Unisys Corporation
Q1 2009 Earnings Call Transcript

Published: 28 Apr 2009

[Operator:]

Good day and welcome to the Unisys first quarter 2009 results conference call. At this time I would like to turn the conference over to Mr. Jack McHale, Vice President of Investor Relations at Unisys Corporation; please go ahead sir.

[Jack McHale:]

Thank you, operator, good morning everyone and thank you for joining us. About an hour ago Unisys released its first quarter 2009 financial results. With us this morning to discuss our results are Ed Coleman, our CEO; and our Chief Financial Officer Janet Haugen. Before we begin I want to cover just a few housekeeping details. First today’s conference call and the Q-and-A session are being webcast by the Unisys investor website. Second you can find on our investor website the earnings release and the presentation slides that we will be using this morning to guide our discussion. These materials are available for viewing as well as for downloading and printing. Finally, I would 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 the expectations. These factors are discussed more fully in the earnings release and in the Company’s SEC filings. Copies of these SEC reports are available from the SEC and also from the Unisys investor website. Now, let me turn the call over to Ed.

[Ed Coleman:]

Thanks Jack. Hello everybody, thank you for joining us this morning. As we begin our call today please turn to Slide 1 of the presentation for the highlights of the first quarter. We made progress in the quarter, in the challenging economic environment, in driving our turnaround program at Unisys and are encouraged by the progress we made in reducing expenses and improving cash from operations. We put out a strong message internally about the importance of reducing expenses in driving cash as we work through this economic period, and our people rose to the challenge. Operating expenses declined 24% year over year. Some of that improvement came from currency but the bulk of this improvement was driven by the actions we have been taking and continue to take to simplify the organization and reduce SG&A. Progress on expenses in this quarter helped us offset some of the pressure on our gross margins due to lower revenue. In fact we were able to slightly improve operating margins in our services business over the year ago quarter. We also did a good job managing working capital and driving cash. We generated $39 million of operating cash flow compared with the cash usage of $49 million a year ago. That is an $88 million improvement and it came on what is seasonally a weak cash quarter for us. Another highlight was our US federal government business with great revenue and orders in the quarter, and hopefully you have seen some of the orders we have announced in this business in recent months. Turning to Slide 2, unfortunately we are not able to fully leverage our expense improvement and bring it to the bottom line because of lower volume at the top line. The demand environment remains highly uncertain. While our US Federal government business did well in the quarter, we saw a continued weakness in the commercial side of the business as clients delayed spending on IT projects. Our first quarter revenue declined 15%., 5 % if you exclude the impact of foreign currency which had 10-point negative impact on revenue. As you will see when Janet takes you to the numbers, the revenue decline impacted our gross margins in the quarter. We saw the most significant impact in our technology business for a number of expected high margin mainframe deals were deferred during the quarter particularly in Japan. Gross margins and services were also impacted. Some of these are due to the currency but we clearly need to drive greater volume and get some help from a better demand environment to fully leverage the improvements we are making in our expense structure. In the meantime we are not waiting for economic conditions to improve to drive bottom line improvements. We continue to take aggressive actions to tighten our strategic focus through brand differentiation, reduced cost and expenses and drive profit and cash flow. In doing so we feel we will be positioned to benefit the bottom line when business conditions improve and demand comes back. You will remember from our last call on February that there are four priorities in our turn around program. You can see those listed on Slide 3. To concentrate our resources on fewer, high potential markets with a portfolio of value added offerings. To offer clear compelling value proposition that differentiate Unisys in the market place. To drive expansion in our gross profit margin by enhancing the cost efficiency of our labor model. And finally to simplify the organization and significantly reduce our expense structure. The first two priorities are about driving profitable revenue by being more focused in the markets we serve and providing solutions that client recognize as being differentiated and adding value. The third and fourth priorities are about bringing more of this revenue to the bottom line by being extremely efficient in how we deliver services and operate our business. Turning to slide 4, in the first two priorities of business concentration and market differentiation, we have worked in recent months to tighten our strategic focus in terms of how and where we invest our resources. As I discussed in our last call, we focused our resources on pursuing growth opportunities in four primary market areas, security, data center transformation and outsourcing, end-user outsourcing and support services and application modernization. We chose these four areas because it matched growing areas of market needs with strength that our core to Unisys such as our decades of experience in the data center, our expertise in security, industry recognized capabilities and outsourcing and end-user support and our skills in building, managing and modernizing enterprise mission critical applications. Throughout 2009 we will be strengthening our portfolio of offering in each of this targeted market. We will be introducing differentiated solutions that help clients cut costs, improve security and efficiency and achieve greater return on investment which is what every client I talk to is looking for right now. As part of narrowing our strategic focus, we are also working to identify and explore potential divestitures of non-core assets and to rationalize their geographic presence. To put this effort in perspective the four areas of strength that I have just noted

[Janet Haugen:]

Thanks Ed, and hello everyone. As Ed discussed the tough economic environment in the first quarter along with the impact of currency impacted our top line. We significantly reduced SG&A expenses, improved working capital management, and drove improvement in the cash requirements of our business model. Our cash flow from operations improved significantly year-over-year in the quarter. This morning I will take you through our financial results for the quarter and the key drivers behind the expense reduction and the improved cash performance in the quarter. I will also update you on a revised outlook for cash funding to our US pension plan in 2010. To start please turn to Slide 7 for an overview of order trends in the quarter. As Ed mentioned, we continue to see organizations pulling back on discretionary spending in this uncertain economy and deferring decisions on IT projects. We saw order declines in the US and all international regions with the exception of Latin America where orders grew. We closed the quarter with $5.7 billion in services in backlog which was down 6% from the services backlog at December 31, 2008. Moving to Slide 8, which summarizes our financial results in the first quarter. At the top line we reported revenue of $1.1 billion, a decline of 15% year over year. Foreign currency exchange had a 10 point negative impact on revenue this quarter. This is the highest we have seen in many years. On accounts in currency basis revenue was down 5%. Based on today’s rate we anticipate a 9 to 10 percentage point negative impact on revenue in the second quarter of 2009. As you can see in our results, our gross margin was impacted in the quarter by lower revenue and the negative impact of foreign currency fluctuations. More than half of the impact on the gross margin percentage was due to the foreign currency exchange. Operating expenses came down 24% year over year driven by the cost reduction actions we have taken as well as the favorable impact from currency. Currency was about 9 point of the 24 percentage point decline. The reduction in operating expenses helped mitigate some of the impact of lower revenue in the quarter. In fact, we were able to slightly improve operating profit margins in our services business on lower revenue. Operating profit declined primarily due to the loss of royalty income from Nihon Unisys Limited (NUL) and weak sales of high margin servers particularly ear in Japan. Other expense increased to $6.7 million of expense in the quarter. The year over year increase was largely driven by foreign currency losses in 2009. At the tax line, we had a $15.6 million tax provision in the quarter versus the tax provision of $23.9 million in the year over ago quarter. At the bottom line after taxes, we reported a $24.4 million net loss in the quarter compared with $23.4 million net loss a year ago. Slide 9 shows our first quarter revenue by geography, Our US revenue was flat in the quarter and represented 49% of our revenue in quarter. Within the US, growth in our US Federal government revenue was offset by revenue declines in commercial market. We saw double digit growth in our Federal systems revenue in the first quarter. International revenue declined 27% and represented 51% of our revenue in the quarter. On a constant currency basis, international revenue declined 10%. In the constant currency basis revenue grew in Latin America but declined in Europe and Pacific Asia. Slide 10 provides more detail on our first quarter revenue by business offering. Outsourcing, our largest business offering declined 14% in the quarter while systems integration continued to show stabilization declining 1%. We continue to see significant declines in the infrastructure services as de-emphasized lower margin aspects of this business. Enterprise server revenue declined 38% in the quarter. Lower sales in Japan including the loss of revenue of royalty revenue income from Nihon Unisys Limited (NUL) accounted for a large portion of this decline. Core maintenance declined 21% while specialized technology increased slightly. Moving on, Slide 11 highlights our margin trends in the quarter. As you cane see, gross margins in both our services and technology businesses were impacted in the quarter by lower revenue and negative currency translation. This impact was greater in our technology business because of the higher fixed cost in this business. On the operating line, we were able to improve operating profit in our services business by 40 basis points by reducing expenses however our technology business reported an operating loss in the quarter on lower volume of enterprise server sales primarily in Japan. Slide 12 shows the progress we have made in the quarter in our ongoing program to reduced operating expenses. Operating expenses came down 24% to approximately 200 million in the first quarter. Operating expenses has also declined as a percentage of revenue. Given the weak revenue environment we are proactively working on additional opportunities to further reduced expenses. Now please to Slide 13 for an overview of our cash flow performance in the first quarter. We generated $39 million of cash from operations in the quarter, an improvement of $88 million year over year compared to the $49 million of cash used for the operations in the year ago quarter. Our cash performance was driven by strong working capital management in particular a 12 –day year over year improvement in Days Sales Outstanding. We used $27 million of cash in the quarter for restructuring payments compared with $21 million to a year ago. We continue to tightly manage capital expenditures as we work through the economic downturn. CapEx for the first quarter was $47 million, down from $65 million in the first quarter of 2008. After capital expenditures we used $8 million of free cash in the quarter compared with $114 million of free cash usage a year ago, an improvement of over $100 million. Depreciation and amortization was $84 million in the quarter down from $100 million last year, reflecting a lower CapEx base and currency translation. We ended the quarter with $460 million of cash on hand down from $544 million at December 31, 2008 due primarily to the $61 million of cash that was used to collateralize Letters of Credit previously issued under our Company’s revolving credit facility. Since the cash is restricted the $61 million is not reported in cash and it is reported in other assets. For the full year of 2009 we looked for capital expenditures in the $200 million to $225 million range compared with $295 million in 2008. We looked for depreciation and amortization in the $325 million to $35o million range in 2009. Now moving on to slide 14, I would like to update you on cash requirements for our world wide pension plan. In the first quarter we made $14 million of cash contributions to our international pension plan. We made no cash contribution to our US qualified pension plan in the first quarter and we are not required to make any cash contributions to this plan for 2009. For the full year of 2009, we expect to make cash contributions of approximately $90 million to $95 million to our international pension plan. Looking ahead to 2010, we have revised our expectation for the funding requirements of our US qualified pension plan. As I have mentioned in our last call in February, that based upon our under funded position at year end 2008, at that time we expected that we would have to contribute up to a maximum of $90 million to the US qualified pension plan in 2010. Under recently clarified IRS regulation, we now do not expect to be required to make cash contribution in 2010 to fund our US qualified pension plan. Turning to Slide 15, in summary, I am pleased by the work we are doing and the progress we are showing in reducing expenses across the organization and driving improved cash flow. This expense improvement is helping us weather a very difficult demand environment in offsetting some of the pressure that we are seeing at the top line. We will be aggressive in looking for further opportunities to reduce our cost base, operate more efficiently and improve the cash flow of the business. Thank you for your time and now I would like to turn the call over to Ed.

[Ed Coleman:]

Thank you very much, Janet. At this time we would like to open the lines up for your questions and operator if you could do so, I would appreciate it.

[Operator:]

Thank you, (Operator instructions). Your first question is coming from Jason Kupferberg - UBS.

[Jason Kupferberg:]

I wanted to ask a question about the top line efforts and I can certainly appreciate how the approach to cost and the execution there is differing from the some of the Company’s past efforts but we can talk a little bit about the part of the turn around program that is more top line oriented and it seems like the whole notion of tightening the strategic focus in narrowing the focus on a smaller number of service lines and use more offshore labor something that Unisys has talked about for quite a while and wanted to get a sense of what aspects of that strategy might be different this time around that might make you guys feel like there is a better chance of success in that regard despite the macro environment.

[Ed Coleman:]

Thank you very much, Jason. I think it comes down to what we are calling out as the four fold key growth opportunities for us as we defined them around data center transformation, security, end-user outsourcing and application modernization. What is going on inside the Company is allocating more of our resources and focusing resources across the Company on those four areas. While we are organized by business units from technology to integration, to outsourcing in our federal unit, what we are doing is pooling together representatives from all of those business units around these four initiatives and building a strong platform of capability and offerings that we believe will be differentiated in the marketplace across all four of those. I cannot speak really to the history of the Company in the sense of what has been done in the past but I can tell you that I am really gratified to see how strongly the geographies and the business units were all rallying around these four opportunity areas. We have also taken each one of our business unit leaders and assigned them one of these four to be the lead person to drive this. Data center transformation which Marcello who runs the technology business has the lead on that but he is working with representatives from all the business units. Anthony Doye has the lead from our outsourcing business for end-user outsourcing. Dominick Cavuoto has the lead for application modernization from our GI business and Ted Davies has the lead for security but these are truly cross business unit teams doing some exciting work. You are beginning to see some of it announced with our converged remote infrastructure management offering that was announced a couple of months ago. We got some very interesting work going on in cloud particularly in secure cloud. Application modernization, we think, is a real opportunity for us particularly within our clear path install-base and on the security side we continue to make real stride for physical and logical security come together, not only in the business world but also in key government agencies around the world. So I am excited about what we are doing but again it is tough demand environment to be doing this in. We have got to differentiate ourselves in the marketplace with the set of rich offerings that people believe are leading edge. They are providing real value. I think we are making good progress here Jason.

[Jason Kupferberg:]

Okay and can you talk a little bit about how customers are reacting to your current financial situation and you mentioned, I think in the press release that outsourcing orders were down significantly year over year in the quarter. Any sense of how much of that is more Unisys specific versus general market conditions because it would be, I guess not illogical to think that some customers might be a little gun shy about entering into a large long term outsourcing deal with a vendor who is under some degree of financial pressure relative to some of their competitors.

[Ed Coleman:]

Jason, I think compared you are characterizing it correctly for transaction oriented business or shorter term projects. I think the impact that we are seeing is really the broader economic impact but for longer term, multi year outsourcing engagements there is the economic impact but there is definitely a concern on the part of the customers about the balance sheet and that is why I have said it, Janet has said it as well but this is something that we understand, that we are attacking with a sense of urgency with a multi- pronged approach to it but we need to give the customers comfort that not only will they great service and we are going to continue to provide the service that we have a terrific reputation for that they can count on us to be a long term partner.

[Jason Kupferberg:]

Last question on the cash flow, obviously you have made some cut backs in CapEx and where the notable working capital improvement sin the quarter. You were barely free cash flow negative in the quarter which by seasonal standards is a pretty good accomplishment. I mean if we should reread into that as we think about the balance of the year that Unisys is in a good position to generate positive free cash flow for the full year.

[Janet Haugen:]

Jason it is Janet and we have said al along that moving our business model to the point of generating free cash flow is part of the goal in addressing the customer concerns that you articulated in your earlier comment but also what we believe the operating model should look like. We are very pleased with the first quarter performance. We think that is very strong step towards reaching the goal of getting to free cash flow positive and as we said that remains a goal for us for 2009.

[Jason Kupferberg:]

One just quick housekeeping item, any pension income in the quarter?

[Janet Haugen:]

Yes, it is a minor amount. It is about $4 million.

[Operator:]

Your next question from [ Sindar Adarjan] – Deutsche Bank

[[Sindar Adarjan]:]

Just to follow up on the pension question. What was it last year the same quarter, was it in expense or a credit? I know you discontinued contributions on your stock from a stock perspective on the employee 401K plan. Could you give a year over year comp on how the pension impacted your PNL in the first quarter?

[Janet Haugen:]

Pension expense or the retirement related expense for the three months ended 2009, in total was $2.9 million. Last year that number was 11.5, I am sorry they are both income. $2.9 maybe clear and that compares to $11.5 million in 2008 first quarter.

[[Sindar Adarjan]:]

Was there any restructuring expense that you charged this quarter or any color or anything in the first release? Was there any charge taken for any of the restructuring actually?

[Janet Haugen:]

From a restructuring standpoint, the actions that we are continuing work, we are looking towards making sure that they have the type of actions that self fund within the quarter. We have not called that a restructuring charge, a major program that is not how we are reducing the cost base right now. We are doing this through self funded primarily with a three month or less return.

[[Sindar Adarjan]:]

On the targeted savings of more than $300 million, how much would you say was realized pout of the first quarter on an annualized basis

[Janet Haugen:]

We have a little bit of seasonality in our business right now and so we remain cognizant in giving you a sense of where we are of that $300 million and how much we expect to realize in 2009. It is the most important measure for us particularly on some of our seasonal businesses like the technology business. Our teams around the world are executing to get it done as quickly as possible so we have made significant move forward against those goals in the first quarter. We have actions continuing to remain in the second and the third quarter.

[[Sindar Adarjan]:]

But the first quarter does reflect savings realized against it.

[Janet Haugen:]

Absolutely!

[[Sindar Adarjan]:]

Just moving ion the balance sheet issues. Number one you decided to cash collateralize your credit facility, I mean, these LCs that you had under your credit facility. Does it pretty much mean that you will not be renewing that credit facility or this is just an interim step?

[Janet Haugen:]

As we said in our 10K filing in the beginning of March, based upon the current credit environment, we do not expect to renew that revolving credit facility at this time. The credit markets are very different than the markets that we entered into or that existed at the time we entered into that agreement. So as part of that agreement as that unwinds in May, we did need to cash collateralized Letters of Credits that have been issued against us and we did $61 million of that in the first quarter

[[Sindar Adarjan]:]

Then on your 2010 maturity, you did not talk about pursuing a couple of alternatives. Any timeline you have set for yourselves in terms of when this would be completed?

[Janet Haugen:]

All I will mention is what we said in the press release. We expect to announce something shortly.

[Operator:]

Your next question is coming from Joseph Vafi – Jeffries & Company

[Joseph Vafi:]

Janet I know you said your OpEx was down 24% driven by so many actions in FX, could you break that down between those 2 categories of reductions.

[Janet Haugen:]

Sure, the OpEx was down 24 percentage points, currency was about 8 percentage points of that so 15% of the reduction in SG&A is coming from the actions that we have been working on.

[Joseph Vafi:]

That is great to see that but I guess the next question is obviously as you are reducing costs you are having to make some trade-offs between potentially some service provisions and maybe layers of other service. I wonder if you could talk a little bit more qualitatively about how you are approaching that process and what it means for customer service and just your ability to deliver the services for the customers.

[Ed Coleman:]

Thanks for the question Jo. On the SG&A side it is really not a customer service impact. Predominantly what has been driving our reductions is twofold. First I would say it is unwinding the matrix management structure that the Company has historically had and we talked about this a bit in the past but the Company historically has had management by business unit, management by geography, management by industry and then a series of strategic program offices and change management offices. In addition to that which I think has created a lot of excess overhead for the Company. So we have been clear they were Company by business unit. We have disbanded the strategic program offices and the change management offices. Geographic management is typically now dual roled as also one of the business unit leaders in that geography. It is really from a geographic stand points for the landlord management and support management role as opposed to trigger it as a line management, same thing with the industry. So unwinding the matrix has generated a lot of reductions in higher level management as well as in the supporting staff they have surrounded those management team. And then in other case it has taken really taken the view of what is necessary versus what is desirable from a staff standpoint around all those staff areas that do not have direct contact and support requirements with customers. That is where we have aimed the reduction activity on the SG&A front. On the total cost side there have been cost reductions associated with declining volumes and that is really about just managing the productivity of the service delivery people relative to the revenue opportunity.

[Joseph Vafi:]

Okay that is helpful and I guess ion that last point on the cost relative to the service provision capability which is basically in the gross line. Do you feel that that right now is optimized and more of the cost is still coming out of the SG&A line or is there any other efficiency improvements in the cost to services.

[Ed Coleman:]

I think there are definitely other efficiency improvement opportunities in the cost of the service side. I mentioned a couple of them in my comments, one moving more to remote infrastructure management capabilities opposed to onsite technical support. So moving to more remote and self service technology, they are good for both cost efficiencies and for customer satisfaction. The other is on the labor management side where again we are continuing to drive towards higher use of lower cost labor pool. As I mentioned over the last six months, our low cost labor has an increase as percentage of our population from 15% of the population to 18% and we want to keep driving that.

[Operator:]

Your next question is coming from John D. Moore - KDP Investment Advisors, Inc.

[John D. Moore:]

Hi I just have two questions; the first is on technology environment. We are dealing with deferrals here. Do you have any sense for how long that might be where customers are saying they… how long they can hold their breath on server buying in particular?

[Ed Coleman:]

Let me take that one if I may. The biggest impact that we have had in the technology business in the quarter which is typically a fairly weak quarter for us to be begin with has been in Japan. The business in Japan has just been very soft. Obviously you have seen that their economy is having some very rough gust as well. I am reluctant to predict when those customers are going to feel confident enough to execute on new purchases.

[John D. Moore:]

Just a housekeeping one on the proposed debt plans here. In terms of the security collateral, if you go down that route. What might that be and how does that pair up with the receivable facility that is outstanding right now.

[Janet Haugen:]

John, since we have not announced the transaction, I do not want to speculate as to what the transaction may look like. We did say that we intend to look for alternative or involve security and that we will expect to announce shortly. You just have to stay tuned for that but I do not want to speculate on the potential collateral package right now.

[Operator:]

Your next question is coming from [Sunny Seccombe] - JP Morgan

[[Sunny Seccombe]:]

Regarding the balance sheet, how much capital base do you need to be well positioned going forward and how much secure debt do you can issue in this environment.

[Janet Haugen:]

Unfortunately it is the same answer as the previous caller. We have announced that we are considering two alternatives. We expect to issue something on that shortly. It is a function of the market conditions at the time with regard to the amount of demand that exist, the type of transaction. You just have to stay tuned. We expect to issue something shortly.

[[Sunny Seccombe]:]

Could equity issuance be part of any capital risks

[Janet Haugen:]

I would refer you to the comments that we have made in the press release, talking about secured offering or an exchange.

[[Sunny Seccombe]:]

Could you remind me how much minimum cash do you need on the balance sheet to operate the Company?

[Janet Haugen:]

What we have said is that we are currently running with more cash than what we need to run the Company globally. That we are working on improving the efficiency of our operating models. We have reduced the cash requirements on that but we have not commented on what the minimum amount of cash is needed to run the business.

[Operator:]

Your next question is coming from Mark Kauffmann – [Lazard Capital]

[Mark Kauffmann:]

My question pertains to COD income and that might be raised if you were to do some type of a tender for lease out. I guess specifically, have you explored the opportunity for some of your foreign subsidiaries to actually bake the purchases and tender offers for the US debt. I understand underneath the stimulus package if that would be allowed as well.

[Janet Haugen:]

Given the fact that we have said that we are considering two alternatives and expect to issue something shortly, I do not want to comment on other potential alternative at this time.

[Operator:]

We have no further questions at this time. I would like to turn it back over to our presenters for any additional or closing remarks.

[Ed Coleman:]

Great! Let me just thank everyone for attending the call. I appreciate your participation very much and we would also just like to take the opportunity to thank all the Unisys employees, they are listening in as well for their hard work and their efforts and let us keep going. Thank you and good bye.