Unisys Corp (UIS) 2002 Q2 法說會逐字稿

Good afternoon and welcome to Unisys' second quarter 2002 results teleconference. At this time all lines have been placed in a listen-only mode and the floor will be open for questions following the presentation. It is now my pleasure to turn the floor over to your host, Mr Jack McHale. Sir, you may begin.

Thank you very much operator and hello everyone. Thank you for joining us today. I would like also to welcome those of you who are listening to us across the Internet. If you need a copy of today's earnings press release you can get one on FirstCall or via the Unisys investors website at unisys.com/investor. Despite what continues to be a very challenging economic environment Unisys met its earnings target for the second quarter and showed significant earnings growth over the prior year. With us today to talk about the quarter and those results are Unisys' Chairman and CEO, Larry Weinbach, and our Chief Financial Officer, Janet Haugen. Before we begin just a few housekeeping details. First, we will be using some presentation cells this morning to guide the discussion. These cells are available on our investors website for viewing or downloading and you can advance through them as Larry and Janet make their remarks. Second, a recording of this conference call will be available shortly after the conclusion of the live call. The replay will be available for about ten days and you can access the replay on the Internet via the Unisys investors website. Finally, please note that all forward looking statements made in this conference call are subject to various risks and uncertainties that could cause actual results to differ materially from expectations. These factors are discussed more fully in the company's latest Form 10Q as filed with the SEC. Now, to start today's call, let me hand it off to Larry.

Thanks Jack and good afternoon everyone. Thank you for joining us today and giving us an opportunity to discuss our second quarter 2002 financial results. I hope you have all had a chance to review our earnings release. We issued it about half an hour ago after the close of trading on the New York Stock Exchange. For those of you who are viewing our presentation slides on the web, please turn to Chart 1 of the materials for an overview of our performance in the quarter. Overall, I was very pleased by our execution in this second quarter. We met our earnings target for the quarter. We achieved a 44% year-over-year growth in our per share earnings, as we said we would. The 44% is the per share earnings increase for the second quarter of 2002, compare with a year ago earnings per share before the extraordinary item. We achieved this earnings increase in what continues to be a very challenging and also very volatile economic environment. But there were three key contributors to our earnings improvement in the quarter. First, we achieved a sharp improvement in our services margins over the year-ago period. We have now shown steady , sequential improvement in our services margins for four consecutive quarters. I will speak more about this in a few moments. A second key contributor to our profit growth was strong ClearPath sales in the quarter. We continue to be encouraged by the level of customer interest that we are seeing in our new ClearPath Plus models. These are the models based on our Cellular Multiprocessing (CMP) architecture. Third, we continue to exercise tight control over costs as we have all year and throughout the technology downturn over the past 18 months or so. In fact, over the past six quarters, during what has arguably been the sharpest downturn in technology spending in 30 years, Unisys has consistently met or beat the quarterly financial targets that we communicate at the beginning of each quarter. Chart 2 of the presentation materials shows key financial highlights from the quarter. Starting from the top line, we reported second quarter revenue of US$ 1.36 billion, which was within our targeted revenue range, but down about 7% from year-ago levels. Our services revenue came in at US$ 1.04 billion, down 4% compared to the second quarter of 2001. We saw continued growth in outsourcing revenue in the quarter, while other areas of our services business showed some revenue declines. Customer revenue for our technology business was US$ 321 million in the quarter, a decline of 15% from a year ago, as customers continued to defer new IT projects during this period. However, we were encouraged, as I mentioned, by mid single-digit growth in sales of our ClearPath servers. Strength in ClearPath offset double-digit revenue declines in specialised equipment and in our ES7000 line. Turning to margins, our gross and operating margins improved significantly in the quarter, reflecting cost reductions, reflecting our focus in higher value-add services business, and also higher ClearPath sales. We showed a 2.5 percentage point improvement in our gross margin in the quarter, and our operating margin more than doubled from a year ago to 7.1%. Margins improved in both our services and technology businesses with a particularly sharp year-to-year improvement in services operating margins. As I mentioned, we continue exercise tight control over costs. We reduced selling, general and administrative expenses by 11% in the quarter as we continue to implement the cost reduction actions, which we announced last year, as we continue to streamline our internal processes, and as we continue to reduce discretionary expenditures. At the bottom line we reported earnings per share of US$ 0.14 in the quarter, which was within the targeted range that we provided back in April. We also met the street consensus estimate. Overall, it was a solid quarter for Unisys. We grew our earnings significantly. We achieved our financial targets despite the environment in which we are operating. Our Chief Financial Officer, Janet Haugen, will provide further details on our second quarter results after my remarks. But right now I would like to provide further details about the two segments of our business, services and technology, and I want to discuss some key trends and initiatives in each of them. Starting with our services business, please turn to Chart 3. As you know, we have engineering a major repositioning of our services business over the past 18 months. We have done this so that we can focus on higher value-added services and enhance our profit profile. This has been a multi-pronged effort. It has involved re-skilling. It has involved resizing our workforce to the current demand environment and bringing on experienced new leadership and consultants for our global industry practices. It has involved showing greater discipline and focus in pursuing only value-added business opportunities with higher margin potential, while at the same time de-emphasizing commodity-based business. It has involved placer a greater emphasis on long-term annuity-based services business, such as business process outsourcing and managed network services - services that provide greater visibility into our future revenue and earnings stream. It has involved an ongoing change in the culture of our organisation, and we have been succeeding in these efforts. Our progress is yielding tangible results, as evidenced by the increasing profitability of our services business. Chart 4 shows the improvement we have made in our services margin over the past year. As you can see, our services operating margin have improved steadily from the second quarter of 2001. While we still have more work to go in order to achieve our long-term margin targets for our services business, we are now as a company generating more operating profit from services than from technology. As you can see in Chart 5, in the second quarter of 2002 56% of our total operating profit, before any company eliminations, came from our services business. This compares to only 18% in the second quarter of 2001. So, we are making good progress in improving the profitability of our services business, and we are looking for continued, sequential operating margin improvement in the second half of this year. While the first half of 2002 was challenging from a services order perspective, we do have a strong pipeline of services proposals, particularly in outsourcing. Chart 6 gives an overview of trends that we are seeing in our outsourcing business. We are currently working a number of significant outsourcing deals, which we hope to close in the third and fourth quarters. While competition is intense, we believe that we are well positioned with a clear value proposition, and our chances are good to win a fair number of these deals. As I have discussed before, we are very selective in the outsourcing opportunities that we choose to pursue. Our focus is primarily on business process outsourcing and managed network services deals - deals where we can add value to our industry expertise and our solutions. In business process outsourcing we are focused on opportunities in such areas as payment processing, mortgage and insurance processing, claims processing, remittance processing, and healthcare payer administration. In managed network services we are pursuing opportunities in security, remote network management, infrastructure consolidation, as well as helpdesk and support. The common denominator in our outsourcing business is that we are focused on opportunities where we are viewed as a long-term strategic partner to the client, not just a vendor. This is a critical distinction. Partner relationships are based on value. As an outsourcing partner, we can structure deals where both Unisys and our client mutually benefit over the long term. Vendor relationships, on the other hand, are typically price driven. Clients work to get the lowest price deal, and the supplier tries to recoup lost margins by continually hitting the client with change orders. As I have said before, and it bears repeating, our strategy at Unisys is based on opportunities where we can add value for the client in a partnering relationship. This is true across all our businesses, whether in outsourcing, systems integration, network services, high-end servers or consulting. Certainly we work very hard within our own business to continually reduce costs and expenses, to create cost efficiencies in our services practice and our manufacturing operations, so that we can be cost competitive in the marketplace. But, ultimately the deciding factor in the deal is strictly the lowest price and the client is not really concerned about value. We have walked away from some deals. In fact, we do a lot of work in due diligence in advance, so we can make sure we know a client is really focused on value. Of course, the process of pursuing value-based, relationship-based service opportunities frequently takes longer than price-driven deals. This is particularly the case in large scale business process outsourcing deals - deals where the client is, in essence, turning over a key part of their business for us to operate over a five to ten year period. The current economic environment is only adding to the time needed to close these deals, given the scrutiny being placed on virtually all spending decisions, especially those in the hundreds of millions of dollars. Still, we are well along in the proposal process of many of these large outsourcing opportunities, and we expect a significant increase in our outsourcing order bookings in the second half of the year. Please turn now to Chart 7 for a brief discussion of trends in our systems integration and consulting business. While our systems integration revenue and orders were down in the quarter, a quarter where this market remained weak industry-wide, we continue to see pent-up demand for IT projects - projects in security, web-based commerce, advanced messaging solutions and other strategic areas. Among the industries on which we focus the most active right now is the public sector. As I am sure you have all been reading in the papers, many agencies of the US federal government are looking for more robust, integrated information systems to help them improve security, enhance intelligence operations and better protect and serve US citizens. As a leading provider of services and solutions to the federal government Unisys is actively engaged in a number of these initiatives. We have one of the industry's strongest bases of approved contracting vehicles, and the use of vehicles against which we can bid on large government opportunities. We are leveraging these vehicles to bid on selected value-added government proposals. To bolster our IT consulting capabilities in the federal marketplace about 150 professionals, including seven former partners of Andersen's Office of Government Services in Washington D.C., have joined Unisys in June. Given the opportunities that are opening up in the federal marketplace, we saw this as a unique opportunity to bring on experienced, high-level consulting talent that enhances our capabilities as an end-to-end service provider to federal government agencies. We also continue to selectively bring on high-level consulting talent in our other industry practices on a worldwide basis. Over the past six months we have hired some 80 principals, practice heads and other experienced consultants into our systems integration business. This is part of our ongoing process of re-skilling our workforce through selective hiring and retraining, while reducing headcount in areas of under-utilisation or poor performance. Just to summarise what we are seeing in our services business. While the economic environment continues to present challenges, and these challenges are leading to order delays and lengthened decision cycles, we continue the improve the profit profile of this business. We remain optimistic about our opportunities in key areas such as business process outsourcing, managed network services and systems integration. Let us turn now to our technology business, and please refer to Chart 8 for an overview of that business. As I mentioned earlier, our technology business turned in a strong profit performance in the quarter despite what continues to be a very tough market for selling high-end enterprise servers. We are seeing two trends playing out in the technology market so far in 2002. With economic conditions uncertain organisations are spending selectively where they have to, mainly on maintaining their mission-critical infrastructure and making sure that they have the computing capacity and the performance needed to run their core applications. At the same time organisations remain reluctant to spend on new applications and initiatives and the serves for those projects. They remain reluctant without a clear, compelling and, ideally, short-term return on investment. This has resulted in some mixed trends in our technology business so far in 2002. On the positive side sales of our ClearPath systems have remained solid through the first half as our client base takes advantage of the increased price performance and the flexibility of our new ClearPath Plus models, based on a CMP architecture. In fact, for the first time in several quarters, we saw a year-over-year growth in ClearPath sales in the second quarter, and this enhanced our profit performance in technology in the quarter. I believe that credit must be given to the marketing programmes that we have been implementing to drive sales of our CMP-based ClearPath systems. ClearPath continues to be an extremely powerful, reliable and cost-efficient platform for running our clients' mission-critical applications. For instance, because these new models are based on the CMP architecture they can run the client's legacy applications in more or more partitions, with the flexibility of also running standard Intel- and Windows-based applications and other partitions. As a result, we are seeing our client base use these new models not only to refresh their legacy systems, but also as a platform to consolidate their existing servers and applications. About half of ClearPath sales have a consolidation element and many of these include both legacy and Windows partitions. We also continue to offer unique and powerful applications, such as our voice messaging system and insurance processing system, on a ClearPath platform. A customer considering these applications cares about functionality, and he cares about performance, which is enhanced by the ClearPath platform. As a result, we continue to sell these ClearPath based applications, not only to existing clients, but also to new clients. Turning now to Chart 9. While ClearPath held its own in the second quarter, sales of our ES7000 servers in 2002 have been below our expectations. While we continuing to receive high marks for our ES7000 technology, getting those high marks from clients, industry analysts and in benchmark testing, like many of our competitors we are finding it difficult to sell new technology in the current environment as clients defer spending on the rollout of leading-edge applications. Despite this we remain optimistic about the long-term potential of our ES7000 servers, and we continue to be aggressive in marketing the benefits of high performance Intel-based systems over proprietary Unix systems and commodity servers. At the end of the first quarter we initiated a series of joint marketing campaigns with Microsoft and leading independent software vendors to drive more sales of ES7000 servers. The campaigns include direct selling to targeted accounts, joint advertising, seminars and other activities to communicate and provide proof points about the advantages of this technology. We plan to extend our joint marketing campaigns into Europe in the third quarter. Our partnership with Microsoft remains very strong. In fact, last week Microsoft awarded Unisys its 2002 Global Services Partner of the Year Award for our work as Microsoft's lead partner in sales and support of high-end enterprise class Windows systems. What is most exciting about this award is that it came from Microsoft's regional field people, who ranked us above all their other partners, including companies like Cap Gemini, EDS and KPMG to mention a few. They did this for the value that we bring when engaging customers. In addition, we continue to roll out leading edge new models. Just this week we announced four new models of the ES7000 family, including systems running Intel's new Itanium 2 chip. We remain the technology leader in this market space, and we are committed to staying there. So, while it takes time for our marketing and sales effort to bear fruit, particularly in the current environment, we believe that persistence will ultimately pay off in higher sales of the ES7000. Turning now turn our outlook going forward, please turn to Chart 10. Obviously, the current economic environment remains challenging, and we see no near term prospect for significant turnaround in worldwide IT spending trends. Despite this, we remain focused on delivering continued year-over-year growth in our earning, and we are going to do it by pursuing our value-added business strategy and keeping tight controls over costs. The third quarter tends to be the weakest for our technology business, particularly in Europe. We do not expect year-over-year growth in the third quarter in ClearPath revenue. However, in the third quarter of 2002 we look for earnings per share in the US$ 0.13 to US$ 0.18 range and revenue of about US$ 1.35 billion to US$ 1.40 billion. This EPS range represents a greater than 50% increase as compared to the earnings per share of the prior year. For 2002 overall we continue to look for about a 50% growth in our full year earnings per share, as compared to the US$ 0.48 we achieved in the year 2001, excluding the special items in that year. Finally, let me close my remarks with a few words about our corporate governance policies at Unisys. Obviously, there has been a great deal of focus in the markets these days on corporate governance and financial accounting issues. It seems every day we open the newspapers to a new revelation that adds to the current level of distrust in corporate America. Let me assure you and all of Unisys' stockholders that Unisys has operated and continues to operate with a strong corporate governance structure, and continues to use accounting policies that we believe fairly represent our financial position and results of operation. We support efforts by the New York Stock Exchange and other regulatory and governmental bodies to set stricter guidelines for US companies regarding the independence of board directors and key board committees. In fact, our corporate governance guidelines, which we have disclosed in our annual praxis statement since 1999, require a majority of our board of directors to be independent, and limit membership on our audit, nominating and corporate governance and compensation committees to outside directors. We invite our stockholders to read a summary of our corporate governance guidelines in the proxy or on our investor website. We also support New York Stock Exchange proposals that would require stockholder approval of all stock option plans, and for non-management directors to meet at regularly scheduled executive sessions without Unisys' management present. I speak for the board of directors and the entire Unisys executive management team in saying that we take our ethical and corporate governance responsibilities very seriously, and we will continue to manage the company in the best interest of our stakeholders. With that I would like to turn things over to Janet Haugen for more details on our financial results in the quarter.

Thank you Larry. Hello everyone. Like Larry I was pleased by our execution in the quarter. Despite the challenging economic environment we significantly increased our earnings over the prior year and met our financial targets for the quarter. In my remarks this afternoon I will expand on the operating results of the quarter and on our cash flows. Since Larry has already covered the operating performance for our two businesses, services and technology, let me provide a geographic perspective on orders and revenue. Please advance to Chart 11. Overall, we have continued delays in IT spending by customers. Our worldwide orders were down by low double digits for the quarter, primarily driven by order declines in the United States. International orders declined slightly as gains in Japan and South Pacific were offset by order declines in Europe and Asia. Our volume of pending proposals is at the highest level we have experienced in over a year. But, getting the proposal to an order continues to take a while. Our worldwide revenue was down by 7%, primarily driven by declines in North America, Europe and Latin America. Currency, for a change, had no overall impact on revenue in the quarter, as currency strengths in Europe were offset by currency weakness in Latin America. We expect the second half currency impact on revenue to be about 1-2 points favourable in the third and fourth quarters. Moving on to expenses, please turn to chart 12 for an overview of trends in the second quarter. As Larry mentioned, our SG&A expenses declined 11% in the quarter, benefiting from our continued focus on reducing expenses, including the cost reduction actions that we announced late last year and the continued focus on process improvement throughout our business. SG&A as a percentage of revenue was 18.1% in the quarter, compared to 18.9% of revenue in the second quarter of 2001. When the economy improves and good revenue growth returns we expect our SG&A as a percentage of revenue to be in the 17% range. We are on target with our headcount reduction plan, and we will complete the remaining reductions over the next several months. Our headcount at the end of the quarter was 37,000, down 1,900 from year-end. This number is net of new hires as well as the employees who joined us as part of our new outsourcing contract. Research and development expenditures in the second quarter were US$ 62 million, compared to US$ 75 million a year ago. The lower level of R&D reflects the changes we have made in our R&D processes to improve efficiencies, consolidate development initiatives in our systems integration business, and to make use of lower cost offshore development capabilities. We continue to invest in our high-end server technologies and in key solution programmes within our industry practices. Overall, research and development represented 4.6% of our revenue in the second quarter, and as a percent of our technology revenue our spending on technology R&D exceeds 10% of the technology revenue. Based on the lower operating expenses our company-wide operating profit margin more than doubled from a year ago to 7.1%. There are two other items regarding the income statement that I want to discuss. First, you will know that we incurred an 'Other Expense' of US$ 16 million in the quarter, compared to 'Other Income' of US$ 16 million in a year-ago quarter. This change was primarily driven by an equity loss from our Japanese joint venture, Nihon Unisys, Ltd. (NUL), compared to equity income in the year-ago period. As we communicated to you back in April, in the second quarter of 2002 we recorded US$ 22 million of costs relating to our share of NUL's recent early retirement programme. The second item I wanted to mention is pension income. Our pre-tax income in the second quarter of 2002 included US$ 34 million of pension income, which is down US$ 9 million from a year ago. Our 2002 pension income reflects a reduction in our actuarial assumption regarding the long-term rate or return on the US plan assets. 9.5% for 2002, down from 10% in 2001. Our average return on the US pension plan assets for the last ten years is 10%. During this ten year period there has been a wide spread in our returns, as high as 23% in 1995 and as low as a loss of 8% in 2001. In accordance with SFAS 87, the GAAP announcement covering pension expenses, the rate of return used for the actuarial valuation is the expected long-term average rate of return on pension assets. We have used a 10% assumption for the last 12 years. However, because of the market performance over the last year or so, we reduced our expected long-term average rate of return to 9.5% for 2002. As always, we will re-evaluate this rate in January when the rate for 2003 is determined. As a result we look for worldwide pension income to be about US$ 140 million in 2002, compared to US$ 170 million in 2001. Moving to the cash flow statement, please turn to Chart 13. We generated US$ 3 million of cash from operations in the second quarter of 2002, compared to an operational cash usage of US$ 14 million in the year-ago quarter. When comparing our net income to cash from operations I want to point out four major differences. First, obviously there is appreciation and amortisation. Second, pension income is a non-cash income item. Third, we spent US$ 32 million in the quarter related to prior restructuring charges. Lastly, we experienced our normal seasonal reduction in [tables] in the second quarter. Capital spending in the second quarter was US$ 102 million, which was US$ 16 million above the second quarter of 2001. We are continuing to increase our investment in revenue generating capital projects, particularly in outsourcing. We invested US$ 79 million in revenue generating capital in the second quarter. That is US$ 79 million of the US$ 102 million capital spending for the quarter. That compares to about US$ 53 million in the year-ago quarter. We continue to expect capital expenditures in the US$ 300 million to US$ 350 million range for 2002. where we end up in this range will depend upon economic conditions and the amount of new outsourcing revenue. Depreciation and amortisation was US$ 75 million in the second quarter, compared to US$ 70 million in the second quarter of 2001. For the full year of 2002 we continue to expect depreciation and amortisation to be around the US$ 300 million range. Short-term debt increased slightly in the quarter. However, we ended the quarter with no borrowings against our revolving credit facility. We had US$ 201 million of cash on hand at 30 June 2002, and our debt to capital ratio at the end of the quarter was 28%, which continues to be within our targeted range of 25-30% of debt to capital. For the full year we expect cash from operations at around US$ 150 million, which includes cash payments of approximately US$ 130 million to US$ 140 million for the restructuring actions, which were part of the fourth quarter charge. So, excluding the cash needed this year to fund the headcount reduction, our operations will produce about US$ 300 million in cash to fund a CAPEX to investment of US$ 300 million to US$ 350 million. In closing, we showed solid execution in the second quarter of 2002 despite the challenging business environment. We significantly grew our earnings from a year ago and achieved our earnings and revenue target. Our services business continues to show steady quarter-over-quarter margin improvement, and we are doing a good job containing costs. I am pleased by the tight discipline and focus we are showing throughout our operations. While business conditions remain tough, this discipline positions us well for continued profit improvement in the second half of 2002. Now I would like to turn the call back over to Jack.

Thank you Janet and Larry for that overview. Operator, we are now ready to open up for the questions.

[JOHN JONES]: Larry, can you review where your confidence level comes from regarding pick-up in outsourcing in the second half? And, would you comment on how hard you are stretched to get your operating expenses down to the level they are at?

As far as my confidence in outsourcing in the second half, we are presently involved in about a dozen or so large outsourcing deals - and for us large would be over US$ 100 million. As I mentioned in my remarks, we expect to win our fair share. You all can judge what the fair share is. We know we are not going to win them all, but we would certainly like to win a fair number. I have personally been involved in many of those proposals myself, so I feel reasonably optimistic. What I do not want to do is to say whether it is going to hit in the third quarter or in the fourth quarter, because in this environment we have seen that things seem to take a little longer to get the signatures done. Nevertheless, this is not youthful enthusiasm. I do feel that we do have enough things in the works, so that is where my confidence comes. On operating expenses, as you know, we have been working very hard over the last two years, going all the way back to September 2000 when we were one of the first companies to say, 'hey, let us see what is going on with technology, and what is the next year going to look like.' We never knew it was going to be two years, but we certainly raised the question. We started way back then looking at all our expenses. We have done a tremendous job in taking out lots of general administrative expenses. When you think about what we have done in the company, we walked away from over US$ 1 billion in revenue because we have given up lots of commodity kinds of things that the company was doing. That forced us to take out a couple of hundred million or more of SG&A and overhead cost just to stay even, because even though we were not making money on this it was absorbing a certain amount of overhead. So, we have been at this for two years. We have worked very hard in the systems integration and services business to make sure that we have developed the right kind of leverage within the pyramids in the business, that we are getting the levels of chargeable time that we need, and that we are right-sizing the portfolio and the people. More importantly, we are going after those jobs where we can make a profit. We have been very tough on whether we are going to propose on work just to say that we have some work, as opposed to having the margins. Because of that I think we have been able to for six quarters now to forecast three months in advance what our EPS would be. It is a little harder to figure out what your revenue is going to be, but we can forecast what our EPS is going to be, and we have delivered every quarter for the last six quarters. [DON YOUNG]: An accounting question. I was wondering why the pensions benefit to pre-tax is not paralleling the pre-paid pension cost on the balance sheet. I always thought those should be relatively similar. It almost looks like the balance sheet is indicating a greater benefit from the pension side.

With regard to the pension income, we have a number of pension plans around the world and there is a portion of the pension assets in the pre-paid pension and some that is in the liability. The net change in those accounts is the pensions income adjustment that you see and that we have discussed for the year. We would be happy to give you a schedule supplementary to walk you through that. [DON YOUNG]: If I could ask a question, Larry, on the ES7000. It seems like we have had a couple of years now where the products has gotten rave reviews, but it has not been sold. What do you think is necessary to get the product more adoption in the marketplace? I get the sense that you are frustrated, but I do not get the sense that there is a clear answer to move that product in higher volumes.

Well, you are right, I am frustrated. We came out with some, I believe, excellent technology, and we brought it to market unbeknownst to what was at the time the wrong time. We brought it at a time when people were not opening their pocketbooks for new capital expenditures in technology. What I really think needs to happen is that the pocketbooks have to open, capital expenditures have to increase. We continue to sell not at the level we would like to sell these at. We continue to get rave reviews, but we, like everybody, are just not seeing the interest in developing new systems, and because the ES7000 is new technology it would typically be new systems as opposed to legacy systems. As I mentioned, with ClearPath, if you look at the quarter, we were actually up year-over-year in ClearPath sales in the second quarter. That is more legacy driven than is the ES7000, which is new application driven. [DON YOUNG]: Do you see any repetitive solutions that [said] well with the ES7000 that you can package?

There are some, but what we have done in order to protect our investment, if you will, in the ES7000 is that, when we saw what was happening in the marketplace we pushed very hard in server consolidation. We have done a very good job in getting companies to look at the ES7000 as a way to save money in server consolidation. I do not remember offhand the percentage, but I would say that probably half or so of our sales have a server consolidation attribute to the application that the customer is using. But, as far picking a single application, what we have done at this point is that we are working very closely with Microsoft, because we do think that we are they only player at the present time, although we think there will probably be one other player or maybe more in the very high end Windows data centre environment. Yet, at the same time we actually have some people who are running Linux on the ES7000. That is relatively new to us. We have not promoted it from a Linux standpoint, because it is very high end, but we do see people running that application. So, we still have our fingers crossed. We think the technology is good enough and the investment we have made is reaping benefits, because, as you know, we also have moved our ClearPath Plus onto the CMP architecture. So, it was not just an investment in ES7000. It is really a single platform now that goes across everything we do.

Looking at the services gross margin performance and operating margin performance you have great [inaudible]. How much further improvement is left there without the benefit of improved IT spending? Looking at the technology, can you give us some further insight to the strength that you seeing in the new CMP line and how long that might be [inaudible]?

When you look at the service business, we kind of hit the bottom in the beginning of 2001. I committed at that time that we would make the changes that were required in order for us to rescale to make sure that we had the right configuration and people, and that we would not accept some of this low margin kind of work in order just to say that we have work. We have taken that margin a long way up to 5.8% in this quarter. We believe that even without major IT spending coming back in the short term you will see sequential improvement in the third and fourth quarters. We are not going to be happy until we can get that operating margin up to 10-12%. We give you both gross margin and operating margin. The reason why I say operating margin is that we really concentrate more on the operating margin, because if you look at the public sector the margins and the SG&A costs are different from what they are in the private sector. Instead of giving you a single gross margin number, we are shooting for the 10-12% across all of our services and we are not going to be satisfied until we can get there. Obviously, a strong market would make it happen faster, but even without a strong market, as I just said a moment ago, we will have continued sequential growth in the third and fourth quarters. As far as technology goes we had a very good quarter with CMP as I mentioned. The problem is that the third quarter is typically the toughest quarter for us and certainly the toughest quarter for us in technology. The main reason is that over 30% of our business and Europe pretty much closes down. A number of countries close down in August, some at the end of July or end of August. So, I made the comment that we do not expect to see year-over-year increases in revenues in CMP in the third quarter. Yet, when we look at the fourth quarter that is typically the strongest quarter, so we feel a little better about, if you look at the second half, that is going to be better. But, we will see a little pressure in the third quarter coming back in the fourth quarter. Again, we feel the product is good, we are seeing continued interest in the product and even in some of the applications that run on the product. Particularly in mortgage processing we are getting continued interest in the voice messaging product, because the telecommunications companies are at this point not spending a lot of money. They do look at our product. This is a combination of the services - the voice messaging service along with the hardware - as a revenue producer. Because it is a revenue producer, if they need the capacity they will spend. We hope that by the end of the year we are actually going to add a rather large new client in this area that will show that when you need something that is revenue producing, even in the tight time, you will spend the money. [STEVEN WEBBER]: In order to do the full year earnings number that you have put forth what kind of revenues do you need to accomplish in the fourth quarter? Separately, could you give us some feel for what your utilisation rate is on your people in your services business at this point?

First, I am not going to forecast revenue in the fourth quarter at this time. We are forecasting it quarter by quarter. But, when we look at the improvements that we have made in our operating expenses and look at the base of business that we have, which goes forward from quarter to quarter, we can feel pretty comfortable that the outlook of 50% improvement over last year's US$ 0.48 before the extraordinary item is doable and achievable. I do not want to give you a forecast for the fourth quarter revenue, but I will tell you that we do reaffirm the forecast that we made at the beginning of the year in January on our earnings for the year. As far as utilisation goes I will give you utilisation statistics. But, first I have to share with you my view that utilisation is something that is of interest to everyone, but it is only one piece of creating the operating margins that you need in the services business. Utilisation is one piece, rate realisation is another, leverage is a third, and really the skilling of the people is the fourth. Seeing how asked utilisation.... [STEVEN WEBBER]: I would not mind asking all of them.

I am only going to give you the one you asked for, because I do not want to take up the time for everyone else to speak. For utilisation we are running right now in the low 70s. A year ago we would have been slightly behind that. So, we have picked up a few points in utilisation year-to-year. I think what has happened is that it is not utilisation per se. As we have brought on these new people with better skills in the systems integration work and the services work we are getting better efficiency out of the hours that are put in, as opposed to having the hours put in before and not getting the same efficiency. We also less jobs that get in trouble when you have better skills base, so that the utilisation is again a more efficient utilisation. Those are some of the reasons why you are seeing better improvement. We realised that we had to go out and make an investment. In these tough times even last year when we had to do the thing none of us like to do, have a reduction in force, we also continued to go out and hire partner and principal kinds of people who can bring in a skill and understanding of how to create this new level of efficiency. There is no silver bullet. It is not just saying, 'get you efficiency and utilisation up to 75%, that will make the difference.' The real question is, 'you make it up to 75% - is the work getting done?' So, we have spent a lot of time on what I would call basic one-on-one - how do you manage a business. I think we have trained an awful lot of people here, so that it is not a single metric, but really looking at the inner play of all these different things and the ability to integrate them all, project by project. That is probably more than you wanted to know, but I did want to make sure that you appreciate that it is not simply getting utilisation 80% that is going to make the difference for us. Let me add one other thing, Steve. You are typically operating in a percentage of completion. What you find in a lot of cases is that you can have great utilisation, but the last 10% cost you 20% if you are not careful. So, what we are trying to do is mange to process so that the last 10% cost us 8% or maybe 10%, but not 20%. [JULIO QUINTERROS]: On the composition of bookings, maybe for the expectations that you have for the bookings that are supposed to come on-line in the second half of the year, can you just talk a little bit about the mix - is it obviously more weighted towards BPO network or some of the other areas that you are looking at there?

The main focus that we have is on business process outsourcing. We are not chasing anything in ITO. That does not mean we will not take it on if it is strategic or makes sense for us to take it on, but we are basically going after BPO kinds of work. We are also going after network infrastructure and there is a lot of work right now in the federal government space that we proposing on, and there is a lot of work outside the United States in the same area. Those are the two areas that we are really concentrating on. We are not trying to go after these very large ITO. We would not, for example, go after a Procter & Gamble type of deal or something of that nature. [JULIO QUITERROS]: Maybe this is more qualitative than quantitative, but of the 12 deals that are in the pipeline with a value of US$ 100 million or more, can you give us some sense of how many of those deals are running over 100 days, say, as far as the proposals have been outstanding, or maybe over 200 days? If you could give us some sense on that.

I am going to hip shoot a little when I give this to you. They are all over 100 days. I cannot answer that one, but I can tell you that nothing of this nature or this size will get done in three months or a hundred days. We are seeing longer and longer timeframes. [JULIO QUINTERROS]: That was the point I just wanted to try a confirm here, because that is what we have been hearing as well.

The other point here is that it is very important when you look at these, as I mentioned in my remarks, that there are two kinds of outsourcing deals. There is the pure price, and people who want to play in the pure price eventually have a high risk of getting burned. Those who want to play in the value, it take a lot longer, because there is a lot more due diligence and work to prove value to make sure that the client understand that there truly is value and what that value is. So, when I made those comments I was trying to make the distinction that we are trying to stay out of the 'burn' business. We do not want to get ourselves into a situation where you take something on and you have not done the right kind of due diligence. So, we have been very careful and very cautious. That does not mean we could not make a mistake and take on something we thought was value, which the client thought was price. We are doing the necessary due diligence. It is a long way off telling you that nothing will get done in three or four months on these large outsourcing deals. They all run longer - I just cannot give you the actual breakout. We have a mindset that six months or more is probably what it takes, from the initial talking to the client to the time that they make a decision. [JULIO QUINTERROS]: Finally, in your comments you mentioned offshore capabilities, or at least looking at that as part of the R&D for you. Can you talk a little bit about what you are think about there?

Janet actually mentioned that when you look at our R&D, which went from US$ 75 million to US$ 62 million in a quarter, it is not because we have decided that our R&D is not good or that we are cutting back on our R&D. As a matter of fact, as Janet mentioned, in our technology business over 10% of every dollar of sales goes into R&D. What we have done in all of the application development, operating system development and so forth is that we were operating more in a decentralised basis. We have hired someone about six months ago who had very good capability in bringing it all together. We now have it under one roof, so to speak. We have gone through India and have made some arrangements there to have some of the work done at a lower price. We are beginning to see some benefits. We hope that over the course of the next 18 months we will see a lot more benefits coming through. Again, it does not mean that we are giving up on R&D, we are just arbitraging the difference in salary levels so that we can get the same quality, yet do it at a cheaper price. [JULIO QUINTERROS]: You are not setting up your own application centre in India?

We looked at doing this thing and decided, given all the history of companies that have been there and done different things, we are much better off partnering with a couple of parties and being in a position to have enough comfort that we can get delivery. We think start-off at this stage would be very difficult. [JULIO QUINTERROS]: Finally, for Janet, would you mind repeating the CAPEX projection and the D&A projections for the second half of the year and possibly for 2003?

I did not give the projection for '03 for CAPEX, but I will repeat the projection I gave you for '02. we said that the CAPEX projection is in the US$ 300 million to US$ 350 million range for the full year. The level where we are at depends upon the altering winds and whether the economy picks up. The depreciation is in the US$ 300 million range for the whole year.

That ends the call today. I would like to thank everyone for joining us, and Larry can give some final or closing comments.

I would like to thank everyone for listening to us and giving us a chance to tell our story. You hear from us, our competitors and everyone in the IT market that this is one tough market. We all recognise that this is a tough market. But, as I said a few minutes ago, we actually looked in our own crystal ball almost a couple of years ago now, certainly 21 months ago, and realised that we had to do some very, very strategic things. We cut out all of the commodity stuff because we could not make money, we had to do some downsizing, we cut back on cost, we resized our whole cost structure, and frankly it is paying off and will pay off as we go forward. So, although I would love to see runaway revenue growth again, it may be another quarter or two or three or four - I am not smart enough to tell you what quarter. I do know that this is a company that has its operations under control, and we feel very comfortable with that. So, I leave you with the message that when the economy turns around we are going to be very well positioned. Thanks.

Thank you all for your participation. That does conclude your teleconference. You may disconnect your lines at this time. Thank you.