approach. It was critical for example in our winning a very large new outsourcing client with Ciba Specialty Chemicals. In fact, our outsourcing orders in the UK and Europe grew double-digits in 2007 and 30% in the fourth quarter of 2007. In the number of large deals over $30 million in our pipeline worldwide has grown more than 25% from a year ago. We are now rolling out a similar mega deal team in the US and we are looking for good success here as well. Overall, in our strategic programs, we've seen close to 20% growth in our pipeline in 2007. The strategic areas that we are seeing the most growth and success are in outsourcing and enterprise security. Slide 13, shows the selected new client logos that we signed in our outsourcing business in 2007. These include such leading organizations as Ciba, the Idaho Department of Health & Welfare, Diamond Trading Company, ELOPAK, Elekta and Linklaters. We've also recently been selected by the State of Maine for a new Medicaid processing contract that we are working to finalize. Turning to slide 14, in the area of enterprise security in 2007, we won major security contracts from the US Department of Defense, and the Canadian Port of Halifax. We also were awarded the final year of our Bridge contract with the Transportation Security Administration for continued support of TSA's airport and transportation security mission. Earlier this month, Unisys received a task order worth up to $62 million from the US Customs and Border Protection organization, to design and implement a leading edge solution using RFID technology to help identify travelers at 39 ports of entry along the US borders. Unisys is also part of a team of companies led by DGM-Sistemas that was recently rewarded an estimated $400 million contract from the government of Angola for a national identification card system. We're currently working to close our subcontract with the prime contractor. Turning to slide 15, the fourth key driver to building our momentum in 2008 is leadership. We continue to strengthen our management team to ensure we've the right leadership that we need to drive success and growth in our strategic areas. Over the past seven months, we've changed the leadership of three of our business units at Unisys. At the beginning of this year, we moved Randy Hendricks to run our global industry business unit. As the leader of our outsourcing business in recent years, Randy has grown our outsourcing business to our single largest services business. With global industries, he will now lead the business in which we provide systems integration and consulting services through industry-led practices. It's a natural fit for Randy, since before coming to Unisys in 2001 he was a managing partner at Anderson Consulting, where he had a 20-year-career in this consulting area. I am confident that Randy will be instrumental in tuning around our systems integration and consulting business and returning it to growth. We've also brought in Tony Doye from Computer Sciences Corporation to run our global outsourcing and infrastructure services business. Tony was previously a Group President at CFC, where he held a number of leadership roles in IT services, IT outsourcing, application outsourcing and consulting services. Over his 30 year career in the IT industry he has managed global businesses not just with CFC, but also at IBM and British Telecom. Tony has a long and impressive track record of growth; he is also spearheading the mega deal initiative that I just discussed. We are fortunate to have him join our management team, and to lead our outsourcing and infrastructure services businesses. Randy and Tony complement Rich Marcello who as you recall joined us earlier in 2007 from Hewlett-Packard to mange our systems and technology businesses. Over the past seven months, Rich has done exciting and groundbreaking work in creating a new virtualization software and services based strategy for our technology business. Rich has rebuilt his entire leadership team from product planning to sales leadership. These changes are already having an impact on the technology business as seen in our strong fourth quarter results. As we push these four drivers of growth; refresh portfolio, concentrated sales approach, mega deal initiative and new leadership, we look forward to continued momentum in our financial progress in 2008. And we look for our revenue to begin growing as we move towards the second half of the year. In the mean time, as Janet will discuss in her remarks we will continue to streamline operations, reduce costs and enhance the profitability of our businesses and operations. As we do this, we continue to expect to achieve an 8% to 10% operating profit margin for the second half of 2008. This would give Unisys a strong financial foundation on which to continue building our business in years ahead. So, in summary turning to slide 16. As we move into 2008 the final lag of repositioning program, I believe that Unisys is better positioned than we have been in many years. Our profitability is at the highest it has been since 2003. Our margins are steadily improving and expenses continue to comedown. We are on track to have about 6000 resources in low costs countries by the end of 2008, an effort that is making us more competitive. We are winning new client accounts and we’re accelerating our focus on growth. We are investing in growing our strategic programs, and our top 500 accounts and we believe this is the year when these efforts enable us to begin to drive the top line. As can be expected, with a turnaround of this complexity, there have been bumps in the road. We continue to have issues that we must deal with, and we are frustrated as you are that our progress is not being recognized in our stock price. But we are confident that we are on the right path, and that we continue to delivered tangible results, and as we deliver those results, our efforts will be rewarded in terms of shareholder value. Thank you again for joining us this morning. Now I will turn the call over to Janet for a more in-depth review of our financial. Janet?

[Janet Haugen:]

Thank you, Joe and hello everyone. This morning I'll provide more details on our fourth quarter and full year 2007 financial results, including cash flow. I will also discuss CapEx expectations for 2008. To begin with the fourth quarter financial performance, please turn to slide 17. At the top line we reported revenue of $1.54 billion for the fourth quarter of 2007. This was down 1% from the year ago quarter. Currency had a 5 percentage point positive impact on our revenue in the quarter. Our fourth quarter results include $55 million in net charges related to our ongoing cost reduction program. The charge includes the cost related to the consolidation of 46 facilities and cost for approximately 220 workforce reductions. These headcount reductions are primarily in our technology business in North America. We expect these actions, facilities, consolidation and the headcount reduction to generate $20 million in savings in 2008, and $40 million in savings on a run-rate basis. Our fourth quarter results also included $11.6 million of pre-tax retirement related expense, compared with $47.6 million a year ago. Including the cost reduction charge and retirement related expense we reported fourth quarter 2007 operating income of $69.4 million. This compares with the fourth quarter 2006 operating income of $68.6 million which included a $10 million benefit from a change in estimate on previously recorded restructuring charges. After tax expense, we reported fourth quarter 2007 net income of $13.8 million or $0.04 per share. By comparison in the year ago quarter we reported net income of $21.3 million or $0.06 per share. We ended 2007 with $6.9 billion of firm services backlog, this was up 4% from year-end 2006 services backlog. Approximately 45% of this backlog is anticipated to convert into revenue in 2008. Going forward, we will provide services backlog information every quarter. In the back of this presentation slides, we have also provided supplemental slides showing details on cost reduction charges and retirement related expense for the quarter and the year. Turning now to revenue, please turn to slide 18 for an overview of our fourth quarter revenue by geography. Our US revenue represented 41% of our revenue and declined 4% in the quarter driven by a decline in our federal business. International revenue accounted for 59% of our overall revenue in the fourth quarter and grew 1% in the quarter. We saw growth in Latin America, partially offset by declines in Europe. On a constant currency basis international revenue declined to 8% in the quarter. Slide 19, shows our fourth quarter revenue by business segment. We had a strong quarter in the technology business in the fourth quarter. Our technology revenue grew 6% and represented 70% of our revenue in the quarter. Services revenue declined 2% in the quarter and represented 83% of our fourth quarter revenue. For more details on our services revenue please turn to slide 20. Within services we saw good growth in our outsourcing business, which grew 9% in the quarter. The growth in outsourcing was more than offset by an 18% decline in infrastructure services revenue as we continue to see a shift of project-based work to managed services outsourcing contracts, and the emphasis of our non-strategic business. We expect infrastructure services to continue to decline in the first half of 2008. Our systems integration and consulting revenue declined 4% in the quarter and core maintenance revenue declined 10%. Turning to slide 21, in our technology business, we had a strong quarter in our ClearPath business, driven by a number of large client system upgrade. The ClearPath revenue showed double-digit growth in quarter driven by strength internationally. Overall, enterprise server revenue was up 13% in quarter and represented 88% of our technology revenue this quarter. Turning now for the full year, you can see the highlights of 2007 result on slide 22. Our revenue in 2007 declined 2% as we continue to deemphasize non-strategic areas of our business and focus on enhancing our profitability. During 2007, we recorded net cost reduction charges of $105 million compared with net cost reduction charges of about $316 million in the full year of 2006. Our retirement-related expenses declined to $82 million in 2007 compared to $154 million in 2006, reflecting significantly lower US pension expense. Including retirement related expense and the cost reduction charges; we reported operating income of $86 million in 2007 compared to an operating loss of $327 million in the full year of 2006. Other income in 2006 included the $150 million gain on the sale of our NUL shares. On a net basis after tax expense we reported full year 2007 loss of $79.1 million or $0.23 per share, this compares with a full year 2006 net loss of $278.7 million or $0.81 per share. Slide 23, shows our full year 2007 revenue by geography. Our US revenue declined 4% in 2007, and represented 43% of our revenues for the full year. Revenues from federal agencies declined 3% for the full year of 2007. International revenue was flat in 2007, and accounted for 57% of our full year revenue. Within international markets, we saw revenue growth in Latin America and Asia Pacific region. This was offset by double-digit revenue decline in Japan, and a low single-digit decline in Europe. On a constant currency basis, international revenue declined 7% in 2007. Slide 24 shows our full year 2007 revenue by business segment. Services revenue declined 1% in 2007 and represented 86% of total revenues for the year. Technology revenue declined 4% in 2007 and accounted for 14% of our revenue this year. Drilling down into our two business segments, slide 25 shows our full year 2007 services revenue by components. Outsourcing revenue grew 6% in 2007, and accounted for 42% of our services revenue for the full year. Systems integration and consulting revenues declined 6%, and represented 31% of services revenue. Infrastructure services revenue declined 7% in 2007, and represented 18% of our services revenue. Finally, core maintenance revenue declined 8% in 2007, and accounted for 9% of our services revenues for the full year. Slide 26 breaks down revenue in our technology segment in 2007. Enterprise server revenue declined 3% in 2007, and accounted for 80% of technology revenue for the full year. Within enterprise servers, ClearPath revenue was flat for the full year of 2007, while ES7000 server revenue showed a double-digit revenue decline. Now coming on expenses, as Joe discussed, the progress we are making in our ongoing program to reduce our operating expenses by streamlining our operation, we are making progress in reducing our third-party contractor spending. As we said last quarter, we are seeing about $20 million of extra cost from third-party contractors on a quarterly basis in the third quarter of 2007. In the fourth quarter, we reduced that to about $10 million, and we expect to get the remaining $10 million out in the first quarter and put this issue behind us. We are continuing benchmarking our operations as well, and identifying opportunities for further cost reductions. For instance, reflecting our increasing lean mobile services workforce as well as headcount reductions, we continue to consolidate facility space in our operations globally. As I mentioned earlier, we took actions to close or consolidate space at some 46 facilities around the world. As a result of this overall program for facilities reductions, we have been able to reduce facilities expense from roughly 4% of revenue in 2005, to 2.6% going forward, even while we have been making investments in our strategic program areas, such as new centers of excellence and new outsourcing data center. We also continue to look for areas for further cost reductions, such as simplifying our geographic management and infrastructure cost as we did recently in our Latin America operations, and we are extending that approach into Continental Europe. Moving on, please turn to slide 27 for a view of our services and technology segment margins in the fourth quarter. As a reminder, Unisys has a longstanding policy of evaluating business segment performance on operating income, exclusive of cost reduction charges and unusual nonrecurring items. Therefore, these segment results include such items. On a non-GAAP basis, which excludes retirement relating expenses, services gross margins improved to 20.3% in the fourth quarter, a 19 basis points improvement over the year ago period. Services operating margins improved 110 basis points to 5.4% from 4.3% a year ago. In technology, gross and operating margins also showed substantial improvement in the fourth quarter from year ago level. This reflected the strong mix of ClearPath sales in the quarter. Slide 28 shows segment margins by business segment for the full year of 2007. On a non-GAAP basis, excluding retirement-related expense, services gross profit margins improved to 18.7% for the full year of 2007, up 140 basis points year-over-year. Services operating profit margin on this basis improved to 4%, 170 basis points improvement from 2006. In the technology business, both gross and operating profit margins improved on a full year basis over 2006. These margin improvements reflected a richer mix of ClearPath sales, as well as continued reduction in operating expenses. Now, please turn to slide 29 for an overview of our cash flow in the fourth quarter of 2007. We had a good quarter in terms of cash flow. We generated $247 million of cash from operations in the quarter compared with $167 million in the fourth quarter of 2006. We used approximately $28 million in cash for restructuring payments compared to $88 million in the fourth quarter of 2006. For the full year of 2007, we used $152 million of cash for restructuring payments, and we expect to use about $60 million of cash for restructuring in 2008. Total capital expenditures were $71 million for the fourth quarter and $300 million for the full year. We've discussed previously CapEx increased in 2007 from the 2006 levels due to higher expenditures on new outsourcing projects. After deducting capital expenditures, we generated $176 million of free cash flow in the fourth quarter of 2007 compared to free cash flow of $109 million in the year ago quarter. Depreciation and amortization was $104 million in the fourth quarter of 2007 and $381 million for the full year. Looking ahead for the full year of 2008, we anticipate capital expenditures of around $300 million and depreciation and amortization in the $360 million to $380 million range. Lastly, I would like to comment on the debt refinancing that we completed in December. We issued $210 million of senior notes to refinance $200 million of 7 7/8% notes that were coming due in April 2008. As a condition of our revolving credit agreement, these notes needed to be refinanced by December 31. While we considered a number of alternative beyond straight debt, including equity-linked debt, we determined that based upon the stock performance at that time and the capital market, the most appropriate approach was to use straight debt at the lowest amounts that we needed to refinance the debt. These new notes were priced to yield 12.75%, which reflected the credit market at that time. The old notes were redeemed on January 11 of 2008. Our cash balance of $830 million at December 31, 2007 included the proceeds of this note offering. We have since redeemed the 7 7/8% notes on January 11, 2008. This concludes my comments for this morning. And now, I'd like to turn the call over to Jack.

[Jack McHale:]

Well, thank you, Janet, and thank you, Joe. Operator, we'd now like to open the call up for questions, please.

[Operator:]

Thank you. (Operator Instructions) We'll take our first question from Julie Santoriello with Morgan Stanley.

[Julie Santoriello:]

Thanks, good morning. Joe, could you comment a bit on 2008 expectations for revenue growth. I believe in your comments you sort of alluded to expectation for an improvement, and showed revenue growth in the second half of 08. So can you give us an idea of what you are looking at for the full year? I realize the services backlog was up 4%, which is a good leading indicator, but then coming into 2007 the backlog was actually up, but it didn’t follow through in revenue for the year, I guess because short-term projects were declining?

[Joe McGrath:]

First of all let me give you a kind of a disclaimer, Julie. We went back to our board as a number of you have asked to see if we could give guidance for 2008. And a number of you on the call have specifically asked us to see if we could work through that since the belief is that, at the two year point of a three year transition period, we should be in a position to start to do that. And so we heard everyone's feedback, we discussed it with our board and frankly the feedback they gave us was that this moment in time, considering the volatile economic environment, and a possible recession, it will be the wrong time to begin to give guidance. Now, we discussed further if we could revisit this at the end of the first quarter, and the answer was, yes. That said, what we put in our comments here was soft and we knew that. But we are really not prepared to go any further than we did. I will tell you the reason that we emphasized so much on the second part of my call, on the changes we are making in the System Integration business and it's turnaround, because as you know that’s been somewhat problematic for us. We think we'll have a big impact, positive impact in 2008, starting from leadership through finally having a world-class portfolio across that entire business. We actually have a simplified structure that we've put into place the 1st of the year, and we believe almost all of our solutions have leading price performance. So frankly, that has been a growth drag on us and we believe that’s turning and that’s extremely important. As you know the outsourcing business continue to grow, you heard those comments we actually believe that with the addition of mega deal teams in the United States, in addition to what we've already been doing in Europe that can start to really grow the North America outsourcing business fasters as well. But unfortunately, the guidance that we gave you in revenue growth is about as far we can go.

[Julie Santoriello:]

Okay. You had a very good quarter in the ClearPath, congratulations on that and that carried through nicely to cash flow. If we run numbers through our model, and then assume that you can hit those expectations for 8% to 10% margins in the second half of the year. It looks like it's shaping up to be a positive free cash flow year for you this year, would be able to agree with that at this point?

[Joe McGrath:]

Well, I am going deferred it to Janet to do some…

[Janet Haugen:]

For others that was Julie there. Obviously, consistent with the policy of the portion that Joe commented, on we can’t give the specific guidance. What I will tell you is consistent with what we have said along this plan to move to the 8% to 10% operating profit in the second half of the year, is consistent with a plan to continue to improve the cash performance of the company. And you are right to recognize the fact that we have a strong ClearPath quarter, but I also want to comment that as you can see in the statement of cash flow, we particularly had good performance across all of our businesses and all of our geographies in improving our DSOs, and that drop through in the AR DSOs, and that drop through to cash flow performance. So, we need to keep that ongoing. But, going into next year with fewer requirements for restructuring payments as I mentioned, we anticipate that to be $60 million in 2008. The continued improvements, which will increase obviously the EBITDA line as we go forward. All of those items with CapEx staying at roughly the same level would obviously yield for improvements going on that free cash flow number for 2008.

[Julie Santoriello:]

Okay, thanks. If I can get just one more question, I found the slides helpful in terms of that the breakout you had for the strategic businesses, and how those have grown. So I definitely appreciate that. And so when we look at overhead your business is growing 10%, the other half by default is declining more than 10%, at what point do we – what point would you expect the other businesses, the areas where the developments that are either in secular decline that you are deemphasizing or exiting, when does that decline begin to slow, stop having such a drag on the total number? And does declining piece of business get down to zero ultimately, or does it get down to just a smaller base from where it is today?

[Joe McGrath:]

Yeah. Let me divide that segment into two segments. There is one part that as you might imagine, ClearPath and core, which is in that top number, as you know it’s in secular decline. That's a business that's strategic to us, but it's not part of that bottom part of the table. And so, even though the industry is in secular decline, that's the part where we've tried to slowdown. At first, we were successful in core maintenance, and you have recently seen the success we were starting to have in the technology business there, in ClearPath and so on. So that part we want to slowdown. Other parts, where we believe the margins are unattractive in part of that infrastructure services business; the margins are unattractive project-based work. I believe now there are still some pass-throughs of things like Cisco hardware and third-party hardware in that. We're trying to continue to further consciously exit that. And so, think of the two sections as; one we want to slowdown, even though we know it's in secular decline; and the other one, we have mixed feelings on how fast we take it out, because, obviously, people have looked at our revenue picture and would love to see us at least in a modest increase. So, we are torn a bit there, but we do want to get all of that third party equipment of small project, lower margin workout overtime and eventually that piece, Julie, we actually would like to get to zero. In there, there was, if you remember when we talked on previous calls about, what I called non-strategic SI solutions were in there, non-core development environment work, meaning J2EE, not dotcom but older development environment. So, on a theoretical basis we would love to get that to zero, but not the other part of it which is ClearPath and core.

[Julie Santoriello:]

Thanks. Got it. Thank you very much.

[Joe Mcgrath:]

Great.

[Operator:]

Our next question is from Jason Kupferberg with UBS.

[Jason Kupferberg:]

Good morning, guys.

[Joe Mcgrath:]

Good morning.

[Jason Kupferberg:]

Just given the comments that you guys made about your disappoint in the stock price and the fact that the shares are undervalued, in your opinion you just posted your strongest cash flow quarter in I think four years or so. Why not consider a share buyback program? Is that been discussed with the board?

[Janet Haugen:]

Jason, on the consideration of the stock buyback program, as part of Joe's comment he said that the board and continues, the board and management continue to evaluate all strategic alternative. At this point in time, it's been considered, but there are no current plans for a stock buyback. As we continue to proceed going forward, the stock buyback along with other alternatives would continue to be evaluated. Our thoughts right now are that given that we may potentially be going into a soft economic environment, and given that we have kept the capital expenditures at $300 million. I would tell you that right now based upon today's environment right now it's not something that we are considering to do in the very near term. But as with anything, we will continue to evaluate those alternatives and if the time is right and it's appropriate for that we would consider it.

[Jason Kupferberg:]

Are there any limitations in the new bonds that would prevent you from doing that?

[Janet Haugen:]

For us there are limitations on that. One of the things that we are trying to make sure we balance is that we are working towards trying to improve the rating agencies; the current rating agencies currently have this on a negative outlook. That is a consideration that goes into that. Generally, stock buyback with the cash we have on hand, at our credit rating, are generally not favorably viewed by the rating agencies. So, that is the primary consideration that we consider at this point in time.

[Jason Kupferberg:]

Okay. Let me shift to margins for a minute, though we are sticking with the 8% to 10% target for second half '08, that's the one piece of guidance you are giving us. My model suggests you did about 6.9% in the second half of 07 on an apples-to-apples basis, so to get to the midpoint of 8% to 10% it's about a couple of hundred basis points still to go. Can you breakdown for us what the key moving parts or factors are that will get you from second half of '07 to second half '08?

[Janet Haugen:]

Sure Jason. This is Janet. I will take that from high level. Obviously, as we go into '08, we will have the continued pressure from the declining revenue streams of the ClearPath and the core maintenance. In addition, as you know Jason, we don't have the royalty we received from NUL on March 31st effectively of 2008. So, we have that type of headwind coming into the year. Offsetting that, first at the cost line we have the continuing benefit from the restructuring actions that we have taken already. There will be continued -- this year, in 2007 we don't have a full year impact for those restructuring actions that will go forward. We will also have the benefit of the savings coming from the charges that we announced this quarter. So the biggest driver for us on a sequential perspective is coming from the restructuring cost savings. That being said, as Joe mentioned in his comments, as we continue to improve the strategic program and our cost base is in line, we do expect to get incremental benefit from that growth at higher than our normal rate of margins given that the cost base structure is in place.

[Jason Kupferberg:]

Okay. And last question on topline, strategic programs grew 10% in '07 is that general range sustainable in '08 given the new sales focus?

[Joe Mcgrath:]

Yeah, I obviously would love to see it increase in '08. So at a minimum we believe it's sustainable and longer term we believe we can accelerate that growth rate.

[Jason Kupferberg:]

Okay. So sustainable in '08 at a 10%.

[Joe Mcgrath:]

Yeah.

[Jason Kupferberg:]

Thank you.

[Operator:]

Our next question is from Susan Chen with Merrill Lynch.

[Susan Chen:]

Thank you. This quarter has done very good operating cash flow, things were held by [sales] from the DSO. It seems that improved DSO about 7 days to 8 days versus last quarter. My question is, is that a one time improvement by year end collection or do you see this trend going forward to next year?

[Janet Haugen:]

If you look historically at our financial statement, typically between the third and the fourth quarter, we see generally in the neighborhood of about 3 days DSO improvement on a sequential basis. You saw double that this quarter. And we probably won't be able to hold all of that improvement, because it does get the benefit of some of the ClearPath transactions in the quarter. But those three additional days, three days is seasonal – three days is additional above our prior performance, we’re going to put emphasis throughout the business to try to retain that three day improvement as we go through our 2008.

[Susan Chen:]

Again, also what should the tax rate ratio, what the tax rate we should look for 2008?

[Janet Haugen:]

The tax rate in 2008, unfortunately given the fact that we’re in a situation where given the period of losses that we had, we no longer have a deferred tax asset on our balance sheet. Our tax rate varies from year-to-year depending upon the geographic mix of our income, 50% of our entities; we do provide a provision or a benefit for the result, the other we do not just as a result of US GAAP. From a structural standpoint, we believe our tax rate is a 34% is still in place. If you were normalizing it over the time period, but unfortunately to give guidance on that tax rate at this point in time going into the year is next to impossible to do, because we don’t know the countries and legalities where all the transactions will take place.

[Susan Chen:]

Thank you.

[Operator:]

We do have time for one more question. Our final question comes from Eric Boyer with Wachovia.

[Eric Boyer:]

Hi thanks. Just, you talked about the federal business I believe you are having a decline of 3% year-over-year, if you just give a little more detail on that business?

[Joe McGrath:]

Yeah. As you see in the 10-K, that business is about a $900 million business. It has declined 3% since 2006. That decline is largely in the defense segment. We’ve three segments that began the year as roughly equal. One was Homeland Security, one was Defense, and one was Civilian. Homeland Security and Civilian had good years. Defense was a challenge for us. Part of that was, because the Department of Defense redirected funds towards the war effort, and the decline of defense offset the growth of the other two segments. So you can imagine what a challenge it was for us. And so, we believe that the worse is over for us in defense, those other two businesses can continue to increase and I'd like to believe that '08 can be a strong year for us.

[Eric Boyer:]

Could you just give us an update on the TSA contract, where does the re-bid status stand on that?

[Joe McGrath:]

Yeah. The expectation is TSA EAGLE is to be re-bid in the first half of 2008, but it's uncertain precisely when that will come back out. So that's where we are, and we're currently on the bridge contract.

[Eric Boyer:]

And the contract runs through '08?

[Joe McGrath:]

Yes.

[Eric Boyer:]

And finally, what percentage of --

[Joe McGrath:]

One other thing on that if you don't mind. We believe we're in a very strong position in the re-compete there as well. So I think we're doing all the right things. There is a temptation when you have been incumbent, to not work as hard for business you already have, and we’ve made sure we put a very strong team in place to re-compete that.

[Eric Boyer:]

I don't know if you went over this, but what percentage of your services backlog is part of your strategic initiatives revenue stream?

[Janet Haugen:]

We do not disclose that what we said was that we disclosed the numbers that we disclose whether its services backlog and that 40%, roughly 45% of that expected to be build in the next 12 months given that most of the non-strategic programs are shorter term based projects. The backlog is disproportionately stronger towards outsourcing, and so it's predominantly more than a majority, it's predominantly based in the strategic program offering.

[Eric Boyer:]

All right. Thank you.

[Operator:]

That does conclude our question and answer session. Mr. McHale, I will turn the conference back to you for any additional or closing comments.

[Joe Mcgrath:]

Yeah, this is actually Joe Mcgrath. Thank you for your support through this transition as you've heard from us. We share your feeling about our stock and being undervalued in the marketplace. And what you really see is look in the next few days you will see a commitment from the senior team in support of our confidence. So, watch this space. Thanks.

[Operator:]

This does conclude today's conference call. Thank you for your participation. You may disconnect at this time.