Unisys Corporation
Q2 2016 Earnings Call Transcript

Published: 27 Jul 2016

[Operator:]

Good day, and welcome to the Unisys Second Quarter 2016 Results Conference Call. At this time, I'd like to turn the conference over to Ms. Courtney Holben, Vice President of Investor Relations at Unisys Corporation. Please go ahead.

[Courtney Holben:]

Thank you, operator. Good afternoon, everyone. This is Courtney Holben speaking, VP of Investor Relations for Unisys. Thank you for joining us. Earlier today, Unisys released its second quarter 2016 financial results. With us this afternoon to discuss our results are Peter Altabef, our President and CEO; Janet Haugen, our CFO; and Inder Singh, our Chief Marketing and Strategy Officer. Before we begin, I'd like to cover a few details. First, today's conference call and the Q&A session are being webcast via the Unisys' investor website. Second, you can find the earnings press release and the presentation slides that we will be using this afternoon to guide our discussion on our investor website. Third, today's presentation, which is complementary to the earnings press release, includes some non-GAAP financial measures. The non-GAAP measures have been reconciled to the related GAAP measures, and we've provided reconciliations with the presentation. Although appropriate under Generally Accepted Accounting Principles, or GAAP, the company's results reflect changes that the company believes are not indicative of its ongoing operations and that can make its profitability and liquidity results difficult to compare to prior periods, anticipated future periods or to its competitors' results. These items consist of pension and restructuring costs. Management believes each of these items can distort the visibility of trends associated with the company's ongoing performance. Management also believes that the evaluation of the company's financial performance can be enhanced by use of supplemental presentation of its results that exclude the impact of these items in order to enhance consistency and comparativeness with prior or future period results. The following measures are often provided and utilized by the company's management, analysts and investors to enhance comparability of year-over-year results, as well as to compare results to other companies in our industries, non-GAAP operating expenses, non-GAAP operating profit, non-GAAP diluted earnings per share, free cash flow and adjusted free cash flow, EBITDA and adjusted EBITDA and constant currency. From time-to-time, Unisys may provide specific guidance regarding its expected future financial performance. Such guidance is effective only on the date given. Unisys generally will not update, reaffirm or otherwise comment on any prior guidance except as Unisys deems necessary and then only in a manner that complies with Regulation FD. And finally, I'd like to remind you that all forward-looking statements made during this conference call are subject to various risks and uncertainties that could cause the actual results to differ materially from our expectations. These factors are discussed more fully in the earnings release and in the company's SEC filings. Copies of those SEC reports are available from the SEC and from the Unisys' investor website. And now, I'd like to turn the call over to Peter.

[Peter A. Altabef:]

Thank you, Courtney, and welcome to the company in your new role. Thank you, all, for joining us today to discuss our second quarter financial performance. Our results for the quarter demonstrated continued progress toward our objectives this year of improved profitability and cash flow. Our non-GAAP operating profit margin for the quarter was 11%, which represents an increase of approximately 700 basis points year-over-year. Additionally, we continue to see significant improvements in our cash flow with a $76 million increase to free cash flow from $1 million for the quarter last year. Adjusted free cash flow for the quarter was $54 million, which is a $79 million year-over-year improvement. Some of the key business themes that we saw this quarter that help drive these results were strong performance from our technology business, substantial growth in our financial services vertical and in our Asia-Pacific region. As I will discuss further shortly, our services business is still evolving and we continue to make progress on that front. We will also continue to make progress on our goal of improving our cost structure, which has been one of the key drivers in our increased profitability and improving cash flow story. As we previously discussed, we ended 2015 having achieved $100 million of annualized cost savings and added to that in the first quarter of 2016 with an incremental $25 million. This quarter, we achieved another $30 million, largely driven by further reductions in G&A expenses, which takes our total to-date of achieved annualized cost savings to $155 million. This represents continued progress in delivering on our overall cost reduction initiative plans, and we remain on target with respect to achieving our goal of $200 million of annualized savings by the end of this year, with another $30 million possible in 2017. We were pleased with our top line performance this quarter, with revenue being down less than 1% on a constant currency basis. Lastly, non-GAAP diluted earnings per share were positive this quarter at $0.81, marking a significant improvement versus $0.33 in the second quarter of 2015. On the services side of the business, revenue for the quarter declined 6% on a constant currency basis, principally due to weakness in the cloud and infrastructure services business. The gross margins for the services business at 16.8% on a reported basis were up 110 basis points versus the second quarter last year, but still below where we had anticipated. We are continuing to invest in the transition of our business to more profitable industry relevant offerings with more advisory and consultative skills. We are also working to optimize and leverage the value of our strategic partnerships such as those with Dell, EMC, Amazon and Microsoft. In terms of sales activity, total contract value, or TCV, which represents the total value of contracts signed over their expected lifetime in the second quarter was up slightly over the prior year at $807 million versus $805 million in the second quarter of 2015. As we look at the pipeline for the second half of the year, we are roughly flat to where we were at this time last year. We continue to execute on better aligning our sales team and client executives along industry lines to improve our go-to-market effectiveness. Our technology business had a very strong quarter, with total revenue of $135 million which was an increase of 31% on a year-over-year basis, largely driven by strong sales of our ClearPath Forward line. We continue to focus on new logos, extensions and expansions of existing business, all on a profitable basis. As we have shared with you previously, we have begun taking a more rigorous approach to determining which opportunities make sense to pursue and which ones to walk away from, what I like to call empty calories. We also continue to gain traction with our industry go-to-market approach, and I'd like to talk a bit about the key trends and key wins for the business on a sector basis. The financial services sector, which represented 26% of our revenue in the second quarter, performed strongly, demonstrated 13% growth on a constant currency basis. We expect demand in this sector to grow as digital and mobile conversion will continue to be industry-wide drivers. As an example of our focus on this trend, we recently signed partnerships with Sandstone Technologies (sic) [Sandstone Technology] and Payment Card Technologies, which give us a digital and mobile proposition that we are beginning to leverage with our clients. Additionally, as the industry moves to omni-channel banking, the focus on security and prevention of cybercrime will only increase. We recently won the Retail Banking Security Innovation of the Year award in the United Kingdom for a biometric solution that can be utilized by clients to address these concerns, and we have proof-of-concept with BehavioSec and National Building Society. Some key wins in financial services in the second quarter included in EMEA a ClearPath Forward contract with Nationwide. In Latin America, Kisha (09

[Janet Brutschea Haugen:]

Thanks, Peter. Hello, everyone, and thank you for joining us this afternoon. In my comments today, I will provide comparisons on a GAAP and non-GAAP basis. The non-GAAP results exclude our pension and cost reduction charges. Please turn to slide six for a discussion of our second quarter 2016 financial results. As you can see looking across the slide, we saw a positive trend this quarter for revenue, operating profit, EPS and cash flow. We reported revenue of $749 million in the quarter, which was down 2% on a reported basis year-over-year, but down less than 1% on a constant currency basis. Our operating profit improved year-over-year in the quarter for both GAAP and non-GAAP. Non-GAAP operating profit improved to $81 million from $30 million in the year ago quarter, showing the benefit of our ongoing operating cost reduction. In the quarter, we continue to execute against our cost reduction program. Our actions in the quarter generated approximately $30 million in annual run rate savings, which raised our program to date savings to $155 million against our target of $200 million as we exit 2016 with a possibility of an additional $30 million in annualized savings in 2017. We remain on track. Our diluted earnings per share was $0.36 versus a diluted loss per share of $1.17 in the prior year period. Non-GAAP diluted EPS improved to $0.81 from $0.33 a year ago. The shares used in the second quarter diluted earnings per share calculations were 49,927 shares in the second quarter of 2015. And 71,786 shares in the second quarter of 2016, which reflect 50,069 of outstanding shares plus 21,550 shares were the incremental shares from the added conversion of the convertible note in the fully diluted EPS calculation. We have included a schedule in the appendix to illustrate the impact of the convertible note on the EPS share count. Moving to cash flow. On higher adjusted EBITDA, we generated $35 million of operating cash flow in the quarter, compared to an operating cash usage of $21 million in the second quarter of 2015. Adjusted free cash flow, which is the free cash flow generated from the business excluding the impact of cash payments for our cost reduction program and for pension funding increased $78 million to $54 million for the second quarter of 2016 when compared to the second quarter of 2015. Turning to slide seven for an overview of our revenue in the second quarter of 2016. This chart shows a breakdown of our revenue based on segment, geography, sector and revenue type. On our Investor Relations page, we also provided a similar overview of revenue for the first half of 2016. Turning now to revenue by geographic region and sector on slide eight. As we look at the regional geographic breakdown, U.S. and Canada was down 9% year-over-year. This was largely attributable to lower services revenue, particularly lower cloud and infrastructure revenue. EMEA had a good technology revenue quarter, which contributed to the revenue growth of 6% year-over-year. And Asia Pacific grew 10%, 13% on a constant currency basis, driven by strength in our Australian and New Zealand public sector where we are viewed as a key industry player related to the increased digitization of government. On the sector breakdown, financial services had a strong quarter particularly for technology sales. Public sector revenue declined against a tough comp partially due to the completion of some low margin government contracts. This aligns with our direction to focus on winning and executing higher-margin deal. The pipeline for the second half of 2016 is strong within the public sector. U.S. federal felt slight revenue decline after seven consecutive quarters of growth. As we discussed in prior quarter's earnings call, last year's second quarter had a lot of project-based work on new contract. Moving on to our segment results, please turn to slide nine. Services revenue declined 7% in the second quarter, largely attributable to weakness in cloud and infrastructure services. We are pleased with the increased services gross margin, which were up 110 basis points primarily as a result of our cost reduction effort. We saw improved gross margins in every geographic region. However, we are seeing margin pressure in EMEA. While we made improvement in EMEA services gross margin, it was not at the rate we planned. Offsetting the improvement in services gross margin was increased SG&A expense. As Peter mentioned, we are increasing our investments and advisory and consulting skills to help accelerate the speed of our improvement in our services gross margin. This resulted in services operating margins of 2.1%, which were down 10 basis points year-over-year. We ended the quarter with services backlog of $3.8 billion, which was down both year-over-year and sequentially, of the $3.8 billion in services backlog, approximately $537 million is expected to convert into third quarter 2016 services revenue. The technology business had a very strong ClearPath Forward quarter and the increased revenue helped drive significantly improved technology gross margins and operating margin. We are pleased that the ClearPath Forward family have had a strong start to the year. We currently anticipate that this strong start will result in a different first half, second half seasonality than we typically experienced with first half 2016 technology revenue higher than second half 2016. So for 2016, it looks like first half 2016 revenue would be about 54% to 55% of full year technology revenue. This is different from the last four years where second half revenue was greater than the first half technology revenue. Lastly, in terms of the second quarter results, slide 10 highlights the significant improvement we saw this quarter in operating cash flow. As a result of continued cost cutting measures focused on contract renewal and extension profitability, operating cash flow was positive at $35 million relative to a usage of $21 million in the second quarter last year. CapEx was lower than in the second quarter of 2015 we saw elevated levels of investment in the outsourcing asset. This decline in CapEx coupled with higher operating cash flow led to free cash flow improving to a positive $1 million generation versus a usage of $75 million in the second quarter of 2015. Additionally, adjusted free cash flow increased for the third consecutive quarter to $54 million, which is an increase of $79 million relative to the prior year period. A large driver of that expansion is adjusted EBITDA, which for the second quarter of 2016 was $124 million versus $72 million in the prior-year quarter. As we look at the second half of this year, Q3 is normally seasonally weaker than Q4. And in addition, we anticipate continuing our increased investment spend in both the third and the fourth quarters. As Peter and I both discussed, we anticipate these investments will yield results in future periods. And additionally, our cost saving strategy in Europe is proving to take longer than we had hoped, although we still believe that our target cost savings are achievable. We expect this to weigh on our Q3 and Q4 results. As we look at the full year, our guidance is for revenue in the range of $2.775 billion to $2.875 billion, consistent with our prior guidance. For non-GAAP operating profit margin, given the increased investment spending and the pressure on EMEA's services gross margins that I just discussed, we are guiding to the low end of our previous non-GAAP operating profit margin guidance of 7% to 8%. Adjusted free cash flow in the range of $160 million to $160 million (sic) [$200 million] is consistent with our prior guidance. Turning now to slide 11. In addition to the overview of the second quarter financial results, I also wanted to take this opportunity to briefly cover our tax attributes and their value to the company. We've discussed our tax attributes in some of our past earnings calls. We have summarized our tax attributes on slide 11. This information is also found in our tax footnote in our annual financial statement. Before valuation reserves, we have $2.1 billion in deferred tax assets. Under GAAP, most of these tax attributes are fully reserved. As you can see on slide 11, this results in net deferred tax assets of only $114 million on the 12/31/2015 balance sheet. Based on our understanding of current tax regulations, if Unisys generates future taxable income, jurisdictions where we have net operating loss carry forwards and other favorable tax benefits, and depending on the timing of that taxable income, the gross value of $2.1 billion could be available to reduce or eliminate the related income tax. In closing, during the second quarter, we were very pleased with our strong technology revenue and margin. We also demonstrated continued progress towards improving our cost structure to increase our profitability and strengthen our cash flow generation. Our cost reduction actions are tracking in line with our plan to create a more competitive cost structure and rebalance the company's global skill set. We increased our services investment in advisory and consulting skills for longer-term benefit on services revenue and gross margin rate. We are focused on enhancing the competitiveness of our offering and building the go-to-market and delivery capabilities that will enable us to generate sustainable revenue growth in the future. With that, I would like to thank you all for your time, and I will turn the call back over to Peter.

[Peter A. Altabef:]

Thank you, Janet. We'd like to now give you a chance to ask any questions you may have. And just as a reminder, in addition to Janet and myself, we're joined on the call today by Inder Singh, who is our Chief Strategy and Chief Marketing Officer, as well as by Courtney. Operator, would you please open the line.

[Operator:]

Thank you. And our first question comes from Frank Atkins with SunTrust.

[Frank C. Atkins:]

Thanks for taking my questions. First question, I wanted to ask about Brexit. And it's early days, but have you seen any impact on the pipeline or volumes, especially in the BPO business, and then what impact does that have on the top line in terms of your currency assumptions?

[Peter A. Altabef:]

So, I'll take the first part of that question, Frank, relay to Janet for the second half and actually ask Inder to weigh in on some of the security elements of that. So we'll do a trio on this call. The first part of your question, with respect to our business, as you can see from our numbers about 30% of our revenue is in EMEA, 14% – and here I'm giving you first half numbers. 14% of our revenue is in the UK, that's as a company, 14% company-wide, and 10%, again first half numbers, of our revenue is in financial services in the UK. So, we have a decent presence in the UK and in financial services. The financial services piece is really roughly split between what I would call traditional financial services work and more BPO-type of activities, right. So, bottom line is, right now, we obviously have not seen any significant effect in the UK or in financial services. I think it's fair to say, like I think everyone, and we probably all get this in our inboxes on a daily basis now, there are a lot of companies that are kind of in a wait-and-see attitude. We'll just have to see if that wait-and-see attitude affects any of our prospects or pipeline. I think it's just too early to call. But I would expect there would be some wait-and-see that would eventually affect us in our historic business. I think I'll turn next to Inder before going over to Janet. And Inder, one of the takes, and I referenced it in my opening remarks, that takes us a little bit out of the ordinary here is our core competency about border security and protection, some of what we're already doing in the EU and how that might affect the situation with Brexit?

[Inder M. Singh:]

Sure, Peter, thanks. So, Frank, as we look at Brexit, post sort of the intermediate period here as the country thinks about executing on that, we're looking at essentially new borders coming up where borders haven't existed for a few years, right. So we look at our practice in the United States where we actually help screen about a million passengers and cargo a day inbound and outbound, virtually all of the land-based incoming and outbound traffic. We field 1.5 billion transactions a day in terms of queries into a vast data lake, so we're trying to take all of those capabilities and the conversations that Peter referred to earlier that we've been having with the European Union, leverage those capabilities as well as some of the advanced analytics that go with assisting to identify terror and other types of threats. So border security, passenger and cargo tracking, those are the capabilities that we've been known for here in the U.S. and that we are now deploying in other parts of the world including in Australia and now we see more and more opportunity potentially as the European Union realigns its borders. The second thing I would add is the potential lift and shift of data centers, and you're probably aware, Frank of the Privacy Shield that has finally gotten negotiated and finalized between the European Union and the United States and that will still continue to apply to the UK as if and as it separates from the European Union. Those types of agreements actually require data centers to be domiciled on potentially both sides of the channel on a go forward basis. In fact, just very recently a payment processing company said they would start potentially looking at moving their data centers. So our data center business and our extended data center business we believe in the longer-term stands to benefit from that. And to Peter's comments earlier about our presence on both sides of the channel, we think that helps us with some incumbency factors.

[Janet Brutschea Haugen:]

So, Frank with regard to currency, we started the year expecting that currency would have about a negative 2 percentage point impact on our revenue compares year-over-year. The currencies that we are affected by have moved up and down, but for the full year we're still expecting that the currency impact is 2 percentage points negative. With specific comments on the Brexit, we think that that's about right now, based on currency rates a $10 million to $15 million negative impact on second half revenue for us.

[Frank C. Atkins:]

Okay, great.

[Peter A. Altabef:]

Frank, thanks again.

[Frank C. Atkins:]

Good. And then as a follow up, I wanted to ask you press released the NSA designation as well as partnerships with Microsoft and AWS over the last few months. Can you talk about the opportunity set going forward there and what traction you're seeing in those areas?

[Peter A. Altabef:]

Well, again we see this kind of in two ways. Unisys Stealth we think is a distinguishing technology for us, and we are continuing our efforts not only to market and build that, but also to build that middle layer you see in slide four of many different security products. Some of this or some of them are well established such as border security and others such as the advisory and consulting work we're investing pretty heavily now to build up. And then finally when we looked across the board, we're putting next generation and leading protocol securities in really all our offerings, some of that may be Stealth and some of that may not be depending on its applicability. So Stealth is very important for us as kind of a flagship product, getting these certifications which take a long time and are not easily obtained, we think enhances its flagship nature for us. That said, the sales length of closing transactions when you're talking about basically putting new protocols into company's infrastructures that includes the government as well as private. It is not a quick sale and it's very cautious. We believe that that continued interest is going to ultimately create significant demand, but I will tell you right now it is still early days. And the pipeline is growing but we do not yet have a substantial amount of revenue specifically related to Stealth. But we think the interest is apparent and growing and the need as well. So, that's kind of where we are on it and we'll continue to update you as it extends. We think the certifications this quarter are very important.

[Frank C. Atkins:]

All right. Great. Thank you very much.

[Peter A. Altabef:]

Welcome.

[Operator:]

. Our next question comes from James Friedman with Susquehanna.

[Peter A. Altabef:]

Hi. I think that's Jamie, but I'm not sure unless there's a change Jamie that we need to know.

[James Friedman:]

Hi, sorry I muted myself. Can you hear me okay?

[Peter A. Altabef:]

We can.

[James Friedman:]

Okay. Yeah, nice job here. I just had a couple of questions. Janet, I wanted to ask about this slide 11, the potential economic benefit of the tax assets. I understand the math. I'm wondering is there a reason why you're calling this out now because I haven't seen this one in a while.

[Janet Brutschea Haugen:]

So Jamie, it is an item that we obviously disclose in the annual financial statements. We've talked about it periodically. We haven't spoken about it in a while. As we continue to improve the profitability of the company, and as we look to further out to improve both the revenue and the margin, we thought it was important to give an update on tax attributes that we have available to us to offset any type of perception of an increased tax burden as we improve our profitability over time.

[Peter A. Altabef:]

And Jamie, this is Peter. Thanks for asking the question. It is also consistent with what I hope you have seen from us for over a year now, and that is more and more kind of transparency in the data that we have. Again, as Janet mentioned, the data is not new, it was publicly available, but perhaps not in as easily referenced way as this. And so, you're seeing us now put it into a slide. It'll move into the appendix for future calls, just like the pension obligation data, which is in the appendix and now with the share count analysis. We thought that, given the convertible issuance earlier in the year, we needed to provide some more examples about how that share count can work up and down. So, we're really trying to make sure that we could be as transparent as possible and respond to requests. We've had requests on some of this kind of disclosure. And so, if there are other things we can add in the future, we're happy to look at it.

[James Friedman:]

Okay. Thanks, Peter. And then, I had a question about slide 10. So, looks to me like free cash flow not adjusted, but free cash flow was positive in the Q2 for Unisys. I realize you don't guide to free cash flow, although you gave guidance for adjusted free cash flow. And I don't think that you're going to guide to a cash balance at year end, but maybe if you could at least help us with some of the waterfall of the free cash flow as we move forward excluding the adjustments that would be helpful as well.

[Janet Brutschea Haugen:]

So, Jamie, adjusted free cash flow was what we talked about on the call, the $160 million to the $200 million range. To get to free cash flow, there are two reconciling items. The first is the cost reduction payment which we talked about earlier in the year. Our estimate at that time and continues to be about $90 million to $100 million worth of cash payments for the cost reduction. And then our pension contribution, right now as you can see on the chart in the appendix is roughly $136 million of cash acquired for pension contribution.

[James Friedman:]

Yeah, I'm just getting in the appendix. Okay, so those would be the – I mean, what was – I'm sorry, what was your CapEx number for the year, again?

[Janet Brutschea Haugen:]

So, the CapEx number that we have discussed has been around $200 million which is a decline year-over-year, but we also said that we are continuing to look at more capital light approaches in our offerings. First half of the year, we are down in spending year-over-year, and so I would tell you right now that we think about $200 million but won't be surprised if that comes in a bit lighter.

[James Friedman:]

Okay. And then my last one, Peter, so I was interested in the announcement earlier this month about the Stealth certification for the payments industry. I think, you mentioned Sandstone in your prepared remarks, but I was just curious as to how you think about sizing that opportunity, the applicability or unique attributes of Stealth for payments, any kind of contextual color you could share and that would be helpful? Thank you.

[Peter A. Altabef:]

You're welcome. Thanks. About those two – the partnerships and kind of the new platform we're providing Eric Crabtree, who joined us earlier this year and leads our financial services team globally is actually in the middle of a three-week trip in Asia-Pacific where we're actually actively talking about that platform to a number of financial services organizations in Asia-Pacific. We're actually quite excited about it. It definitely represents a step forward and a significant lean forward for our financial services business, right. With respect specifically to, let's say, PCI compliance and Stealth, yeah, I'll defer to Inder just very quickly as you know Jamie that PCI compliance is in the eye of the beholder and it really is a user requirement as opposed to a provider requirement. So we can go only so far in getting there and ultimately the end user has to finish it. But we made very, very significant progress in kind of doing our part. So, Inder over to you.

[Inder M. Singh:]

So, Jamie, the PCI compliance obviously is something that credit card processors like Visa, MasterCard, Amex and others have to all deal with. There are traditional ways of delivering PCI compliance. The way that we are actually delivering it is differentiated in the sense that we're deploying Stealth, which is a software-defined networking micro-segmentation suite as you know. And in the PCI compliance protocol, there are 12 critical steps that you've to be able to certify for to be compliant as a payments processor. We help address some of the key ones there with a software solution rather than a hardware solution. So, I'll just give you one example. One of the first requirements has to be to install and maintain a firewall configured to protect the cardholder's data. Firewalls as you know, have been proven to be vulnerable. Moreover firewalls have been ineffective in preventing issues where there is an insider in the company, or for that matter, even an outsider. By deploying micro-segmentation, you're basically creating a smaller attack surface and a smaller amount of data that someone can access. So, these communities of interest or communities of trust as well call them allow the Amex or any other operator to be able to easily say, they have provided perhaps more than the bare minimum requirements of PCI. Similarly, that Stealth solution helps secure several other parts of that 12-step PCI compliance overview. So for our client, it becomes a simpler thing for them to basically certify once they deploy Stealth.

[Peter A. Altabef:]

Jamie, thanks again for your question.

[James Friedman:]

Thank you. Thank you.

[Operator:]

And the next question comes from Joan Tong with Sidoti & Company.

[Joan K. Tong:]

Good afternoon. A couple of questions. Regarding the investments that you guys are making right now and will continue to make those investments in the third quarter and the fourth quarter. Can you just give us some color like – further color in terms of what type of investment is that? You mentioned advisory and consulting, and also like when do you expect to see like the return on those investments, would that be first half of next year or is it more like a long range like a gradual or steady type of return going forward?

[Peter A. Altabef:]

Yeah, Joan, thank you. That's a great question. And it highlights kind of the two kind of financial goals that we've set for ourselves. Obviously, we all know that this is the first year in over 10 years that the company has given guidance. We're working very hard to make sure that we can deliver to that guidance and we reaffirmed that guidance on this call, although we did it for the operating margin at the low end of that range. And so, what's going on there? There are a couple of things going on there. So, one thing is that the services margin enhancement, you saw 110 basis point improvement in gross margins year-over-year, while certainly in the right direction, is frankly a little harder slogging than we had hoped. It's taking more cycles and it's taking longer. And so, we are, A, using the, if you will the benefit of our current profitability to enhance the revenue – the investment in things like security expertise, in things like dedicated security sales people, in things like cloud advisory and consulting capabilities, in things like our next generation application development and DevOps capabilities. So a fair amount of investment is going in place. Some of that we would be doing anyway and some of that frankly we need to do more of, because we're realizing that our initial plan was just harder to achieve. And while we are interested in our 2016 numbers, the other half of the equation is we're looking out to 2017, 2018 and 2019. And we need to get increased profitability and ultimately increased revenue. The second part of that equation, as Janet outlined, is EMEA is itself a harder slog. And as we've talked about for the last several calls, we've kind of delayed a bit some of our more extensive EMEA cost forward – that's why you hear me talk about we might have another $30 million next year. Part of that is because we haven't fully quantified it – the savings because honestly we haven't fully locked in to exactly what the action plan is. A, that's because EMEA is simply a very difficult environment and a very costly requirement; and B, it's because the marketplace, even though the revenue this quarter was above a year ago, I think, it was a 6% increase, there's mix challenges there and some of that was benefited by a technology sale. So again, we're very transparent on these calls. We are appreciative of the fact that we've got an opportunity to kind of double down in some of those investments. We're taking advantage of that to prepare for the long term, but acknowledging that it is a little harder slog than we had hoped on services margin in general and on EMEA in particular. I hope that helps, Joan.

[Joan K. Tong:]

Yeah, that's definitely helpful. And so, you are now pointing to the low end of the 7% to 8% non-GAAP margin. But how about the services margin that you – in the original guidance, you looked for 3.75% to 3.5%. Are you still like having that target range in mind or are you kind of coming off that because you're a little bit behind schedule in the first half of the year?

[Janet Brutschea Haugen:]

So, Joan, as we said on the last quarter call, when we talked about where we stood against guidance, we talked about where we are at the business from an overall revenue standpoint and overall non-GAAP operating profit guidance in that 7% to 8%, and the adjusted free cash flow. Those are our three main elements of guidance. As we talked about on last quarter's call and this quarter's call, the services operating margins, for the reasons that Peter just went through, are under – a pressure point in the near term, but we are taking the actions to both effect the cost reduction as well as improve the mix of revenue. We started out the beginning of the year with a much stronger tech quarter – tech first half than I think we thought coming into the year. But with regard to any of the particular elements above it, which we gave and we talked about coming into the year, last quarter, we did comment that we were moving to guidance on the top three, the overall revenue, the overall non-GAAP operating profit margin and the overall adjusted free cash flow, recognizing that we would see movement within the course of the year of the underlying measures.

[Joan K. Tong:]

Okay. Got it. All right. That's fair. And then, if you guys were to go forward with that extra $30 million cost savings, like, in Europe next year, and I assume that there will be more charges and then the charges we talked about in the past would be higher than before. So, I think you guys mentioned $80 million (56

[Peter A. Altabef:]

Joan, it is the right way to think about it as of now. That's our current default model. And I guess what I'm saying to you is we are really continuing to look at what's the best plan. There's an opportunity we will wind up spending more than that because we think it's the right thing to do. There's an opportunity that we'll actually wind up spending less than that if we don't think the return on investment is sufficient. So, I hate to throw a little uncertainty in there, but I hope you guys have confidence that that uncertainty is because we're counting twice and three times before we pull those triggers. Obviously, it also depends on cooperation with the workers councils. But getting Europe on a firm footing is not frankly as easy as we had hoped, and it was never considered easy. So, we're really spending the time to make sure that as we pull the triggers in Europe, we think that we're doing it right. We think, for the long term benefit of the company, that's frankly an important initiative. And we've got new leadership in Europe with Tom Higgins joining us in February to lead our EMEA team; Andy Stafford, who is our Head of Global Services, is actually based out of London; Steve Nunn, who leads our cloud and infrastructure team globally, which represents about 45% of our global revenue, is based out of London; Eric Crabtree is based out of Europe, leading our financial services. We've got a lot of brain power, honestly, in Europe. We didn't have at the beginning of this year, let alone last year when we setup this plan, so we're using that. We're not putting that on autopilot and we're taking a very deep dive and saying how do we get Europe on solid ground. That's a work in progress.

[Joan K. Tong:]

Right, right, okay. And obviously, there's always like people – in people's mind is the pensions, GAAP, I guess, interest rates, like, edged down again and pension GAAP probably edged up. And I'm just wondering, is there any impact on the way you think about cash flow, non-adjusted, going forward?

[Janet Brutschea Haugen:]

So, the non-adjusted free cash flow would be – is without the impact of the pension funding or the cost reduction action, so it is not impacting our view of the adjusted free cash flow. And keep in mind...

[Joan K. Tong:]

I'm sorry. I meant, like, exactly reported free cash flow.

[Janet Brutschea Haugen:]

So, keep in mind that when we're talking about the change in the pension liability on the balance sheet. And you're right, if you have it reset today, you would reset it at a lower discount rate. When it comes to funding based upon the way, particularly in the U.S., the calculations work, there is a lag before you see any type of impact in our estimates – you know, in the next two years of cash funding for a change in that discount rate, so expect us more in the mid and the out-term years.

[Joan K. Tong:]

Okay. Great. Thank you. And then, finally, Peter is on the security side in terms of product sales, software sales. Obviously, a lot of color, a lot of partnership being announced and, like, excitement around that product. Any financial guidance like that or maybe more higher level outlook, if you can talk to maybe within the next, like, three to five years, where are you going to see Stealth as a percentage of revenue and how big is the target market?

[Peter A. Altabef:]

Yeah, Joan, I appreciate the question. Clearly, we don't consider that number significant yet, and we are not in a position, we think, to start talking about financials for that at this point. I think I've made it very clear. We're excited about the product. We're getting a lot of interest in it. But the numbers in the context of the overall revenue of Unisys are still not significant, the positioning is. And if you go back to slide four, we expect Stealth not only to drive Stealth licenses and Stealth services but to frankly be a foot in the door that then sells the middle layer or the middle ring of all of those other services. So, we think its importance will actually be outsized of just its specific revenue because it does really put us in a leadership position in the marketplace both as thought leaders and as doers. And we think, that's a good and/or to the benefit of our security practice and the business as a whole.

[Joan K. Tong:]

All right. That's fair, Peter. Thank you so much.

[Peter A. Altabef:]

You're welcome, Joan. Thanks, again.

[Operator:]

And our next question comes from Ana Goshko with Bank of America.

[Anastazia Goshko:]

Hi. Thanks very much. You actually addressed many of the questions that I had. But just to clarify on the discussion on the cash flow and on the guidance. So Joan, I understand that you're directing us to the low end of the non-GAAP operating profit margin, so to the 7% end. But I think you did not adjust or direct us to the lower end of the adjusted free cash flow guidance. And is it the CapEx that you think that it's going to come in light and it's going to be a benefit relative to what you originally guided to?

[Janet Brutschea Haugen:]

Thank you for joining the call. Thank you for the questions. Yeah, so we're very committed to in that adjusted free cash flow to hit that range of $160 million to $200 million, while we are seeing an impact and guiding to the low end on the non-GAAP operating profit, as I mentioned in the comments as you rightly picked up. We are looking to see what we can adjust for that, either through lower CapEx without affecting the business and the prospects for the business in the top line, as well as other working capital improvements.

[Anastazia Goshko:]

Okay. And then, with regard to the EBITDA metric, I'm assuming that you are also guiding to a lower end of the adjusted EBITDA because that's kind of in tandem with the operating margin, is that accurate?

[Janet Brutschea Haugen:]

So, Ana, as I mentioned to Joan, we have been talking about the three past metrics for us, the overall revenue, the non-GAAP operating profit and the adjusted free cash flow. And obviously, towards the low end of that adjusted free cash – the adjusted free cash flow on – I'm sorry, the low end of the non-GAAP operating profit percentage, that would imply an impact on the adjusted EBITDA.

[Anastazia Goshko:]

Got it. Right. Okay. Okay, Well, thank you very much.

[Janet Brutschea Haugen:]

Thank you, Ana.

[Operator:]

And that does conclude the question-and-answer session. I'll now turn the conference back over to you for any additional or closing remarks.

[Peter A. Altabef:]

Thanks, operator, and thanks everyone on this call for your questions. And to close out, I'd like to reiterate that we're pleased with the results of the quarter, which were held by our technology business and that we're seeing the benefits of our cost reductions and focus on profitability. We're excited to continue our efforts along these fronts and also on approving our top line over time. Thank you, again, for being on the call, and we look forward to continuing discussion.

[Operator:]

Thank you. That does conclude today's conference call. We do thank you for your participation today.