Unisys Corporation
Q2 2012 Earnings Call Transcript

Published: 25 Jul 2012

[Operator:]

Good day, ladies and gentlemen. Welcome to Unisys' Second Quarter 2012 Results Conference Call. At this time, I would like to turn the conference over to Mr. Niels Christensen at Unisys Corporation. Please go ahead, sir.

[Niels Christensen:]

Thank you, operator. Good afternoon, everyone, and thank you for joining us. Earlier today, Unisys released its second quarter 2012 financial results. With us this afternoon to discuss our results are Ed Coleman, our CEO; and Janet Haugen, our CFO. Before we begin, I want to cover a few housekeeping details. First, today's conference call and the Q&A session are being webcast via the Unisys investor website. Secondly, 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. These materials are available for viewing as well as downloading and printing. Third, today's presentation, which is complementary to the earnings press release, includes some non-GAAP financial measures. These have been provided in an effort to give investors additional information. The non-GAAP measures have been reconciled to their related GAAP measures, and we've provided reconciliation charts at the end of the presentation. 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 actual results to differ materially from 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 from the Unisys investor website. And now I'd like to turn the call over to Ed.

[J. Edward Coleman:]

Thanks, Niels. Hello, everyone. Thank you for joining us today to discuss our second quarter 2012 financial results. This is a solid quarter for Unisys. We reported significantly higher profits, grew revenue on a constant currency basis and continued to make progress on our 3-year financial objectives. Please see Page 4 in the presentation materials for highlights of our results. We reported net income of $46.6 million compared with an $11.6 million net loss a year ago. The year-ago net loss included a $45.7 million debt reduction charge. Excluding debt reduction charges and pension expense in both years, as well as the impact of a Brazilian tax matter in the year-ago quarter, our non-GAAP earnings per share rose to $1.41 from $1.07 in the year-ago quarter. Revenue declined 2% but grew 3% in constant currency despite a 20% revenue decline in our U.S. Federal business where market conditions continue to be challenging. This was the third quarter out of the past 4 that we've grown our overall revenue on a constant currency basis. Our technology business had a particularly strong quarter, growing revenue 12% on strong ClearPath sales. Year-to-date, our technology revenue was up 3%. We continue to believe the best way to measure this business is on an annual basis, and our goal is to maintain stable technology revenue for the full year, most importantly in our flagship ClearPath platform. Revenue in our services business declined 3% but was up 1% in constant currency. Within services, we grew our IT outsourcing revenue 8%. We saw good margin improvement year-over-year in both our services and technology businesses. In services, we were pleased to reach our targeted 8% to 10% operating profit margin range. Cash flow also improved in the quarter, and we are announcing today a further debt reduction action of $84.5 million that will enable us to achieve over a year early our debt reduction goal for year-end 2013. Turning to Page 5. As you recall at the end of 2010, we set financial objectives that we wanted to achieve by the end of 2013. Those objectives are

[Janet Brutschea Haugen:]

Thanks, Ed, and hello, everyone. Page 9 highlights our financial results for the second quarter. At the top line, we reported total revenue of $921.3 million in the quarter, which was down 2% year-over-year. Currency had a 5 percentage point negative impact on our revenue in the quarter. So as Ed noted, on a constant currency basis, revenue rose 3%. We have now grown revenue 3 of the last 4 quarters on a constant currency basis. Based on today's rates, we anticipate currency to have about a 5- to 6-percentage-point negative impact on revenue in the third quarter of 2012. We reported an operating profit of $79 million in the quarter, which was $30.9 million or 64% higher than the year-ago quarter's operating profit of $48.1 million. Our gross profit margin improved year-over-year by 360 basis points and our operating profit margin was 8.6%, up from 5.1% a year ago. Interest expense decreased $5.4 million from $13.3 million in the second quarter of 2011 to $7.9 million in the second quarter of 2012, reflecting the impact of our ongoing debt reduction. Other income expense for the second quarter of 2012 was $4.1 million of other income, of which $3.1 million related to a favorable currency impact. In the second quarter of 2011, other income and expense was $49.4 million of other expense, which included the $45.7 million charge related to the debt reduction. Our second quarter 2012 U.S. GAAP pension expense increased $12.4 million to $21.1 million compared to $8.7 million in the second quarter of 2011. Within the income statement, pension expense is allocated to cost of revenue, SG&A and R&D on the same basis as the salaries of active employees. Pension expense is not included in this segment result. We expect approximately $100 million in pension expense in 2012 compared with pension expense of about $34 million in 2011. For the second quarter of 2012, pretax income was $75.2 million compared to a loss of $14.6 million in the second quarter of 2011. Excluding the impact of pension expense and debt reduction charges in both years, as well as excluding the second quarter 2011 $13.5 million Brazil non-income tax matter, our non-GAAP pretax income increased to $96.6 million compared to $53.3 million of non-GAAP pretax income last year. At the tax line, we had a $22.1 million tax provision in the quarter compared with a $9.2 million tax benefit in the year-ago quarter. The second quarter 2011 tax benefit reflected the settlement of 2 European tax cases, which benefited our tax provision by $30.3 million. And as I've said previously, our tax provision continues to be highly variable from quarter-to-quarter depending upon the geographic distribution of our income. We reported net income of $46.6 million in the quarter versus a net loss of $11.6 million in the year-ago quarter. Excluding the impact of the debt reduction charges and pension expense in the second quarter of 2012 and 2011, as well as the Brazilian non-income tax item in the second quarter of 2011, Unisys generated adjusted EBITDA of $148.6 million for the quarter versus $114.2 million in the second quarter of 2011. Our diluted earnings per common share improved to $0.99 per share from a loss of $0.27 per share in the year-ago quarter. The diluted EPS calculation reflected an average share count of 51.2 million shares for the second quarter of 2012 and 43.1 million shares for the second quarter of 2011. Excluding the impact of the debt reduction charges, pension expense and the prior year Brazilian tax matter, our second quarter 2012 non-GAAP diluted EPS was $1.41 per share compared to $1.07 in the second quarter of 2011. Please turn to Page 10 for some context on the progress we have made in terms of strengthening our operating profitability. With our performance in the second quarter of 2012, we have achieved the highest trailing 12-month operating profit margin we have recorded since our turnaround efforts began. We recognize that we still have work to do to achieve consistent and predictable profitability each quarter, but we are encouraged by our progress to date. Moving to our second quarter revenue, please turn to Page 11. Services revenue, which represented 89% of our revenue in the second quarter of 2012, declined 3% year-over-year. Currency had a 4-percentage-point negative impact in the quarter, so services revenue grew 1% on a constant currency basis. Excluding our U.S. Federal business, services revenue was flat, up 5% on a constant currency basis. Technology revenue, which accounted for 11% of our revenue, rose 12% year-over-year. On Page 12, you can see services revenue and margin. Services gross profit margin increased 90 basis points year-over-year to 21% from 20.1% in the second quarter of 2011. This primarily reflected improved gross profit margins in IT outsourcing. Our services operating margin rose by 90 basis points year-over-year to 8%, which reached our targeted range for services operating profit in the quarter. Within outsourcing, IT outsourcing revenue was up 8% versus the second quarter of 2011. Moving on to technology revenue and margins on Page 13, ClearPath's revenue rose year-over-year. Sales of other technology, which includes third-party equipment, declined by $10 million. Our annual goal continues to be to maintain stable technology revenue, most importantly in our flagship ClearPath platform. Benefiting from higher ClearPath sales, we reported a technology gross margin of 63.4%, up over 14 percentage points from the prior year. Our technology operating margin improved significantly to 28.6% from 2.4% in the second quarter of 2011. Page 14 provides more detail on our U.S. Federal government revenue over the past 6 quarters. Our Federal Systems business serves 3 primary sectors of the U.S. Federal government

[J. Edward Coleman:]

Great. Thank you, Janet, very much. Operator, we'd like to open the call up to questions now, if we may.

[Operator:]

[Operator Instructions] We'll take our first question from Jamie Friedman with Susquehanna.

[James E. Friedman:]

So I was hoping to get a -- the thing that jumps out, first off, is the ClearPath performance. I was hoping that you could share a little bit more detail. Is this a reflection of one large project or a couple of good-sized projects or a general improvement in the demand environment?

[J. Edward Coleman:]

Jamie, I think it's fair to characterize this as just a good quarter for ClearPath across many clients around the world. As you know, we've been working hard to reaffirm our commitment to ClearPath, reaffirm our investments and accelerate our investments in ClearPath. And I think all of that's paying dividends in terms of our clients continuing to view ClearPath as a mission-critical platform to run their businesses on. As we've said before, it's hard to look at ClearPath quarter-to-quarter or quarter-by-quarter and better to look at it on a yearly basis. Our goal is still, as it has been for the last 3 years, to maintain stable revenue, most particularly in ClearPath, and we're glad to be able to say that we have done that for the last 3 years, and we're on track so far this year.

[James E. Friedman:]

So Ed, was there a call-out of a large contract in there? Or it was more distributed demand observation?

[J. Edward Coleman:]

I'd characterize it as more distributed demand observation for the ClearPath platform.

[James E. Friedman:]

Great, great, okay. And then, Janet, could you say again what the currency exposures are for the company? Like specifically, what percentages year-round, if you have that? And I recall you do a fair amount in Brazil, if I'm not mistaken, maybe some more color on the currency.

[Janet Brutschea Haugen:]

Sure. So Jamie, I said in my comments that currency, as we go into the third quarter, will have about a 5- to 6-percentage-point impact on the revenue comparisons year-over-year for the third quarter. The 4 main currencies that are impacting us right now, in order of significance, is the euro, the Brazilian real, then the pound and then the Aussie dollar, with the euro and the Brazilian real movements making up the majority of that change.

[James E. Friedman:]

Okay. And I appreciate the updated color with regard to the pension. And I may be embarrassing myself here, but can you just state again what the discount rate is that you're using to update the pension contribution?

[Janet Brutschea Haugen:]

The discount rate that is being used as a result of the U.S. legislation is different from the U.S. GAAP rate. At the end of the year, we determined that the year-end GAAP discount rate was 4.96% for the U.S. plans; internationally, 4.65%. Under the MAP-21 legislation, you now have the ability to look at the 25-year average of rate by segment as it's defined in the legislation. So you have a combination of a segment approach, as well as a 25-year average compared to previously it was about a 2-year average. We've made an estimate based upon what we understand the legislation, based upon some discussion with our actuaries, but the rate will not be final until the IRS publishes the rates.

[Operator:]

We'll go next to Ned Davis with Wm Smith & Co.

[Ned Davis:]

Focusing again on the pension numbers, you don't -- you can't release what the rate is that you're assuming based on your actuarial analysis, and so that we at least know what it is? And secondly, could you tell us the precise key assumptions that go into what looks like an increase in the domestic funding of $10 million in 2014, notwithstanding the benefits of the federal legislation. I'm sorry, I just don't understand what the mix of assumptions that go into that increase are.

[Janet Brutschea Haugen:]

It's probably a more complex answer to do in a short time period, Ned. It's a function of the way the layers get amortized in under the U.S. funding calculation. So as you go out, we have the impact of multiple things happening. Earlier legislative change provided a 15-year amortization of some of the earlier underperformance corridors, so that goes out over time. The second thing is the discount rate, which is the 25-year average of different segments compared to the 2-year average. The combination of those 2 things, combined with the funding regulations that vary depending upon what percentage funded you are in triggering the subsequent year's funding, results in this calculation. What we believe what the best way to approach it, as we did in the last quarter, is given the fact that there are many nuances into that calculation that the best approach was to provide what we see those calculations to be over the out years, because it is be very difficult to get through all the moving pieces in a real short concise way. So the impact of the MAP-21 legislation provides funding relief for companies for 2012 and 2013 funding, but it doesn't go beyond that based upon the passage of the current legislation. They may come back and extend the release that's in '12 and '13 beyond that. But right now, it is only expected to be there for -- well, it's only in the legislation for '12 and '13.

[Ned Davis:]

Okay. Just a related question. I've asked you before about as time goes on what the capability of the company would be to, in effect, de-seize [ph] all or part of the pension liability. Can you provide any color as a result of the legislation and the company's progress in cash flow and reducing your expensive debt as to what the chances of that would be over the next 5 years?

[Janet Brutschea Haugen:]

Just to put perspective, as you know, Ned, the December 31, 2011, underfunding was $1.6 billion in the U.S. and $400 million internationally, for a total of about $2 billion. We are very excited that we early achieved our debt reduction goal. As a result of doing that and continuing to work on improving the free cash flow generation of the business, we believe that gives us more opportunities for options, and we are currently evaluating a number of different options as we go forward. I don't want to comment on a specific one at this point in time.

[Ned Davis:]

Okay. One last question. Once the debt redemptions are completed that you've announced, what would your weighted average interest rate be on your debt going forward?

[Janet Brutschea Haugen:]

It's going to be slightly -- about 12.5%, a little bit higher than that, 12.6%.

[Ned Davis:]

Going forward, on the -- you mean on the outstandings after the redemptions?

[Janet Brutschea Haugen:]

That's right. Because after these redemptions, we will have $183.1 million of the 2014 maturities that are at 12 3/4% and $26 million of the 2016 maturities that are at 12.5%. As I said in my comments, and last quarter I said we were going to look at ways to reduce the outstanding debt to hit our goal, we did that with today's announcement. We are as well looking to reduce our interest expense on the remaining debt by continuing to evaluate options going forward for refinancing.

[Ned Davis:]

Okay. One last thing on the capital side. Has the company got any more to say about the potential of share buyback?

[Janet Brutschea Haugen:]

We are pleased that we've met our 2013 debt reduction goal early. This creates greater options for us. We are continuing to evaluate the best choices to make for that as market and other conditions change over time. But we don't -- I don't want to comment specifically on any particular option at this point in time. The good news is we've accomplished the debt reduction goal, and that gives us greater optionality going forward.

[Operator:]

[Operator Instructions] We'll take our next question from Frank Jarman with Goldman Sachs.

[Karl Blunden:]

This is Karl Blunden on for Frank. Just a quick question on the success that you've had in addressing your balance sheet. Have you initiated discussions with the rating agencies around a potential future upgrade? And do you expect an upgrade following these actions?

[Janet Brutschea Haugen:]

I don't know that I would ever be in a position to forecast what the rating agencies are going to do. Just comment that we're BB- from S&P and Moody's has us at B1, both have us as stable. Their recent reports have commented on the pension obligations. They recognize the performance we've made in improving the debt position, but they do recognize the uncertainty around the pension area. We have ongoing conversations with the rating agencies, keeping apprised, making sure they understand the progress that we've made. But I don't want to comment on any future action by the rating agency.

[Operator:]

And ladies and gentlemen, this does conclude today's question-and-answer session. At this time, for closing remarks, I'd like to turn the conference over to the Chairman and CEO, Mr. Ed Coleman.

[J. Edward Coleman:]

Well, thank you, operator. And more importantly, thank all of you for being on the call today. We certainly appreciate your participation and look forward to speaking with you on our next call. Thank you very much.

[Operator:]

Ladies and gentlemen, this does conclude today's conference. We appreciate your participation.