Unisys Corporation
Q2 2015 Earnings Call Transcript

Published: 24 Jul 2015

[Operator:]

Welcome to the Unisys Second Quarter 2015 Results Conference Call. At this time I would like to turn the conference over to Mr. Niels Christensen, Vice President of Investor Relationships at Unisys Corporation. Please go ahead.

[Niels Christensen:]

Thank you, operator. Good afternoon everyone and thank you for joining us. Earlier today Unisys released its second quarter 2015 financial results. With us this afternoon to discuss our results are Peter Altabef, our President and CEO and Janet Haugen, our CFO. 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. And 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 provided reconciliations within the presentation. Finally, I would 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. Now I'd like to turn the call over to Peter.

[Peter Altabef:]

Thank you, Niels and thank you all for joining us today. In the second quarter we accelerated our efforts to improve Unisys' profitability, increase our competitiveness and market differentiation and ultimately drive revenue growth. During this call I will take you through our second quarter performance and provide an update on our progress. In the second quarter we reported revenue of 765 million, a decrease of 5% from the same quarter last year with an increase of 4% on a constant currency basis. We had revenue growth in both our services and technology segments on a constant currency basis. The gross profit in our technology segment was lower year-over-year despite essentially flat revenue due to a higher proportion of non-proprietary technology. Our technology operating profit margin improved significantly due to lower SG&A costs. While it improved sequentially, our services gross profit was below the prior year and continues to be challenged but the startup costs are new multi-year engagements. The company's gross and operating profits in the second quarter of 2015 were adversely impacted by the initial cost reduction charges associated with the program we announced in April as well as higher year-over-year pension expense. Excluding the impact of the cost reduction charges and pension expense during the second quarters of 2015 and 2014 our diluted earnings per share rose to $0.33 per share from $0.11 per share. As I’ve mentioned before, we’re increasingly focused on vertical markets to build on our strengths, offer attractive growth and margin potential and provide a good fit for our capabilities and offerings and our three aggregated verticals, are government, commercial and financial services. In the second quarter of 2015 government revenue increased to 10% on a constant currency basis. Our government vertical includes revenue from both the U.S. Federal government and the public sector which includes the work we do for state and local governments in the U.S. and for governments outside the U.S. We had another strong quarter in the U.S. federal market with year-over-year revenue growth of 32% as we continue to see the benefit of revenue coming online from contracts we won last year as well as accelerated deployments at some clients. While we expect to continue to see year-over-year services revenue growth from our U.S. federal organization through the end of 2015. This was an exceptionally strong quarter and we expect the level of growth during the second half to be considerably lower. We also expect U.S. federal technology revenue for the full year to be significantly below 2014 due to a very strong fourth quarter for technology in 2014. Within our U.S. federal organization we expanded our work with the U.S. patent and trade mark office which awarded us an advisory services engagement to design a road map for our next generation IT service management system. We also won a contract to provide cloud and infrastructure services to the U.S. federal energy regulatory commission, a new client for Unisys and we signed a contract to provide a storage and networking technology solution to the defense logistics agency another new client. Public sector revenue declined 3% on a constant currency basis reflecting lower year-over-year services revenue and technology channels. Within the public sector we won an engagement with the government of New South Wales in Australia. We will be moving this client's work to a consumption based as a service model for IT services, very similar to what we’re doing for the Commonwealth in Pennsylvania, an exciting offering for our company. During the second quarter we also expanded the services we are providing to the Commonwealth of Pennsylvania. Moving to the commercial sector, revenue grew 8% on a constant currency basis. This growth was driven largely by technology revenue from travel and transportation clients. There were a number of important wins including a multi-year contract with a global air transport leader that included a clear path, our air core software and services. In Asia Pacific, we won additional business with an exciting transportation client for an incremental clear path capability. In other commercial sector business, we won a significant cloud and infrastructure contract expansion with the leading Latin American retailer. Our financial services industry revenue declined 11% on a constant currency basis. The year-over-year decline in financial services reflected lower BPO services and technology revenue from banking clients. During the second quarter, we signed new cloud infrastructure contracts with two new financial services clients in the U.S. and Canada. When a bank and the other leading insurance brokerage firm. We also extended a cloud and infrastructure engagement with a major Latin American bank client. After an evaluation of our capabilities and the market we have determined that within the vertical sectors we serve, we will focus our initial investments on four specific initiatives. In the government sector we will emphasize justice, law enforcement and border security. In the commercial space we have two initiatives the first is life sciences and healthcare and the second is travel and transportation. Finally in financial services the initial initiative is retail banking. We already have a significant presence among some of the largest enterprises in the industries where we have launched these initiatives. Greater focus investment will enable us to get closer to our clients and prospective clients by enhancing our understanding of their business and enabling us to deliver highly differentiated value added solutions that address the most immediate difficult challenges. Overtime we expect to launch additional initiatives within the three verticals. While our industry focus will deepen our domain knowledge, the vast majority of our revenue will continue to derive from leveraged offerings tailored as necessary to industries. Security is a good example and during the second quarter our security solutions practice continue to build a comprehensive security portfolio that includes security consulting services, physical and logical security products and solutions and managed security services and our [indiscernible] security software. As one of our core assets for our security solutions practice, stealth continues to garner recognition for the unique and innovative ways in which it addresses some of the most urgent security challenges that commercial enterprises and government organizations plays today. Last week stealth received it's second award of 2015, when Frost & Sullivan announced that it earned the North America encrypted network security solutions new product innovation award. Moving to our cost reduction efforts, as I discussed in April, we’re aggressively implementing our plan to increase the competitiveness of our cost base, improve our delivery efficiency and increase our differentiation in the marketplace. The plan that we have announced anticipates restructuring charges of 300 million over the next several quarters that will generate approximately 200 million in net annualized savings by the end of 2016, we recorded a charge for the second quarter for the first phase related to cost reductions in the U.S. and Canada, Asia-Pacific and Latin America, we have more to do in each of these regions but we’re moving as quickly as possible. We also have efforts underway to take costs out of our EMEA region, although we anticipate these will likely ramp next year. We’re also working to improve gross services margins by refining our service delivery models, solution guidelines, work force pyramids, the mix of onshore and off-shore resourcing, levering greater areas of automation and in some cases reducing our dependency on sub-contractors. We expect that these changes will improve services gross margins and also allow us to reduce expenses related to pre-sales, solution architecture, costing and contracting related expenses while increasing the volume and velocity of transactions for our sales team. Finally as we discussed in the context of our reorganization and realignment of the company, having the right leadership is essentially. On our last global earnings call I mentioned that we had hired Neil Gissler to lead our services team. During the second quarter, Tarek El-Sadany joined the company as the leader of our technology organization and as Chief Technology Officer. Tarek has brought experience in product development and support in both the public and private sectors and in his roles at Unisys will be focused on developing future generations of products and software that meet our client's needs. You can also expect us to strengthen the team's responsible for our verticals. In that context we have been actively recruiting within the government sector which represented 44% of our revenue during the second quarter. Yesterday we announced that Mark Forman will join us as the Global Head of the Public Sector which represented 24% of our revenue in the second quarter of 2015. Mark comes to us with a tremendous background and transforming and modernizing sector IT operations including his role as administrator of the office of e-Government and IT, now known as the Federal Government CIO in the George W. Bush administration. We have also strengthened the leadership within our U.S. federal organization which is led by Venkatapathi Puvvada and represented 20% of the company's second quarter 2015 revenue. Early in the second quarter Casey Coleman, the Former CIO for the United States General Services Administration joined Unisys as Group Vice President for the Civilian Agencies Group which represents 40% of our U.S. federal revenue and yesterday we announced the addition of Jennifer Napper, retired major general in the United States army as Group Vice President for the Department of Defense and Intelligence Group, which accounted for 20% of our federal revenue in the second quarter.

[Jennifer Napper:]

There is still much work to do but I'm confident that we’re making the changes necessary to build a more cost effective, efficient and profitable company. Thank you again for joining us. I will now turn the call over to Janet to discuss our second quarter results and we will then open the call to questions.

[Janet Haugen:]

Thank you, Peter. Hello everyone and thank you for joining us this afternoon. Please turn to slide 3 for a discussion of our second quarter 2015 financial results, there were two factors that significantly impacted our results in the quarter. First year-over-year movements in currency rates affected the comparison of our performance and I will identify the impacts as I discuss the results. Secondly, we recorded a $53 million pretax charge related to our cost reduction action and I will cover this in more detail later in my comments. We reported revenue of $765 million in the quarter which was down 5% year-over-year but up 4% on constant currency basis. This represented the second consecutive quarter of growth on a constant currency basis. The major currency fluctuations impact our year-over-year comparisons are the Euro to Sterling, the Brazilian real and the Australian dollar. Based on today's rates we anticipate currency will have an 8 to 9 percentage point unfavorable impact on revenue comparisons for the third quarter of 2015 when compared to the third quarter of 2014 and an unfavorable impact of 7 to 8 percentage points for the full year. Our overall gross profit margin of 16.3% declined from 20.5% in the second quarter of 2014. Off the 420 basis point reduction the cost reduction charges and increased pension expenses were responsible for 270 basis points of the decline and 90 basis points additionally were due to currency fluctuations. The remaining 60 basis point reduction reflected lower services and technology gross margins. There is minimal benefit from our cost reduction actions included in the gross margins in the second quarter. The year-over-year operating expense increase was caused by the cost reduction charges of $39 million and a $2 million increase in pension expense. Excluding the cost reduction charges and pension expense, operating expenses declined 11.5% year-over-year down approximately 1.5 percentage points on a constant currency basis substantially from the benefit of cost reduction actions taken to-date. Non-GAAP pretax profit of $28.3 million towards the second quarter of 2015 compared to $28.6 million in the prior year period. The non-GAAP results exclude the cost reduction charges and pension expense. On a constant currency basis, non-GAAP pretax profit increased from $28.6 million to approximately $29.7 million. Our second quarter 2015 diluted loss per common share was a $1.17 which included $0.97 for cost reduction and $0.53 for pension expense compared to $0.24 diluted loss for common share in the year ago quarter which included $0.35 per pension expense. On a non-GAAP basis second quarter 2015 diluted earnings per common share increased to $0.33 from $0.11 in the year ago quarter. [Indiscernible] our second quarter 2015 revenue by segment, geography and industry. From a segment view services represented 86% of our second quarter 2015 revenue. Services revenue declined 6% year-over-year but was up 3% on a constant currency basis. Looking at the services segment revenue in more detail, cloud and infrastructure services represented 51% of our overall second quarter 2015 revenue and was down 10%. Currency caused approximately 9 percentage points as a decline, the cloud and infrastructure services were down 1.3% on a constant currency basis. Application services was 28% of our second quarter 2015 revenue and grew 6% up 16% on a constant currency basis. Our new work at the U.S. Federal and Customs and Border Patrol and [indiscernible] contract which we won last year was a major contributor to the revenue growth. Business process outsourcing was 7% of our overall second quarter 2015 revenue. BPO revenue declined 17% year-over-year, all of the BPO operations are outside of the U.S. so currency movements had a significant impact on these results closing approximately 10 percentage points of the decline. Technology represented 14% of second quarter of 2015 revenue. Revenue was flat year-over-year but up 10% on a constant currency basis. While we are pleased with the first half technology revenue growth, it does not change our view that 2015 technology revenue will be negatively impacted by currency and lower renewal opportunities compared to 2014. Quarterly seasonality can vary from year-to-year. Last year first half technology revenue was 30% of the full year, this year is looking different. We currently anticipate that the first half technology revenue in 2015 will represent a bit over 40% of the full year with the lower volume the gross margin percentage will be lower. Moving to geography, U.S. and Canada represented 51% of our overall revenue and grew 23% on the strength of higher application services and technology revenues. Revenue outside of the U.S. and Canada represented 49% of our overall second quarter 2015 revenue. All of our international regions declined on a reported basis but we have a modest growth of 2% in Asia-Pacific on a constant currency basis led by higher technology and cloud and infrastructure revenue. Revenue in Latin America declined 35% as reported and 19% on a constant currency basis while revenue in EMEA decreased 24% as reported and 11% in constant currency. Most of the year-over-year constant currency decline in Latin America and EMEA reflected lower technology revenue which can vary significantly from quarter to quarter. From an industry perspective we break our revenue into four groups, commercial, financial services and two industry groups within government, U.S. Federal and public sector. Public sector includes the work for local and national governments around the world other than the U.S. federal government. Based on second quarter 2015 revenue, government is our largest industry group representing 44% of our overall revenue. Within government public sector represented 24% of our overall second quarter 2015 revenue and declined 3% in constant currency. U.S. federal the other component of our government group was 20% of our second quarter 2015 revenue and grew 32% year-over-year. The commercial sector represented 34% of our overall revenue and the revenue from our commercial industry customers declined 4% as recorded but rose 8% on a constant currency basis. Financial services represents 22% of our overall revenue and revenue from our financial services industry customers declined 19%, 11% in constant currency. Moving to discuss our second quarter segment results in more detail, please turn to slide 5, services gross profit margin declined a 120 basis points year-over-year to 15.7% with currency causing 60 basis points of the decline. Our second quarter 2015 services margins were impacted by lower revenue and startup cost on new multi-year engagements. As Peter mentioned our services delivery team is working to improve services gross margins by refining our services delivery model, solution guidelines, workforce pyramids and the mix of onshore and offshore resources as well as reducing our dependencies on sub-contractors and leveraging automation. Through the second quarter there are minimal benefits from our cross reduction actions in the gross margins. However, services operating expenses had a $5 million benefit in the quarter from cost reduction action. The services operating margin of 2.2% in the second quarter of 2015 was down a 140 basis points year-over-year with 10 basis point decline on a constant currency basis. Technology gross margins declined 590 basis points year-over-year to 43.9% due to the mix of business and currency fluctuations. Currency fluctuations negatively affected technology gross margins by 430 basis points. The remaining 160 basis points decline reflected a higher proportion of revenue from non-proprietary technology. Our operating profit margin improved due to lower SG&A expense. There is some comments on services orders please turn to slide 6, in the second quarter of 2015 our overall services orders declined year-over-year. Last year we had a very large order in the U.S. and Canada related to the cloud and infrastructure contracts we signed with the Commonwealth of Pennsylvania. Second quarter 2015 orders were up year-over-year in every region other than U.S. and Canada. We ended the second quarter with $4.4 billion in services backlog, backlog was down 5% year-over-year but up 3% in constant currency. Off the services backlog at June 30, 2015 approximately $605 million is expected to convert into third quarter 2015 services revenue. This compares to $590 million going into the second quarter of 2015 which represented 89% of the second quarter services revenue. The amount on revenue and backlog at the start of the quarter is estimated to be between 90% and 95% of our quarterly services revenue for the full quarter. Moving to cash flow, please turn to slide 7 for an overview of our performance in the quarter. Cash used in operations was $21 million in the second quarter of 2015 including cost reduction payments of $30 million and pension contributions of $37 million versus cash from operations of $3 million in the second quarter of 2014 which included pension contributions of $48 million. Capital expenditures were $54 million in the second quarter of 2015 versus $45 million in the second quarter of 2014, the increase in capital expenditures reflected higher investment in outsourcing assets. For the full year we anticipate CapEx of approximately $200 million. Excluding the impact of pension and cost reduction charges, Unisys generated adjusted EBITDA of $72 million in the second quarter of 2015 versus 77 million in the prior year period. We have free cash usage of 75 million in the second quarter of 2015 versus free cash usage of 42 million for the same period last year. The increased usage reflected the combination of lower operating cash flow and higher capital expenditures. Our free cash usage for pension and cash contribution and cost reduction payments was $24 million for the second quarter of 2015 versus free cash flow generation of $6 million in the second quarter of 2014. At the end of the second quarter the company had approximately $365 million in cash and approximately $255 million in debt. The company expects to opportunistically access the capital markets and issue debt to take advantage of attractive market condition primarily to fund the cost reduction and savings initiative. Now let me provide an update on our cost reduction actions in connection with organizational initiatives to create a more competitive cost structure and rebalance the company's global skillset. As we announced on our last earnings call we expect to record a pretax charge over several quarters of approximately $300 million. During the second quarter of 2015 we recognized a pretax charge of 53 million under this plan. This initial charge includes $43 million in severance and $10 million in asset impairment. Overall our cost reduction actions are expected to generate annualized savings of approximately 200 million exiting 2016 and we believe we will exit 2015 with approximately a $100 million in annualized savings. The cash outlay for these items which commenced in the second quarter of 2015 was expected to occur over the rest of 2015 and 2016. Cash payments of $30 million were made in the second quarter. I also wanted to take a moment to provide an update regarding our defined benefit pension plan, given changes in the interest rate environment during the first half of 2015. On slide 8, we show the impact on our pension liabilities if the discount rate was changed to reflect the interest rate conditions at June 30, 2015. For this estimate we have held all other assumptions constant with those used at December 31, 2014. Of course our 2015 pension obligations will be recalculated using discount rates and other assumptions at December 31, 2015. But if we were to reset the discount rate at June 30, 2015 market conditions the U.S. discount rate increases from 4.09% at December 31, 2014 to an estimated 4.55%. The weighted average international rate increases from 3.05% at December 31, 2014 to approximately 3.38%. This would result in approximately a $600 million reduction in our reported pension liability. The assets have declined modestly since December 31, 2014 as positive asset returns during the first half of 2015 were offset by benefit payments and currency impacts. So our net under-funded position would be approximately $500 million improvement from December 31, 2014. We have a lot of activity going on in the company to improve our competitiveness. As Peter and I both mentioned we have a number of activities underway to improve services gross margins which we see as an area of opportunity for improved performance. We are on track against our cost reduction program to achieve $200 million in annualized savings by the end of 2016 with actions to get a $100 million of these annualized savings completed by the end of 2015. Thank you for your time and now I would like to turn the call back over to Peter.

[Peter Altabef:]

Janet, thanks very much. Operator I think we will now be open for questions or comments.

[Peter Altabef:]

There being no questions we will end the call. We remain available for discussions following the call and at any time in the future. So please don’t hesitate to contact us. Niels, anything further at this point?

[Niels Christensen:]

I would just echo that and we look forward to hearing from everybody. Thank you for listening to the call today.

[Peter Altabef:]

All right. Thank you very much.

[Operator:]

And this does conclude today's conference call. Thank you again for your participation and have a wonderful day.